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TAM S.A. 6-K 2007 SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 6-K
REPORT OF FOREIGN ISSUER
PURSUANT TO RULE 13a-16 OR 15d-16 OF THE SECURITIES EXCHANGE ACT OF 1934
THROUGH August 29, 2007
(Commission File No. 1-32826) TAM S.A.
(Exact name of Registrant
as specified in its Charter)
Av. Jurandir, 856 – Lote 4, 1° andar
04072-000 São Paulo, São Paulo Federative Republic of Brazil (Address of Regristrant's principal executive offices)
Indicate by check mark whether the registrant files or will file
annual reports under cover Form 20-F or Form 40-F. Form 20-F ___X___ Form 40-F ______ Indicate by check mark whether the registrant by furnishing the
If "Yes" is marked, indicated below the file number assigned to the
registrant in connection with Rule 12g3-2(b):
TAM S.A. and
Interim condensed consolidated financial information
2
The accompanying notes are an integral part of these consolidated financial statements. 3
The accompanying notes are an integral part of the consolidated financial statements. 4
The accompanying notes are an integral part of the consolidated financial statements. 5
6
The accompanying notes are an integral part of the consolidated financial statements. 7
8
The accompanying notes are an integral part of the consolidated financial statements. 9
1 Operations TAM S.A. ("TAM'' or "Company'') was incorporated in 1997, to invest in companies which carry out air transportation activities. The Company's principal subsidiary, TAM Linhas Aéreas S.A. ("TLA''), operates in the transportation of passengers and cargo within Brazil and on international routes. In September, 2003, the Company acquired Transportes Aéreos del Mercosur S.A. ("Mercosur''), an airline headquartered in Asunción, Paraguay, which operates in Paraguay, Argentina, Brazil, Chile, Uruguay and Bolivia. In April 2007, TAM Capital Inc. (“TAM Capital”) and TAM Financial Services 1 Limited (“TAM Financial”) were constituted, wholly-owned subsidiaries TLA and both headquartered in Cayman Islands. The TLA quarterly financial information is based on the consolidation of its subsidiaries Fidelidade Viagens e Turismo Ltda. (“Fidelidade”) which operates as a travel and tourism agency under the name of TAM Viagens, TAM Capital and TAM Financial Services 1 Limited whose main activities involve aircraft acquisition and financing. On June 13, 2005 the Company concluded a public offering of its shares on the São Paulo Stock Exchange (“BOVESPA”), which raised funds for the acquisition/lease of narrow bodied aircraft (predominantly the Airbus A320), to renovate and expand its fleet, in line with its strategy to consolidate its leadership in the domestic market and further our participation in the international market. On July 15, 2005, the over-allotment option was exercised by underwriters of the public offering. With the same objective, on March 10, 2006 the Company made an additional Public Offering – this time on the BOVESPA and the New York Stock Exchange – NYSE, which was concluded on April 6, 2006, with the exercise of a supplementary lot of shares as permitted by the Preferential Share Distribution agreement. 2 Presentation of the interim financial information The interim financial information has been prepared in accordance with the accounting practices adopted in Brazil ("Brazilian GAAP'') which are based on:
The Company also utilizes the chart of accounts issued by the Civil Aviation National Agency (Agência Nacional de Aviação Civil, or "ANAC'') (formerly the Civil Aviation Department – DAC). The financial statements for the year ended December 31, 2006 and the financial information for the three and six months periods ended June 30, 2006 were adjusted by recognizing all financial instrument derivatives at their fair value, as described in the Note 21 (g). In accordance with CVM Deliberation n° 506/06, prior periods were restated. The Brazilian GAAP differs in significant aspects of U.S. GAAP. For information add regarding the differences between Brazilian GAAP and U.S. GAAP, and the reconciliation of the net profits and stockholders’ equity, see note 31. The Company presents its statement of cash flows as supplementary information. The statement of cash flows was prepared in accordance with the relevant IBRACON standard (which is similar to IAS 7, except for the definition of cash and cash equivalents), and reflects the main operations that affected the Company's cash and banks and financial investments. Cash and banks consist of highly liquid cash deposits and financial investments as described in Note 5. 10 However, in the Company’s opinion, the interim financial information presented herein includes all adjustments necessary for a fair presentation of the results for interim periods. The result of operations for the three and six month period ended June 30, 2007 is not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2007. 3 Significant accounting practices (a) Determination of results of operations Results of operations are determined on the accrual basis of accounting. Revenue is recognized, as follows: i. air transportation revenues (passengers and cargo) is recognized when transportation services are rendered; ii. tickets sold but not yet used related to advances ticket sales are registered as current liabilities; iii. revenue for unused tickets is recognized on the ticket expiration date, which is one year after the issuance date of the ticket; and iv. other operating revenues represented by fees arising from alterations to flight reservations, sub-lease of aircraft and other services are recognized when the service is provided. Other operating revenues also includes revenue from partnerships with the Fidelity program for frequent flyers ("TAM Loyalty Program'') which is recognized when the points are issued to participants. (b) Accounting estimates The preparation of consolidated interim financial information in conformity with Brazilian GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the interim financial information and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates are used for, but not limited to: the useful life of property, plant and equipment, allowance for doubtful accounts, allowance for inventories, deferred income tax assets, provision for contingencies and tax obligations under judicial dispute, valuation of derivative instruments, and assets and liabilities related to employees' benefits. (c) Foreign currency Monetary assets and liabilities denominated in foreign currencies were translated into reais at the foreign exchange rate ruling at the balance sheet date. Foreign exchange differences arising on translation are recognized in the statements of operations. 11 (d) Current and non-current • Financial investments The financial investments are initially recorded at acquisition cost and subsequently at market value. Investment funds are recorded at market value and are classified under financial investments under Brazilian GAAP. • Allowance for doubtful accounts receivable The allowance for doubtful accounts receivable is established in an amount considered sufficient by management to cover expected losses incurred in the collection of those credits. • Inventories Inventories, consisting of parts and materials to be used in maintenance and repair services, are stated at the average purchase cost, which is lower than replacement cost. Additionally, inventories are reduced by a provision for obsolete items, when applicable. • Advances for aircraft maintenance An advance for aircraft maintenance represents prepayment of maintenance to lessors under some of our operating lease agreements. As the Company presents proof of the performance of such maintenance, the related advances are reimbursed. • Goodwill and negative goodwill Goodwill related to the purchase of a minority interest in TLA, is based substantially on expected future profitability, and is being amortized over ten years, as from the date at which benefits are first generated. Upon consolidation the goodwill is reclassified to “Deferred charge” under Brazilian GAAP. Negative goodwill will be amortized upon the divestiture or write-off of this investment, and is recorded in the balance sheet as “Deferred income”. • Property, plant and equipment Property, plant and equipment are recorded at the cost of acquisition, formation or construction, plus annual revaluation of aircraft, flight equipment land and building to their fair market values. Depreciation is recorded using the straight-line method Note 11, and takes into account the estimated useful lives of assets. Maintenance expenses are recorded using the built-in overhauls method and is amortized through the next scheduled maintenance. Amortization of capitalized maintenance is recorded within cost of services rendered. • Other current receivables and long-term assets Other current receivables and long-term assets are presented at net realizable values. (e) Current and long-term liabilities Current and long-term liabilities are stated at the known or estimated amounts, including, when applicable, accrued indexation charges and exchange rate variations. 12 (f) Provisions Provisions are recognized when the Company has a legal or constituted obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are recorded considering the best estimates of the risk specific to the liability. (g) Advance ticket sales Advances from ticket sales represent the liabilities connected with tickets sold and not yet used in the last 12 months. Such amounts are recognized in income when the associated service is carried out or when the tickets expire. (h) Pension plan and benefits to employees TLA sponsors private defined contribution and defined benefit pension plans. In accordance with CVM Deliberation n° 371/00, the Company recognizes the actuarial liability, which was initially calculated in 2001, in the statements of operations, over a five year period until 2006. For subsequent periods, obligations are actuarially determined and accrued in the statement of operation. On November 21, 2006, the Supplementary Retirement Secretariat (the “SPC”) approved the proposal to migrate participants from the “defined benefits” plan to the “defined contribution” plan. (i) Income tax and social contribution Current and deferred income tax and social contribution are recorded based on composite statutory rates. Deferred tax loss carry forwards are recorded in accordance with CVM Instruction n° 371/02, and consider past profitability and expectations of future taxable income. Income tax and social contribution available for offset against tax payable are limited to 30% of annual taxable income in any single year. The Company also recognized deferred income tax and social contribution on temporary differences, including liabilities over the surplus generated by the revaluation of assets. (j) Leases • Finance lease Recorded in a specific account to reflect our liability in relation to lease contracts where the lessee holds a bargain purchase option to acquire the asset. • Operating lease Operating leases are all leases other than finance leases. Liabilities and the respective expenses of this type of lease are recognized as incurred. 13 (k) Financial instruments TLA contracts operations involving financial instruments with the objective of mitigating exposure to interest rate risk, exchange rate risk and fuel price variations. These risks are managed by defining operational strategies and establishing control systems. In the quarter ended March 31, 2007, the Company, pursuing on going improvements in best corporate governance practices and financial controls, changed its accounting practice and recognizing financial instruments under fair value market. For purposes of comparison, the balance sheet and income statements of previous period include here in have been restated to show the effects retroactively. (l) TAM Loyalty Program The Company sponsors a program (TAM Loyalty Program) to award frequent flyers, whereby points are accumulated from TAM flights or flights with partner airline companies, or upon making purchases using the TAM Loyalty Program credit card, or using the services and products of partner entities. On June 30, 2007, TLA's customers had earned points which had not been utilized. During the quarter ended at March 31, 2006 the Company, pursuing on-going improvements in best corporate governance practices and financial controls, changed its accounting practice and accrued a provision for future liabilities relating to the Loyalty Program. The effect of this change – in the amount of R$ 8,919 was recorded directly to stockholders' equity under retained earnings, net of the tax effect of R$ 4,597. The Company adopts the incremental cost method to recognize its obligation to honor the program benefits, by estimating total expenses of redeeming these tickets, taking into account the current average capacity levels of the flights and marginal cost, per passenger transported (basically insurance and catering). Revenue resulting from the TAM Loyalty Program partnerships, from credit cards, hotels, rental car and others are recorded when the points are issued to participants. 4 Consolidated Interim financial information The consolidated interim financial information included the interim financial information of TAM and its subsidiaries, as listed below:
14 Description of main consolidation procedures i. Elimination of intercompany asset and liability account balances; ii. Elimination of investment in the subsidiaries' capital, reserves and retained earnings; iii. Elimination of intercompany income and expense balances; iv. Identification of minority interests in subsidiaries; v. Additionally, the revaluation of Mercosur’s property, plant and equipment has been considered in the consolidated financial statement, in order to assure consistency with the Company’s accounting practices, without having adjusted the corporate books in the country of origin; and vi. The interim financial information of the company headquartered abroad (Mercosur) were translated into reais at the exchange rate at the balance sheet date. 5 Financial investments
Investment funds represent shares in exclusive funds, which principally include shares in money market funds, federal government securities, bank deposit certificates, debentures and may include derivatives related to such securities. 15 6 Customers accounts receivable (a) Composition of balances
(b) Change in the allowance for doubtful accounts
16 7 Inventories (a) Composition of balances
“Other inventories” is mainly composed of uniforms, stationary and catering items. (b) Change in provision for loss on realization of inventory The changes in provision for obsolete inventories are summarized as follows:
8 Advances to aircraft manufacturers At June 30, 2007, advances to aircraft manufactures (current and non-current) are represented by U.S. dollar denominated contractual prepayments, made to the manufacturer, of R$ 827,829 (December 31, 2006 - R$ 352,708), equivalent to US$ 429,773 thousand (December 31, 2006 – US$ 164,971 thousand). Of this amount, R$ 671,286 (December 31, 2006 – R$ 130,915) refers to aircraft which will be delivered in long-term. The advances are classified as current and non current assets, since TLA is guaranteed reimbursement of these amounts when the aircraft is leased by the manufacturer, or when the financing for the equipment is agreed. 17 9 Deposits in guarantee Deposits and collaterals in guarantee relating to the lease of aircraft and engines serve mainly to guarantee payments of operating lease installments. Such deposits and collaterals are denominated in U.S. dollars, and accrue interest based on the London Interbank Offered Rate ("LIBOR'') plus a spread of 1% per annum (p.a.). The terms for redemption are defined in the lease contracts. 10 Related-party transactions At June 30, 2007, TLA received from Táxi Aéreo Marília S.A. ("Marília"), a company under common control, R$ 284 and R$ 588 for the three and six periods ended June 2007 recorded as “cost of services rendered” (June 30, 2006 – R$ 279 and R$ 568), relating to services provided, such as the use of its importations area and aircraft insurance. TLA and TAM Marília agreed to share the utilization of the hangar located by the Congonhas airport, for a period of 10 years. TLA paid to TAM Marília R$ 15,500 and may use the facilities and the infra-structure of the hangar, providing the same cargo services, as those previously provided in the old cargo terminal. The total amount was established based on valuation reports performed by independent companies, reflecting the economic premium obtained by such a location in TLA cargo activities. The Company and its subsidiaries signed a contract on March, 2005 with TAM Milor Táxi Aéreo, Representações, Marcas e Patentes S.A. ("TAM Milor") for the right to use the "TAM" brand. This contract establishes a monthly fee, adjusted annually by IGPM, which totaled to R 3,637 and R$ 7,194 for the three and six periods ended at June 30, 2007 (2006 – R$ 3,550 and R$ 7,017), recorded as “Administrative expenses”. 11 Property, plant and equipment (a) Composition of balances
18 “Flight equipment” includes engines and spare parts, “Other” is mainly composed of improvements carried out on the runway at the São Carlos Technology Center. The liens (Note 12) on property, plant and equipment amounted to R$ 110,499 (December 31, 2006 – R 110,499). TLA has operational leasing agreements described at Note 14. (b) Revaluation (Note 21 (c)) TLA, updated its revaluation of aircraft engines and properties at November 30, 2006, based on an independent revaluation report issued by Engeval Engenharia de Avaliações S/C Ltda, which was approved at the Extraordinary Board Meeting held on December 29, 2006. This revaluation resulted in an increase in stockholders’ equity of R$ 9,541 or R$ 7,332 net of tax. The revaluation was based on the current fair market value of the assets. When applicable, new estimates of useful lives of these items were determined. Mercosur revalued its aircraft engines and property at November 30, 2006, based on an independent revaluation report. This revaluation resulted in a decrease in the Company’s stockholders’ equity, of R$ 601. The revaluation was based on the current fair market value of the assets. As required by CVM Deliberation n° 183/95, upon realization of the revaluation reserve R$ 840 and R$ 2,246 was appropriated to the “Retained earnings” in the three and six month periods ended June 30, 2007 (2006 – R$ 915 and R$ 1,830), respectively. 19 12 Short and long-term debt
20
FINIMP – Import Financing. Long-term amounts mature as follows:
On December 16, 2005, the Company signed a loan agreement contract with the International Finance Corporation – IFC – in the amount of US$ 50 million, US$ 33 million to be used for the financing of advances to aircraft manufacturers for future aircraft and US$ 17 million as working capital. In the six months ended June 30, 2006, the US$ 17 million working capital portion was drawn down. In the second semester of 2006, US$ 3.9 million was used for financing pre-payments to aircraft manufacturer. Liens on equipment and liens on accounts receivable have been offered to secure the loan. The Company is subject to covenants under its loan facilities such as financial ratios, limitation of issuance of new debt facilities and priority of prepayment of loans. As of June 30, 2007 the Company is in compliance with all of its covenants. 13 Leases Payable
21 Long term finance leases and operating lease liabilities mature as follows:
14 Commitments (a) Operating leases TLA has obligations arising from operating lease commitments. The obligations under these lease commitments are not reflected in the balance sheet because the contracts do not include purchase options for the aircraft subject to the lease agreements. These operating leases cover: 17 Fokkers-100, 15 Airbus A319, 61 Airbus A320, 10 Airbus A330 and 3 MD-11 (December 31, 2006 - 21 Fokkers-100, 14 Airbus A319, 50 Airbus A320 and 10 Airbus A330). These contracts are for average to 102 months and are denominated in north american dollar and LIBOR. The cost of aircraft leases, recognized in the consolidated statement of operations in “Costs of services rendered”, R$ 185,571 and R$ 405,159 for the three and six month periods ended June 30, 2007 (2006 – R$ 181,649 and R$ 343,798), respectively equivalent to US$ 93,638 thousand and US$ 198,102 thousand (2006 – US$ 83,146 thousand and US$ 156,792 thousand), respectively. In addition, to meet the payment conditions established by contract, the Company offered promissory notes guaranteed by TAM totaling at June 30, 2007 US$ 50,982 thousands (December 31, 2006 – US$ 60,943 thousands). Future disbursements due on these contracts (expressed for purpose of convenience in north americandollars, at the balance sheet exchange rates) are as follows: 22 Future disbursements due by year are as follows:
Long term finance leases and operating lease liabilities mature as follows:
(b) Commitments for future aircraft acquisition In 1998, TLA signed an agreement to purchase Airbus aircrafts. Out of this contract, TLA had at June 30, 2007, commitment to purchase 2 A320 aircrafts to be delivered through 2008. 23 In 2005, the Company signed an amendment to the contract with Airbus for the firm purchase of 20 Airbus A320 with an additional 20 options for the same aircraft family (including A319, A320 and A321), remaining 18, the delivery of the A320 family aircraft are scheduled up to 2010. In 2006 the Company finalized the contract to acquire a further 37 Airbus aircraft (15 A319, 16 A320 and 6 A330) for delivery by 2010. Also in 2006, the Company contracted the purchase of 4 new Boeing 777-300 ER with 4 options for the same aircraft. The Company and the Boeing had also signed a short leasing operation for 3 aircrafts MD-11, that will serve as a bridge lean until the delivery of the 4 B777-300 ER. In 2007, the Company announced the acquisition of four additional new Boeing 777-300 ERs. So, the Company has eight an agreement to purchase Boeing for this aircraft. On June 28, 2007, the Company also signed a Memorandum of Understanding signaling its intention to purchase 22 Airbus A350XWB models 800 and 900, with more 10 options; the A350 aircrafts will be delivered between 2013 and 2018. Additionally, the Company had confirmed the exercise of four options for Airbus A330, where two A330 will be delivered in 2010 and other two A330 will be delivered in 2011. The exercise of these four Airbus A330 is related to the agreement signed at the end of 2006. 15 Return of the Fokker 100 fleet As a result of the agreement to return of the Fokker 100 fleet, on December 19, 2003, TLA cancelled 19 lease contracts, of which ten were finance leases and nine were operating leases. These aircraft, as from the date of the renegotiated lease contracts up to their return, are under operating leases. TLA agreed to pay a contractual rescission penalty in 30 consecutive quarterly installments, between April 2004 and July 2011 in the original amount of R$ 94,188. This amount was recognized in the statement of operations in the year ended December 31, 2003. TLA also renegotiated the rescheduled overdue installments in the original amount of R$ 49,599. At June 30, 2007, the total commitment under the Fokker 100 fleet operating leases arrangements amounted to R$ 59,363 (December 31, 2006 – R$ 74,619), equivalent to US$ 30,819 thousand (December 31, 2006 – US$ 34,901 thousand), of which R$ 8,494 (December 31, 2006 – R$ 11,813) is classified in current liabilities. Non-current maturities have the following distribution:
24 16 Advanced ticket sales At June 30, 2007, the balance of advance ticket sales is represented by 2,623,582 (December 31, 2006 –2,263,942) ticket coupons sold but not yet used. 17 Provision for contingencies and judicial deposits Management of TLA and Mercosur recorded provisions for the estimated loss for amounts being disputed in court for those cases, as judged by the Company’s outside legal counsel, where loss to the Company is deemed probable, and for those amounts considered legal obligations under laws or decrees despite the Company’s questioning legislation. At June 30, 2007 the amount of provisions and corresponding deposits into court are summarized below:
(i) Corresponds to the discussion of the constitutionality of the change in the tax base of the PIS and the increase in the contribution and basis of calculation of COFINS, introduced under Law n° 9718/98. Judicial deposits were made for certain months, and others TLA is supported by judicial measures. These amounts, net of judicial deposits, are updated based on the SELIC. On November 9, 2005, the Supreme Federal Court ruled that the change in the tax base was unconstitutional. During the first quarter, the Company has been successful in obtaining favorable ruling on one process which has enabled the partial reversal of established provision in the amount of R$ 7,560, where R$ 3,496 has been from administrative expenses and R$ 4,064 from financial expenses. At June 30, 2007, seven processes are yet to be judged. (ii) Corresponds to the collection of 1% on the amount of fares of all tickets sold for regular domestic routes which are not supplemented. TLA management, based on the opinion of its outside legal counsel, is contesting the constitutionality of this collection, and non-payment is supported by a judicial order. 25 (iii) Corresponds to the collection of 2.5% on the payroll for on the payroll for private social service and professional formation entities. TLA management, based on the opinion of its outside legal counsel, is contesting the constitutionality of this collection, and the non-payment is supported by a judicial order. (iv) On March 31, 2007 judicial deposits have a value in excess of the contingency provision because of judicial withholding orders and judicial deposits for contingencies not included within the provision which is recorded in accordance with the CVM’s Orientation n° 15/87. The changes in provision for contingencies and tax obligations under judicial dispute are summarized as follows:
The Company and its subsidiaries are involved in other contingencies involving fiscal, labor and civil claims in the amount of R$ 396,426 at June 30, 2007 (December 31, 2006 - R$ 292,242). Based on the opinion of its legal counsel, the Company believes that the chances of success for the remaining amounts are probable and therefore, no provision has been recorded. 18 Debentures The outstanding balance per issue is set out below:
26 TAM On July 7, 2006 Board of Directors approved the issue for public distribution of nominative, non-convertible debentures with no guarantee or preference but for provided by TLA. The debentures have a nominal value of R$ 10,000 and a term of six years, the repayment terms call for three successive, equal, annual payments the first of which falls due on August 1, 2010. Interest is to be paid every six months at a rate equivalent to 104.5% of the CDI as calculated and published by CETIP – the custodian and liquidation chamber. TLA At the Extraordinary General Meeting held on April 7, 2003 stockholders approved the private issuance of non-convertible debentures, without the issuance of warrants or certificates, with nominal value of R$ 100.00 each. These debentures have already been placed in three series. Each series falls due 60 months after the subscription date. Debentures are guaranteed by a pledge of credit rights, and interest is 4.75% per annum plus Long-Term Interest Rate (TJLP). The guarantee offered corresponds to the cash balance deposited by travel agents and held at Bank Boston Banco Multiplo S.A. (Itaú), on each 24th day of the month, in amounts considered sufficient to settle the monthly installments. 19 Senior notes On April 25, 2007, TAM Capital Inc., has issued 7.375% US$ 300 million senior guaranted notes due 2017 (“Notes”) in a transaction under the United State Securities Act of 1933, as amended. At June 30, 2007, the outstanding amount of the Notes was R$ 585,673, equivalent to US$ 304,056 thousand, including R$ 7,813 of interest accrued classified as current liabilities. 27 20 Income tax and Social Contribution (a) Reconciliation between nominal and effective income and social contribution taxes
(b) Composition deferred income tax and social contribution assets
The temporary differences are basically related to contingency provisions, allowance for doubtful accounts and exchange variations. Income tax losses and negative basis of social contribution carry forwards do not expire. (c) Deferred income tax and social contribution tax liabilities As prescribed by CVM Deliberation 273/98, the revaluation reserve recorded by TLA at June 30, 2007 is net of income and social contribution charges of R$ 55,222 (December 31, 2006 – R$ 56,306). 28 21 Shareholder’s equity (a) Capital As at June 30, 2007, subscribed and paid-in capital is comprised of 150,563,341 shares (December 31, 2006 – 150,563,341), of which 59,791,955 are common shares (December 31, 2006 – 59,791,955) and 90,771,386 are preferred shares (December 31, 2006 – 90,771,386). Authorized capital amounts to R$ 1,200,000 (December 31, 2006 – R$ 1,200,000) and can be increased upon issuance of common and preferred share with the Board of Directors’ approval. At June 30, 2007 the Company did not hold any shares in treasury. Common share confer to its bearer the right to vote in general meetings. The preferred shares do not have the right to vote in general meetings, except in limited matters, however, they have priority in the distribution of dividends, priority in capital reimbursement, without any premium, in the event the Company is liquidated and the right to participate, under the same terms as the common shares, in the distribution of any benefits to the stockholders. On June 13, 2005 the Board of Directors approved the primary public offering of 21,133,000 preferred shares issued by the Company and the secondary offering of 9,057,000 preferred shares. The price of the primary offering of preferred shares was R$ 18.00 per share. In July, 2005, as a result of the exercise of the over-allotment option under the preferred shares distribution agreement related to the June 2005 public offering of shares, the Company issued 197,120 preferred shares at the price of R$18.00 per share. The over-allotment option was approved by the Company. On March 10, 2006 the Board of Directors approved the global offering of 5,000,000 preferred shares issued by the Company and the secondary offering of 30,618,098 preferred shares. The price of the primary offering of preferred shares was R$ 42.00. In April, 2006, as a result of the exercise of the over-allotment option under the preferred shares distribution agreement related to the March 2006 public offering of shares, the Company issued 1,503,879 preferred shares at the price of R$ 42.00 per share. The over-allotment option was approved by the Company. During 2006, the Company reached its BOVESPA Level 2 requirement to have a free float of 25% of its shares. Since April, 2006 the free float was 45.39% (unaudited). (b) Capital reserve – share premium account The premium on the subscription of shares is allocated to all stockholders equally. (c) Revaluation reserve (Note 11(b)) The amount realized is in proportion to the depreciation of the revalued assets and is transferred to the accumulated deficit for the three and six month periods ended at June 30, 2007, amounted to R$ 840 and R$ 2,246 (2006 – R$ 915 and R$ 1,830), respectively. Of the total reserve, R$ 35,948 (December 31, 2006 – R$ 35,948) corresponds to the revaluation of land, which will only be realized upon sale. 29 In accordance with CVM Instruction n° 197/93, the deferred tax charges on the revaluation reserve, which at June 30, 2007 amounted to R$ 55,222 (December 31, 2006 - R$ 56,306), are recognized in the statement of operations to the extent that the reserve is realized. (d) Dividends and interest on stockholders’ equity Pursuant to the Company's statutes, stockholders are assured a minimum dividend of 25% of adjusted net income for the year, after deducting 5% appropriated to the legal reserve, up to a maximum of 20% of capital. The preferred shares have priority in capital reimbursement and the right to a dividend at least equal to that distributed to the common shares. (e) Retained income reserve Article 196 of Corporation Law requires that the balance of net income after dividend distribution and other statutory appropriations is transferred to this reserve in order to finance the Company’s capital budget and working capital requirements. Future investments include the leasing of additional aircraft. (f) Stock option plan At the Extraordinary Stockholders' Meeting held on May 16, 2005, the stockholders approved the stock option plan. The maximum dilution effect to the Company's stockholders is 2% of outstanding shares, or 2,857,247 shares, for a share options to be granted to full time employees by the Board of Directors. Under the terms of the Plan, the options granted are divided into three equal amounts and employees may exercise one third of their options after three, four and five years, respectively, if still employed by the company at that time. The Board of Directors granted the release of 955,005 preferred shares to be used as options under the plan bellow:
(g) Prior period adjustment During the first quarter ended March 31, 2007, the Company, pursuing on-going improvements in best corporate governance practices and financial controls, changed its accounting practice and began to record derivative financial instruments at their fair value market. The previous accounting practice was to recognize derivative financial instruments at their amortized cost. The Company retrospectively applied this accounting practice to prior periods. The fair value of the derivatives at December 31, 2006 amounted to R$ 9,021 (R$ 5,954 net of the tax effect) and were recorded to "Others accounts payable "and "Retained earnings". For the three and six months periods ended June 30, 2006, the income statement effect of recording derivatives at fair market value was a benefit of R$ 55,436 and R$ 78,917 (R$ 36,588 and R$ 52,085 net of the tax effect), respectively. 30 22 Gross Sales Report The Company presents its gross sales information segmented by type of service rendered and geographic area: (a) By type of service rendered
(b) By region
31 23 Main costs and expenses (a) Three-month periods ended June 30:
32 (b) Six-month periods ended June 30:
33 24 Financial income and expense
25 Benefits to employees (a) Supplementary pension plan TLA sponsors three private pension plans TAM Prev I, II and III which supplement retirement benefits. On November 21, 2006, the Supplementary Retirement Secretariat (the “SPC”) approved the proposal to migrate participants from the TAM Prev I, II and III to a PGBL, a defined contribution plan. At June 30, 2007, there are still 5 participants which have not transferred into the PGBL. The sponsors contribution paid in the period ended June 30, 2007 amounted to R$ 5,968 (December 31, 2006 - R$ 2,905). The independent actuary’s evaluation, dated January 29, 2007, shows a pension asset of R$ 621, not included in the Company’s financial statements. Actuarial assumptions The Projected Unit Credit Method was applied by an independent actuary based on the following actuarial assumptions (nominal rates, including inflation): 34
(b) Profit sharing In accordance with the annual Union agreement, the Company will pay a share of its profits as a result of it reaching certain performance indicators established in line with the annual budget. Consequently, management recorded as “Salaries and payroll charges” at June 30, 2007, the provision for payment of this benefit in the amount of R$ 8,073 (June 30, 2006 – R$ 23,383). 26 Insurance coverage Our subsidiaries contract insurance coverage for amounts above the minimum mandatory levels deemed necessary in light of the nature of our assets and operational risks. Given the nature of the risk premises adopted, we do not revise these assessments quarterly and, accordingly, our independent auditors also do not review these assessments. At June 30, 2007, based on the aircraft fleet of TAM Linhas Aéreas S.A and Transportes Aéreos del Mercosur, our coverage for aviation activities (including both aircraft and civil liabilities) provided for maximum indemnification of US$ 1.5 billion. In addition, the Brazilian Government (through Law 10,744 of October 9, 2003 and Decree n° 5,035 of April 05, 2004) has committed to match civil liability damages payable to third parties that the Company may be required to pay as a result of war or terrorist attack. This law provides that the maximum liability of the Brazilian Government in respect of such matters is an amount in Reais equivalent to US$ 1 billion. The Company maintains insurance for the coverage of these risks and civil liabilities. Any payments for aircraft affected by such events would be covered by the insurance that we maintain. Our subsidiaries also maintain insurance coverage that provides for indemnification in respect of expenses arising from robbery, risk, fire, flooding, electrical damage or other similar events affecting our facilities, vehicles or other property. On July 17, 2007, TAM flight 3054 from Porto Alegre to São Paulo — Congonhas had an accident during landing at Congonhas airport. We set out more information in relation to this accident under “Subsequent event” (Note 30). At the date of this report, the Company maintains insurance for the coverage for the risks, wich are expected to cover any obligations generated by this accident. 35 27 Discussion judicials (a) Value-Added Tax - ICMS i. On December 17, 2001 the Federal Supreme Court ruled that domestic and international air passenger transportation revenue, as well as international air cargo transportation revenue were no longer subject to ICMS. ICMS taxation on domestic air cargo transportation revenue is still due. Management recorded a provision at June 30, 2007 of R$ 7,673 (December 31, 2006 – R$ 7,467), in Taxes and tariffs payable. The installments due in more than one year at June 30, 2007 totaling R$ 157 (December 31, 2006 – R$ 171) are classified as long term liabilities under “Other liabilities”. ii. Collected of certain ICMS payments made from 1989 to 1994 were later ruled to have been unconstitutional. TLA has filled several suits, in different states of the country, to claim the amount paid in error. The Company will recognize the credits, estimated at approximately R$ 55,000 and corresponding indexation adjustments, when final recovery is assured. (b) Indemnification for losses on regulated fares TLA filed a lawsuit against the Federal Government demanding indemnity for losses arising in the period from 1988 to 1993, when the fares were regulated by the Federal Government. In April 1998, the lawsuit was ruled in the Company’s favor by lower court of the Federal Justice, and an indemnity of R$ 245 million was determined based on a calculation made by an expert. This amount is subject to delinquent interest since September 1993, and inflation adjustment since November 1994. The First Panel of Higher Court of Justice accepted the special appeal made by the Company determining that the Federal Court of Appeals judge the merit of the case without intervention from the Public Prosecutor. Management has not recognized in the interim financial information any amount for this indemnity and will do so only when the lawsuit is legally confirmed in its final instance. (c) Additional tariff “ATAERO” TLA filed a claim for anticipated custody addressing the legality of the additional amount to tariffs (ATAERO), which rate is 50% on the tariff amount. At June 30, 2007, the amount under discussion totaled R$ 477,000 (unaudited) (December 31, 2006 - R$ 430,000 (unaudited)), not recognized in the interim financial information. 28 Financial instruments (a) General considerations The Company enters into transactions involving financial instruments in order to reduce the exposure of its risks. In addition, temporary cash surpluses are applied in line with current treasury policies, which are continuously reviewed, besides minimizing the impact of fuel price volatility. The management of these financial instruments is made pursuant to operational strategies, pursuing liquidity, return and security. Management policy consists in monitoring contracted rates against current market rates. The Company does not invest in derivatives or any other high-risk assets of a speculative nature. The Company, in order to align its accounting practices with those of the U.S. GAAP, changed its criteria for recognizing financial instruments to fair value market. Changes in market value are included in the Company’s results of operations 36 (i) Risk from the price of fuel Airline companies are exposed to the volatility in fuel prices. Fuel represented for the three and six month periods ended at June 30, 2007 33.1% and 32.8% (2006 – 33.7% and 33.6%), respectively of cost of services rendered, commercial, sales and administrative expenses. At June 30, 2007, these operations, with maturity up to June, 2008 they are equivalent to approximately 3,060 thousand barrels (December 31, 2006 – 1,150 thousand barrels). (ii) Foreign exchange rate risk This risk is related to possible foreign exchange rates volatility, affecting the financial expense (or income) and the outstanding liabilities (or assets) balances indexed to a foreign currency. Part of this risk is mitigated given the fact that the Company operates overseas and revenues from these transactions are denominated in hard currency. The existing policy for hedging foreign exchange risk is to cover of hard currency cash flow (net) for the subsequent 12 months. At June 30, 2007 the period protected against the foreign exchange rate risk amounted to the following 3 months, based on scenarios and volatility. The Company contracts derivative financial operations, aimed mainly to protect its foreign currency exposure from fuel, engine maintenance services and financing related to its operational activities. On June 30, 2007, contracts with options, acquired to hedge risks with liabilities to suppliers and financing, amounted to R$ 273,520 - US$ 142,000 thousands (December 31, 2006 – R$ 1,137,416 – US$ 532,000 thousands) and have various maturity dates, up to December, 2007. (iii) Interest rate risk This risk arises from possible losses (or gains) as a result of fluctuations of the interest rates to which the Company’s liabilities and assets are linked. To minimize possible impacts from interest rate volatility, the Company has adopted a policy of diversification, alternating between contracting fixed and variable rates (such as LIBOR and CDI), and periodically renegotiates its contracts, in order to adapt them to current market conditions. (iv) Credit risk Credit risk arises from the possibility of the Company not recovering amounts receivable from services provided to consumers and/or travel agencies, or from credits held by financial institutions generated for financial investment operations. To reduce this risk the Company has adopted the practice of establishing credit limits and permanently accompanying its debtor balance (mainly from travel agencies). With respect to marketable securities, the Company only invests with institutions with low credit risk as evaluated by rating agencies. In addition, each institution has a maximum limit for investments, as determined by the Company's Risk Committee. (b) Financial investments Represented by funds designed to invest in quotas of various classes of investment funds and/or in multimarket investment funds with the objective of obtaining an interest yield in excess of the Brazilian interbank interest rate – also known as DI. 37 (c) Investments TLA, Mercosur, TAM Capital e TAM Financial are non-public companies and, therefore, there is no information readily available to evaluate their fair market values. 29 Loyalty Program At June 30, 2007, the TAM Loyalty Program carried 2,159,845 (December 31, 2006 – 1,782,397 (unaudited)) one way domestic trip tickets earned by its clients but not redeemed. The Company currently records the incremental costs when awards are earned. For the three and six months ended at June 30, 2007, 237,569 and 444,919 (unaudited) (June 30, 2006 — 141,852 and 312,596 (unaudited)), respectively, free tickets were granted and used by our clients. The incremental costs of points earned under the Loyalty Program for the period ended June 30, 2007 was R$ 18,931 (December 31, 2006 - R$ 19,039) as recorded “Other liabilities” The base to calculate the incremental costs accrual is an estimative of the redemption for tickets by others airlines companies, quantity of points accumulated, tickets redeemed, estimation for expired points, non-redeemed accumulated points and valued by the incremental costs of service on board, fuel, insurance and boarding pass. The points earned by our clients from the TAM Loyalty Program are valid for two years for the redemption into tickets. This limits any growth in the liability from the program, which has tended to stabilize in relation to the number of passengers transported. 30 Subsequent events (i) On July 17, 2007, TAM flight 3054 from Porto Alegre to São Paulo—Congonhas had an accident during landing at Congonhas airport. There were no survivors among the 163 passengers, 18 TAM employees and six crew members on board the aircraft. There were additional fatalities in a TAM Express facility into which the aircraft collided. The Company immediate priority following the accident was to provide assistance to the families of the victims and also dedicate to ensuring that there is a continuous flow of relevant information to the public. The steps Company has taken since the accident includes:
The Company is following Brazilian regulation IAC 200-1001 on Family Assistance and other national rules regarding the investigation of this accident. 38 The Company is fully cooperating with all regulatory and investigative authorities to determine the cause of this accident. Presently, the Company does not have sufficient information to estimate the amount of potential claims relating to this accident. The Company maintains insurance for the coverage for such risks, wich are expected to cover any obligations generated by this accident. (ii) On August 1, 2007 the Board of Directors’ announced, in respect and honor of the victims of the accident flight 3054, respective family members and our employees, the decision to donate the land utilized before by the Cargo Terminal – TAM Express, located at Av. Washington Luis, to the city of São Paulo, with the intention of providing the location for a Memorial to remind the accident victims. Considering that part of the building was given as part of the guarantees linked to a financial loan, the donation is conditioned to the approval of the financial institution involved. 31 Summary of the Principal Differences between Brazilian GAAP and U.S. GAAP (a) Description of the GAAP differences The accountings practices of the Company are in accordance with Brazilian GAAP (Note 3) with differ significantly from U.S. GAAP, as are summarized below. (b) Supplementary inflation restatement in 1996 and 1997 for U.S. GAAP Brazilian GAAP discontinued inflation accounting effective January 1, 1996, Brazilian GAAP statements included indexation adjustments which partially accounted for the effects of inflation on property, plant and equipment, investments, deferred charges (together, denominated Permanent assets) and stockholders' equity, which reported the net charge or credit in the statement of operations. However, under U.S. GAAP, Brazil ceased to be treated as a highly inflationary economy only from January 1, 1998. Therefore the financial information for purposes of U.S. GAAP include additional inflation restatement adjustments in 1996 and 1997, made by applying the General Price Index - Internal Availability (“IGP-DI”) to the Company permanent assets and stockholders' equity. The IGP-DI index increased by 9.3% in 1996 and by 7.5% in 1997. For purposes of the reconciliation, stockholders' equity under U.S. GAAP was increased by R$ 34 (December 31, 2006 - R$ 68), due to the additional inflation restatement adjustments, net of depreciation. These amounts generate differences in depreciation charges of R$ 17 and R$ 34 for the three and six periods ended June, 2007 (2006 - R$ 22 and R$ 44), respectively. (c) Property, plant and equipment (i) Revaluation of property, plant and equipment Brazilian GAAP permits the revaluation of assets. The revaluation increment, net of deferred tax effects after 1991, is credited to a reserve account in stockholders' equity. Depreciation of the revaluation increments is charged to income and an offsetting amount is transferred from the revaluation reserve in stockholders' equity to retained earnings as the related assets are depreciated or upon disposal. Under U.S. GAAP, revaluation of property, plant and equipment is not accepted and the revaluation increments and related deferred tax effects have therefore been eliminated in order to present property, plant and equipment at historical cost less accumulated depreciation. Accordingly, the depreciation expense on revaluation has also been reversed in the statement of operations. For the purposes of the reconciliation, under U.S. GAAP the revaluation reserve was reversed, net of depreciation and deferred tax effects, totaling R$ 144,424 at June 30, 2007 (December 31, 2006 - R$ 147,874). In the statement of operations, 39 these effects totaled R$ 840 and R$ 2,246 for the three and six periods ended June 30, 2007 (2006 - R$ 915 and R$ 1,830), respectively. (ii) Lease agreements Brazilian GAAP does not have a specific requirement on accounting for leases and TAM recognizes as financial leases only contracts where the lessee has a bargain purchase option for the asset. All other leases are treated as operating leases. Under U.S. GAAP, Statement of Financial Accounting Standards ("SFAS") n° 13 "Accounting for Leases" defines financial leases as those leases that meet at least one of the following criteria:
Additionally, on renegotiation of lease terms, regardless as to whether the lessor is changed, the new lease is maintained as a financing lease by the lessee if under the amended lease terms, the lease would have been classified a finance lease either initially or at the renegotiation date. At June 30, 2007, TAM had 40 aircraft recorded as operating leases under Brazilian GAAP (Airbus A319 – 9 units, Airbus A320 – 15 units; Airbus A330 – 8 units and Fokker 100 – 8 units), which, considering the rule set out above, were considered as financial leases under U.S. GAAP because the present value of the minimum payments of these contracts exceed 90% of the fair value of the asset leased. Under U.S. GAAP, the acquisition cost of these aircraft and the related liability at the inception of the lease contract, totaling, at June 30, 2007, R$ 3,688,093, has been recorded in the balance sheet, while accumulated depreciation amounted to R$ 742,622. The asset is being depreciated over the estimated useful life of 25 years for the aircraft Airbus A319, Airbus A320 and Fokker 100 and 30 years for the aircraft Airbus A330. The obligations are recorded in short and long-term liabilities, including accrued interest and foreign exchange gains or losses. Depreciation expense on these aircraft recognized in the U.S. GAAP interim financial information totaled R$ 34,748 and R$ 67,893, for the three and six periods ended June 30, 2007 (2006 - R$ 33,485 and R$ 67,159), respectively. Foreign exchange gains (losses) on financial lease payables totaled R$ 135,679 and R$ 229,405 for the three and six periods ended June 30, 2007 (2006 - R$ 8,659 and R$ 199,158), respectively. Interest expenses on the financial lease obligation of theses aircraft totaled R$ 35,933 and R$ 69,416, for the three and six periods ended June 30, 2007 (2006 - R$ 30,280 and R$ 64,245), respectively. The operating lease expense recognized under Brazilian GAAP for these aircraft were reversed during all periods and totaled R$ 80,842 and R$ 178,156 for the three and six periods ended June 30, 2007 (2006 R$ 83,662 and R$ 167,249), respectively. The residual value of aircrafts returned have been written off upon return and totaled R$ 5,161 at June 30, 2007 (2006 - R$ 4,023). For reconciliation purposes, the accumulated effects in stockholders’ equity totaled R$ 870,545 at June 30, 2007 (December 31, 2006 – R$ 605,454). 40 Considering the aforementioned adjustments, the lease obligations under U.S. GAAP totaled:
The lease obligations above are secured by letters of credit issued by the Company. Long-term amounts mature as follows:
(iii) Impairment Under Brazilian GAAP, companies are required to determine if operating income is sufficient to absorb the depreciation or amortization of long-lived assets in order to assess potential asset impairment. In the event such operating income is insufficient to recover the depreciation, the assets, or groups of assets, are written-down to recoverable values, preferably based on the projected discounted cash flows of future operations. In the event of a planned substitution of assets prior to the end of the original estimated useful life of the asset, depreciation of such asset is accelerated to ensure the asset is depreciated according to estimated net realizable value at the estimated date of substitution. Under U.S. GAAP, SFAS n° 144 “Accounting for the Impairment or Disposal of Long-lived Assets”, requires companies to evaluate the carrying value of long-lived assets to be held and used, and for long-lived assets to be disposed of, when events and circumstances require such a review. The carrying value of long-lived assets is considered impaired when the anticipated undiscounted cash flow, representing the lowest level in which identifiable cash flow is less than their carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the assets or discounted cash flows generated by the assets. In the case of TAM, there were no impairment indicators and, therefore, no differences between U.S. GAAP and Brazilian 41 GAAP related to impairment provision criteria were recorded for the years presented. (iv) Gains on sale-leaseback Brazilian GAAP does not have specific requirements on sale-leaseback transactions. All gains arising from sale-leaseback transactions were recognized at the time of the transaction. Under U.S. GAAP, SFAS n° 28, "Accounting for Sales with Leaseback", establishes a sale-leaseback as a single financing transaction in which any profit or loss on the sale shall be deferred and amortized by the seller, who becomes the lease, in proportion to rental payments over the period of time the asset is expected to be used. This is obligatory even where the sale-lease-back transaction is considered legally perfect in the Company’s country of origin.
The amortization of gains on sale-leaseback transactions appropriated in the statements of operations for the three and six periods ended June 30, 2007, as “Financial income (expenses), net” totaled R$ 4,288 and R$ 8,576 (2006 - R$ 4,734 and R$ 10,364), respectively and as “Other operating expenses, net” totaled R$ 3,734 and R$ 7,467 (2006 - R$ 3,725 and R$ 7,428), respectively. For reconciliation of gains on sale-leaseback purposes, the effects in stockholders’ at June 30, 2007 totaled R$ 195,568 (December 31, 2006 – R$ 211,611). (i) In August 2001, TAM entered into an agreement which resulted in the termination of a financial lease for three Airbus A330 aircraft with one lessor and a new lease agreement, under operating lease provisions, with a different lessor for the same aircraft. For Brazilian GAAP purposes, TAM recognized a net gain of R$ 319,073 during 2001. This gain is being amortized over the period of the new lease contract, whose final liquidation is estimated to be in August 2013. (ii) In April 2003, TAM entered into an agreement which resulted in the termination of a financial lease agreement for four Airbus A320 aircraft with one lessor and a new lease agreement, under operating lease provisions, with a different lessor for the same aircraft. For Brazilian GAAP purposes, TAM did not recognize any gain, as this contract had already been recorded as an operating lease. Under U.S. GAAP, this transaction generated a deferred gain of R$ 54,957, as this contract was registered as a financial lease. This gain is being amortized in accordance with the operating lease contract, of which final liquidation is estimated to be in March 2013. (iii) Also, in December 2003, TAM reorganized its fleet of 19 Fokker 100 (Note 15), which resulted in the cancellation of 10 financial lease agreements and 9 operating lease agreements generating new operating lease agreements. For Brazilian GAAP purposes, TAM recognized a gain of R$ 76,815, which was recognized in the results for 2003. Under U.S. GAAP, this gain is being amortized in accordance with the aircraft return schedule, originally estimated to be completed in July 2005. In January 2005, an amendment was signed, postponing the return date of the last five aircraft until April 2006. In November 2006, another amendment to the contract was signed extending the timeframe for the return of the last 3 aircraft until May, 2007. The gain has been amortized through December 2006, because the impact of amortization through May 2007 is not relevant. The transactions summarized above were considered to be a modification of the provisions of the original contract under U.S. 42 GAAP. According to recently issued SFAS n° 145 "Rescission of FASB Statements n° 4, 44, and 64, Amendment of FASB Statement n° 13 and Technical Corrections", if the change in the lease provisions gives rise to a new agreement classified as an operating lease, the transaction shall be accounted for under the sale-leaseback requirements in accordance with paragraphs 2 and 3 of SFAS n° 28, mentioned above. (v) Sub-leasing of aircraft The Company sub-leased three Airbus A 330 aircraft and one engine under operating leases to other airline company. The contract matured in November 2006 and the aircrafts and engines had returned. (d) Deferred charges Brazilian GAAP permits deferral of leasehold improvements. Under U.S.GAAP, amounts related to leasehold improvements should be treated as additions to property, plant and equipment and reclassified for balance sheet disclosure purposes. As from the second quarter of 2006 such improvements were reclassified in the Brazilian GAAP financials to Property, plant & equipment and therefore the adjustment is no longer applicable. (e) Business combinations (i) Goodwill Under Brazilian GAAP, goodwill arises from the difference between the amount paid and the book value of the net assets acquired. This goodwill is normally attributed to the market value of assets acquired or justified based on expectation of future profitability and is amortized over the remaining useful lives of the assets or up to 10 years. Negative goodwill arises under Brazilian GAAP when the book value of assets acquired exceeds the purchase consideration; negative goodwill is not generally amortized. Under U.S. GAAP, fair values are assigned to acquired assets and liabilities in business combinations, including intangible assets and unallocated goodwill, applicable to each specific transaction. Upon the adoption of SFAS n° 142, “Goodwill and Other Intangible Assets”, as from January 1, 2002 goodwill is no longer amortized but, instead, is assigned to an entity's reporting units and tested for impairment at least annually. Additionally, according to the U.S. GAAP, goodwill generated in transactions under common control should not be recorded but, instead, the difference between amounts paid and book values of net assets acquired should be recorded as a capital contribution or distribution. The differences related to the Brazilian GAAP applicable to TAM derive mainly from (i) non-amortization of goodwill as from January 1, 2002 and (ii) non-recognition of negative goodwill arising from transactions of companies under common control, (Note 31 (e) (ii) below). For Brazilian GAAP purposes, the net balance of goodwill at June 30, 2007 was R$ 359 (December 31, 2006 - R$ 717), which is being amortized to income over a period of five to 10 years; negative goodwill at June 30, 2007 was R$ 11,099 (December 31, 2006 - R$ 11,099). For reconciliation purposes, amortization of goodwill as from January 1, 2003 was reversed, totaling R$ 179 and R$ 359 in the statement of operations for the three and six periods ended June 30, 2007 (2006 - R$ 179 and R$ 358), respectively. In stockholders’ equity, for reconciliation purposes these effects totaled R$ 9,321 at June 30, 2007 (December 31, 2006 – R$ 8,963). For U.S. GAAP purposes, the net balance of goodwill at June 30, 2007 is R$ 9,680 (December 31, 2006 - R$ 9,680). 43 (ii) Common control and negative goodwill – Mercosur For Brazilian GAAP purposes, TAM Mercosur was acquired and consolidated by the Company in September 2003 through an exchange of shares. For U.S. GAAP purposes, Mercosur has been considered under common control since 1996, because Mercosur has the same controlling stockholders as TAM and therefore, it was consolidated retroactively for all periods presented. The effects of the retroactively consolidation in the changes in stockholders’ equity have been recorded as additional paid-in capital. Additionally, in this transaction, the negative goodwill for Brazilian GAAP purposes was generated by the difference between book value and the amount paid in the transaction for the acquisition of Mercosur. As this transaction was considered to be under common control, for U.S. GAAP purposes the difference between the amount paid and the book value of Mercosur was recognized in stockholders’ equity as a capital contribution. Also, for Brazilian GAAP purposes, the effects of the exchange variation on this subsidiary’s stockholders’ equity are distributed among the lines of the statement of operations. For U.S. GAAP purposes, the effect of this exchange variation was recognized in stockholders’ equity in cumulative translation adjustments, in accordance with SFAS n° 52, “Foreign Currency Translation”. For reconciliation purposes, the effects described above totaled R$ 3,394 and R$ 2,374 for the three and six month periods ended June 30, 2007 (2006 - R$ (4,597) and R$ (4,265)), respectively and R$ 11,828 in stockholders equity at June 30, 2007 (December 31, 2006 – R$ 11,828). (f) Pension and other post-retirement benefits In determining the pension and other post-retirement benefit obligations for Brazilian GAAP purposes, NPC n° 26 is effective for financial statements ended from December 31, 2002. As permitted by the Standard, the transitional gain (being the difference between the plan net assets and the projected benefit obligation ("PBO")) at that date will be charged to income over five years. Under U.S. GAAP, SFAS n° 87 "Employer's Accounting for Pensions", is effective for fiscal years beginning after 1988. As from such dates, when an initial transition obligation determined based on an actuarial valuation was booked, actuarial gains and losses, as well as unexpected variations in plan assets and the PBO and the effects of amendments, settlements and other events, have been recognized in accordance with this standard and therefore results in deferral differences, Until 1997, these amounts were treated as non-monetary items and indexed by the inflation, the U.S. GAAP also requires the recognition of an additional minimum liability. Although the calculation of the sufficiency of the funded status has been the same since December 31, 2001, differences arise in (i) actuarial gains and losses, as initially there is no gain or actuarial loss on December 31, 2001, and (ii) recognition of the initial transition obligation and (iii) minimum liability, according to U.S. GAAP. On November 21, 2006, the Supplementary Retirement Secretariat (the “SPC”) approved the proposal to migrate participants from the TAM Prev I, II and III to a PGBL, a defined contribution plan. At June 30, 2007, there are still 5 participants (December 31, 2006 - 7 participants) which have not transferred into the PGBL. As the migration of the employees to PGBL represents an irrevocable action, relieving the Company of primary responsibility for the pension obligation and eliminated significant risks related to the obligation and assets of the plan (which have already been transferred to PGBL) the participants transferred have been accounted for as partial settlement in accordance with SFAS n° 88 "Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits”. The 5 participants not yet transferred to the PGBL had their benefits frozen in November 2006 and therefore have been accounted for as curtailment. 44 Based on the report of our independent actuary, the accumulated benefit obligation for the pension plan at June 30, 2007 totaled R$ 861 (December 31, 2006 – R$ 679). The appropriated effects in the statements of operations for the three and six periods ended June 30, 2007 totaled R$ 91 and R$ 182 (2006 - R$ 680 and R$ 1,360), respectively.
(g) Derivative instruments Under Brazilian GAAP, the Company recorded through December 31, 2006 its financial instruments based on contractual rates, recognized on the accrual basis of accounting. As from January 1, 2007, as discussed in Note 28, the Company changed its criteria for recognizing financial instruments under Brazilian GAAP to fair value market in a manner similar to U.S. GAAP. For purposes of comparison, the Company restated its Brazilian GAAP interim financial information of previous periods presented herein. Under U.S. GAAP, SFAS n° 133, as amended and interpreted, "Accounting for Derivative Instruments and Hedging Activities", requires that the Company recognizes all derivatives as assets or liabilities and measures these instruments to fair market value. Changes in market value are included in the Company’s results of operations. No derivative financial instrument of the Company qualified as hedges. Through December 31, 2006, for purposes of reconciliation, TAM recorded an adjustment to reflect the fair market value of derivative instruments under U.S. GAAP. As from January 1, 2007, TAM changed its criteria for recognizing financial instruments under Brazilian GAAP to fair value market in a manner similar to U.S.GAAP, and consequently the GAAP difference is no longer applicable. In addition, as the Company restated its Brazilian GAAP interim financial information of previous periods presented herein to reflect the he fair market value of derivative instruments, no adjustment is required for purposes of reconciliation for all periods presented. (h) Revenue recognition – Revenues from partners in the Loyalty Program Under Brazilian GAAP, revenues related partnership with Loyalty Program for frequent flyers are recorded when the points are issued to participants. Under U.S. GAAP, as from 2005, the Company is recognizing revenue earned from selling points into two components. The first component represents the revenue for air transportation sold, which are being valued at current market rate. This revenue is being deferred and recognized over the period the points are expected to be used. The second revenue component, represents the services deemed to have been provided associated with operating the program, which is being recognized when the points are sold. For reconciliation purposes, the Company deferred revenue for the periods ended June 30, 2007 totaling R$ 3,865 and R$ 9,270 (2006 – R$ 10,855 and R$ 15,007). The accumulated effect on stockholders´ equity at June 30, 2007 amounted to R$ 39,468 (December 31, 2006 – R$ 30,198). 45 (i) “Stock options plan” SFAS Statement 123(R) “Share Based Payment”, requires the measuring and recording of the cost of employee services in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). Awards granted with other than market condition, shall be classified as liability awards. That cost will be recognized over the period during which the employee is required to provide the service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. SFAS n° 123R requires entities to initially measure the cost of employee services received in exchange for an award of liability instruments based on its current fair value. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. The grant date fair value and the fair value of each reporting period of employee share options are estimated using the Black-Scholes option-pricing model. SFAS n° 123R is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. As described in further details below, the Company has granted options to certain employees to purchase stock at prices below market. The market value of the options granted will be recognized for U.S. GAAP purposes as expense over the period in which the services are rendered. The fair value of the options classified as liability award will be reassessed each reporting date. Under Brazilian GAAP the stock options do not generate any expense and are recorded as a capital increase only when exercised, in the amount of the exercise price paid. The Extraordinary Stockholders' Meeting held on May 16, 2005, the stockholders approved that a maximum of up to 2% of outstanding shares, or 2,857,247 shares, could be used for share options to be granted to full time employees by the Board of Directors’. Transactions are summarized as follows:
None of the options have been exercised nor cancelled during the periods presented. Under the terms of the Plan, the options granted are divided into three equal amounts and employees may exercise one third of their options after three, four and five years, respectively, if still employed by the company at that time. The options have a contractual term of 7 years. The options contain a “service condition” as vesting and exercisability of the options depending only on the rendering of a defined period of services by the employee. The dismissed employees have the obligation to satisfy conditions in order to maintain their options right. At each reporting period the fair value of the options granted are remeasured as well as the compensation cost and recognized for the options awarded. Stock options were granted initially with an exercise price of R$ 14.40 per share, for the first grant and R$ 43.48 for the second grant. The exercise price is adjusted by the IGPM (General Price Index), from the award date up to the date of the financial statements. 46 For Brazilian GAAP no value registered the expenses for the yielded options. Under U.S. GAAP, the Company accounts for participation in the Plan in accordance with FASB Statement n° 123(R) “Share Based Payment”, since 2005. Accordingly, as the plan is a classified as a liability award, compensation cost has been recognized as the fair value of the options at each reporting date. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
At June 30, 2007, the fair value of the stock options granted in 2005 and 2006 was R$ 51.61 and R$ 38.82, respectively per share resulting in a total fair value of options granted of R$ 36,917 and R$ 9,308, respectively. For U.S. GAAP purposes, the company registered expenses of R$ 5,347 and R$ 5,709 for the three and six periods ended June 30, 2007 (2006 - R$ 1,540 and R$ 3,076), with a corresponding credit to liabilities, considering that the exercise price is indexed to an inflation index (IGPM). This adjustment has no impact for purposes of deferred income tax and social contribution because such expense is a permanent difference. The appropriated effect in the shareholder’s equity at June 30, 2007 was R$ 15,877 (December 31, 2006 - R$ 10,168).
Such adjustment has no tax effects. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumption including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s option, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. (j) Loyalty Program Under Brazilian GAAP, at December 31, 2005, the incremental costs arising from the utilization of free tickets were expensed as incurred. As from 1st quarter 2006, the Company changed its practice and began to accrue future costs related to the utilization of accrued points (Note 3 (l)), thus eliminating this difference between Brazilian GAAP and U.S. GAAP. (k) Maintenance Under Brazilian GAAP, through December 31, 2005 the Company recorded maintenance expenses as incurred. As from January 1, 2006, in accordance with Technical Interpretation of IBRACON 01/2006, the Company changed its accounting policy under Brazilian GAAP to the built-in overhaul method 47 Under U.S. GAAP, the Company records maintenance expenses as incurred. For reconciliation purposes, the Company reversed the effects caused by the change in accounting policy under Brazilian GAAP in 2006. Accordingly, capitalized maintenance costs amounting to R$ 15,445 and the depreciation expenses recorded amounting to R$ 6,752 was reversed from stockholders’ equity. For reconciliation purposes, the Company for the three and six periods ended at June 30, 2007 was reversed depreciation expenses amounted to R$ 1,032 and R$ 129, respectively. The accumulated effect on stockholders´ equity at June 30, 2007 amounted to R$ 8,564 (December 31, 2006 – R$ 8,693). (l) Earnings per share Under Brazilian GAAP, net income (loss) per share is calculated on the number of shares outstanding at the balance sheet date. Information is disclosed per lot of one thousand shares because, generally, this is the minimum number of shares that can be traded on the Brazilian stock exchanges. Under U.S. GAAP, since the preferred and common stockholders have different voting and liquidation rights, basic and diluted earnings per share have been calculated using the "two-class" method, pursuant to SFAS n° 128, "Earnings per Share", which provides computation, presentation and disclosure requirements for earnings per share. The "two-class" method is an earnings allocation formula that determines earnings per share for preferred and common stock according to the dividends to be paid as required by the Company's by-laws and participation rights in undistributed earnings. Basic earnings per common share are computed by dividing net income by the weighted-average number of common and preferred shares outstanding during the period. Earnings may be capitalized used to absorb losses or otherwise appropriated; consequently, such earnings would no longer be available to be paid as dividends. Therefore, no assurance can be made that preferred stockholders will receive distributed earnings.
48
(m) Comprehensive income Under Brazilian GAAP, the concept of comprehensive income is not recognized. Under U.S. GAAP, SFAS n° 130, "Reporting Comprehensive Income", requires the disclosure of comprehensive income. Comprehensive income is comprised of net income/loss and "other comprehensive income" that include charges or credits directly to equity which are not the result of transactions with owners. In the case of TAM, components of comprehensive income are its net income or loss, changes in additional minimum pension liability (SFAS n° 158) and cumulative translation adjustments (Note 31 (q) (iii)). (n) Deferred income tax and social contribution Under Brazilian GAAP, deferred income tax recorded in assets represents the estimated amount to be recovered. Under U.S. GAAP, deferred taxes on all temporary tax differences are accrued. Deferred tax assets and liabilities are classified as current or long term, according to the classification of the asset or liability that originates the temporary difference. Deferred income tax assets and liabilities in the same tax jurisdiction are offset among themselves and are not presented at the net value. In addition for the purpose of reconciliation to U.S. GAAP, the benefits (expenses) of income tax related to U.S. GAAP adjustments were recognized. Together, these adjustments amounted to R$ (50,314) and R$ (94,857) for the three and six periods ended June 30, 2007 (2006 - R$ (7,764) and R$ (84,510)), respectively in the statements of operations. The aggregate net deferred tax assets reflected in the shareholder's equity at June 30, 2007 was R$ (224,109) (December 31, 2006 – R$ (129,253). No valuation allowance has been provided on the deferred tax assets because management believes that these benefits will, more likely than not, be realized. On January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation n° 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”). This interpretation prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties. As a result of the adoption of this interpretation, there has been no impact on the Company’s financials statements. 49 The Company files its tax returns as prescribed by the tax laws of the jurisdictions in which it operates. The Company’s income tax returns, tax and accounting records are subject to review by tax authorities with in variable prescribed periods form five to six years. TAM Mercosur, as prescribed by the legislation of its country of origin is subject to income tax directly on gross sales and carrying value are recognizing in the financial statements. (o) Classification of statement of operations line items Under Brazilian GAAP, the classification of certain income and expense items is presented differently from U.S. GAAP. The consolidated statement of operations under Brazilian GAAP has therefore been reclassified to present a condensed consolidated statement of operations in accordance with U.S. GAAP (Note 31 (r) (i)).The reclassifications, other than those disclosed above, are summarized as follows:
(p) Classification of balance sheet line items Under Brazilian GAAP, the classification of certain balance sheet items is presented differently from U.S. GAAP. The Company recast our consolidated balance sheet prepared in accordance with BR GAAP to present a condensed consolidated balance sheet in accordance with U.S. GAAP (Note 31 (r) (i). The reclassifications, other than those disclosed above, are summarized as follows:
50 (q) Reconciliation of the differences between BR GAAP and U.S. GAAP (i) Net income
51 (ii) Stockholders’ equity
(r) Condensed consolidated interim financial information under U.S. GAAP Based on the reconciliation items and description above, the condensed consolidated balance sheet, condensed consolidated statement of operations and condensed statement of changes in stockholders’ equity of TAM, under U.S. GAAP, were presented as follows: (i) Consolidated balance sheet under U.S. GAAP Based on the reconciliation items and description above, the condensed consolidated balance sheet, condensed consolidated statement of operations and condensed statement of changes in stockholders’ equity of TAM, under U.S. GAAP, are as follows: 52
53
54 (ii) Consolidated statement of operations under U.S. GAAP
55 (iii) Condensed statement of stockholders’ equity movement under U.S. GAAP
56 (iv) Consolidated statement of cash flow under U.S. GAAP
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58 (s) Business segments Under BR GAAP, no separate segment reporting is required. Under U.S. GAAP, SFAS 131 “Disclosures about Segments of an Enterprise and Related Information” defines operating segments as components of an enterprise for which separate financial information is available and evaluated regularly for assessing segment performance and allocating resources to segments. Measures of profit or loss, total assets and other related information are required to be disclosed for each operating segment. In addition, this standard requires the annual disclosure of information concerning revenues derived from the enterprise’s products or services, countries in which revenues or assets are generated and major customers. SFAS 131 requires that segment data be presented in the U.S. GAAP financial statements in accordance with the internal information that is used by management for operating decision making, including allocation of resources among segments, and segment performance. This information results from the statutory accounting records kept under U.S. GAAP and BR GAAP, the Company considers that it has only one reportable segment. (t) Additional disclosure – Advertising and publicity expenses Advertising and publicity expenses totaled R$ 11,116 and R$ 25,930 for the three and six periods ended June 30, 2007 (2006 – R$ 10,019 and R$ 17,493), respectively and are being classified as selling and marketing expenses. (u) Recently issued accounting pronouncements In September 2006, the FASB issued FAS 157, “Fair Value Measurement”, which clarifies and set up a framework for measuring fair value and expands disclosure about fair value measurement. The Company is currently evaluating the impact that the application of this new standard will have on its financial statements, as of January 1, 2008. In February, 2007, the FASB issued FAS 159 "The Fair Value Option for Financial Assets and Financial Liabilities" including an amendment of FASB Statement 115 "Accounting for Certain Investments in Debt and Equity Securities", permits the company to choose to measure many financial instruments and certain other items at fair value. The Company is currently evaluation the impact that the application of this new standard will have on its financial statements, as of 2007. 32 Consolidation schedules In accordance to rule S-X 3-10 the Company is presenting the consolidation schedules for the following entities: TAM S.A. (parent company and guarantor), TAM Linhas Aéreas S.A. (guarantor), TAM Mercosur, TAM Fidelidade, TAM Capital and TAM Financial (non guarantors). All U.S. GAAP adjustments presented in Note 31 are related to TAM Linhas Aéreas S.A., except for the adjustments (e) Business Combinations — (ii) Common control and negative goodwill — Mercosur, and (q) Classification of balance sheet items — Cost of public equity offering which relate to TAM S.A. Such adjustments are not significant for TAM S.A. 59 (i) Balance sheet
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63 (ii) Statement of Operations
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67 (iii) Statement of cash flows
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* * * 75 SIGNATURE
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: August 29, 2007
FORWARD-LOOKING
STATEMENTS
This press release may contain forward-looking statements. These statements are statements that are not historical facts, and are based on management's current view and estimates offuture economic circumstances, industry conditions, company performance and financial results. The words "anticipates", "believes", "estimates", "expects", "plans" and similar expressions, as they relate to the company, are intended to identify forward-looking statements. Statements regarding the declaration or payment of dividends, the implementation of principal operating and financing strategies and capital expenditure plans, the direction of future operations and the factors or trends affecting financial condition, liquidity or results of operations are examples of forward-looking statements. Such statements reflect the current views of management and are subject to a number of risks and uncertainties. There is no guarantee that the expected events, trends or results will actually occur. The statements are based on many assumptions and factors, including general economic and market conditions, industry conditions, and operating factors. Any changes in such assumptions or factors could cause actual results to differ materially from current expectations. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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