20-F 1 brfform20f2009.htm FORM 20-F brfform20f2009.htm - Provided by MZ Technologies

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20-F

¨            REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

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

For the fiscal year ended December 31, 2009

OR

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

OR

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

Commission file number 001-15148

BRF – BRASIL FOODS S.A.
(Exact Name of Registrant as Specified in its Charter)

N/A
(Translation of Registrant’s name into English)

Federative Republic of Brazil
(Jurisdiction of Incorporation or Organization)

760 Av. Escola Politécnica, Jaguaré 05350-901 São Paulo – SP, Brazil
(Address of principal executive offices)

Leopoldo Viriato Saboya, Chief Financial Officer and Investor Relations Officer
Tel. 011-5511-3718-5301, Fax 011-5511-5297
760 Av. Escola Politécnica, Jaguaré 05350-901 São Paulo — SP, Brazil

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

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Name of Each Exchange on
which Registered

Common Shares, no par value per share,
each represented by American Depositary Shares

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

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

None

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

At December 31, 2009

870,021,066 shares of common stock

 

 


 

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

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

Note- Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

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

Indicate by check mark whether the registrant was submitted electronically and posted on its corporate website, if any, every interactive data filed required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 203.405 of this chapter) during the preceding 12 months (or for such other period that the registrant was required to submit and post such files) Yes ¨  No ¨

Note: Not required for registrant.

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. (Check one):

Large accelerated filer  x

Accelerated filer ¨

Non-accelerated filer ¨

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

¨ U.S. GAAP

¨ International Financial Reporting Standards as issued by the International Accounting Standards Board

xOther

 

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 x.

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨  No x

 

 

 


 

 

  TABLE OF CONTENTS   
 
    Page 
 
PART I
 
 INTRODUCTION 
ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 
ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE 
ITEM 3.  KEY INFORMATION 
ITEM 4.  INFORMATION ON THE COMPANY  23 
ITEM 4A. UNRESOLVED STAFF COMMENTS   53 
ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS  54 
ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES  88 
ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS  96 
ITEM 8.  FINANCIAL INFORMATION  99 
ITEM 9.  THE OFFER AND LISTING  102 
ITEM 10.  ADDITIONAL INFORMATION  107 
ITEM 11.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  136 
ITEM 12.  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES  139 
 
PART II    139 
 
ITEM 13.  DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES  139 
ITEM 14.  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF   139 
  PROCEEDS  139 
ITEM 15.  CONTROLS AND PROCEDURES  139 
ITEM 16.  [RESERVED]  140 
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT  140 
ITEM 16B. CODE OF BUSINESS CONDUCT AND ETHICS  140 
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES  141 
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES  141 
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS  142 
ITEM 16F.   CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 142 
ITEM 16G. CORPORATE GOVERNANCE   142 
 
PART III    144 
 
ITEM 17.  FINANCIAL STATEMENTS  144 
ITEM 18.  FINANCIAL STATEMENTS  144 
ITEM 19.  EXHIBITS  144 
 
INDEX TO FINANCIAL STATEMENTS  

 

 

                                                                                                                                                                                                                                                                                               


PART I

INTRODUCTION

Unless otherwise indicated, all references herein (1) to “BRF – Brasil Foods” or “BRF” are references to BRF – Brasil Foods S.A. (formerly known as Perdigão S.A.), a corporation organized under the laws of the Federative Republic of Brazil (“Brazil”), and its consolidated subsidiaries, (2) to “Perdigão” are references to Perdigão S.A.,  a corporation organized under the laws of Brazil, which changed its name to BRF – Brasil Foods S.A. on July 8, 2009, and its consolidated subsidiaries, (3) to “Sadia” are references to Sadia S.A., a corporation organized under the laws of Brazil, and its consolidated subsidiaries, (4)  to the “Company,” “we,” “us,” or “our” are references to Perdigão prior to its business combination with Sadia and to BRF – Brasil Foods after such business combination, and (5) to “common shares” are references to the Company’s authorized and outstanding common stock, designated ordinary shares (ações ordinárias), each without par value. All references herein to the “real,” “reais” or “R$” are to the Brazilian real, the official currency of Brazil. All references to “U.S. dollars,” “dollars” or “U.S.$” are to United States dollars.

Overview

We are one of Brazil’s largest food companies, with a focus on the production and sale of poultry, pork, beef cuts, milk, dairy products and processed food products. We are a vertically integrated business that produces more than 3,000 stock-keeping units, or “SKUs,” which we distribute to customers in Brazil and in more than 140 other countries. Our products currently include:

•     frozen whole and cut chickens;

 

•     frozen pork cuts and beef cuts;

 

•     processed food products, such as the following:

 

•     marinated frozen whole and cut chickens, roosters (sold under the Chester® brand) and turkeys;

 

•     specialty meats, such as sausages, ham products, bologna, frankfurters, salamis, bacon and other smoked products;

 

•     frozen processed meats, such as hamburgers, steaks, breaded meat products, kibes and meatballs, and frozen processed vegetarian foods;

 

•     frozen prepared entrees, such as lasagnas and pizzas, as well as other frozen foods, including vegetables, cheese bread, pies and pastries;

 

•     dairy products, such as cheeses, powdered milk and yogurts;

 

•     juices, soy milk and soy juices; and

 

•     margarine;

 

•     milk; and

 

•     soy meal and refined soy flour, as well as animal feed.

 

In the year ended December 31, 2009, we generated 29.8% of our net sales from poultry, 8.8% from pork and beef, 13.6% from milk and dairy products, 44.7% from processed foods, and 3.1% from other products.

In the domestic market, which accounts for 59% of the Company’s total net sales, the Company operates under such brand names as Perdigão, Sadia, Chester, Batavo, Elegê, Rezende, Confiança, Wilson, Fiesta, Miss Daisy, Qualy, Doriana and Becel (through a strategic joint venture with Unilever) and Turma da Mônica (under license), which are among the most recognized names in Brazil. In its export markets, which take the remaining 41% of the Company’s output, the leading brands are Perdix, Sadia, Hilal, Halal, Corcovado, Batavo, Fazenda, Borella and Confidence.

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We are a leading producer in Brazil of specialty meats (market share of approximately 56.0% from January to December 2009), frozen processed meats (market share of approximately 70.3% from December 2008 to November 2009), dairy processed products (market share of approximately 12.8% from December 2008 to November 2009), pizzas (market share of approximately 67.3% from January 2009 to December 2009), pastas ( with market share of approximately 84.3% from December 2008 to November 2009) and margarines (market share of approximately 60.1% from January to December 2009), in each case based on sales volume, according to A.C. Nielsen do Brasil S.A., and after giving effect to our business combination with Sadia as if we had been a combined company for the full periods indicated. We also sell our frozen poultry, pork and beef products in the domestic market. We are able to reach substantially all of the Brazilian population through a nationwide network of 36 distribution centers. As of March 31, 2010, we operate 42 meat processing plants, 36 of which are owned (six are owned by third parties but process meat for us according to our management), 25 hatcheries of which 23 are owned, 23 animal feed mills, 14 dairy processing plants of which nine are owned (one is under construction) and five are owned by third parties, two margarine processing plants (one of them through a joint venture with Unilever), 13 milk collecting centers, one soybean processing plant and one pizza, pasta, dessert and industrialized processing plant.

We are the largest Brazilian exporter of poultry products, based on export sales volumes in 2009, according to the Brazilian Chicken Producers and Exporters Association (Associação Brasileira de Produtores e Exportadores de Frango), or “ABEF,” and are among the largest such exporters in the world. We are also the leading Brazilian exporter of pork products, based on export sales volumes in 2009, according to the Brazilian Pork Industry and Exporter Association (Associação Brasileira de Indústria Produtora e Exportadora de Carne Suína), or “ABIPECS.”  

We export primarily to distributors, the institutional market, which includes restaurants and food service chains, and to food processing companies. In 2009, our exports accounted for 41.1% of our total net sales. We export to more than 2,500 clients, with customers in Europe accounting for 25.2% of our export net sales in 2009; the Far East, 16.7%; Eurasia (including Russia), 9.4%; the Middle East, 32.7%; Americas, Africa and other regions, 16.0%. In the milk and dairy product sector of the food industry, we are a leader in sales of ultra-heat treatment, or “UHT,” milk in Brazil, with a 14.8% market share, based on volumes of sales from January 2009 to December 2009, according to A.C. Nielsen do Brasil S.A. As of December 2009, we had a 6.5% market share of the Brazilian production of powdered milk, according to the U.S. Department of Agriculture, or “USDA.”

 

On February 21, 2008, we completed the acquisition of Eleva Alimentos S.A., or “Eleva,” a Brazilian company in the food industry, with a focus on milk, dairy products, poultry, pork and processed food products, for a purchase price of approximately R$1.7 billion, of which R$764.6 million was paid in cash to the controlling and non-controlling shareholders of Eleva and R$911.6 million was paid through the exchange of shares of Eleva for shares of Perdigão. By acquiring Eleva, we expanded our portfolio of milk and dairy products, which also includes powdered milk and cheeses, and we expanded our production of chickens, pork and processed food products.

 

On April 2, 2008, we, through our subsidiary, Perdigão Agroindustrial S.A, acquired 100% of the share capital of Maroca e Russo Indústria e Comércio Ltda. (Cotochés), a regional leader in our industry in the State of Minas Gerais, for R$51.0 million and the assumption of R$15.0 million in debt.

 

Internationally, we also continued to grow through the acquisition of Plusfood Groep B.V., or “Plusfood,” a manufacturer of poultry and beef-based processed and convenience food products in the European market, which has enabled us to diversify our operations in Europe into processed and chilled products. On January 2, 2008, we, through our subsidiary Perdigão Holland BV, acquired 100% of the shares of Plusfood from Cebeco Groep BV (“Cebeco”). On June 20, 2008, we finalized the determination of goodwill as the final audited balance sheet of Plusfood became available. The final price paid was €16.5 million (price of €31.2 million less net debt of Plusfood as of December 31, 2007).

 

Business Combination with Sadia

 

On May 19, 2009, we signed a merger agreement with Sadia. On July 8, 2009, the business combination was approved at the shareholders’ meeting of Perdigão, Sadia and HFF Participações S.A., or “HFF,” a holding company formed by the former controlling shareholders of Sadia for purposes of the acquisition. As a result of those approvals, among other things, Sadia became a subsidiary of our company, and we changed our name to BRF – Brasil Foods S.A. In addition, we amended our certificate of incorporation to expand the board of directors, three of whom were elected by the controlling shareholders of Sadia and are expected to serve until the 2011 general shareholders’ meeting. Our board of directors now has a co-chairman structure, and neither of the co-chairmen has a tie-breaking vote in the case of a tie.

 

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At separate meetings held on August 18, 2009, the common shareholders of Perdigão and Sadia approved the final step of the business combination, pursuant to which Sadia became our wholly-owned subsidiary and holders of common and preferred shares of Sadia received common shares of BRF. The business combination became fully effective on September 22, 2009.

 

The business combination remains subject to review by the antitrust authorities in Brazil. On July 7, 2009, we entered into an agreement with the Brazilian antitrust authorities under which we agreed to ensure the reversibility of the business combination until a final decision is made by these authorities. The agreement, among other things, prevents our company and Sadia from integrating their administrative, production and commercial operations. On September 18, 2009, the Brazilian antitrust authorities authorized the coordination of the companies’ activities directed towards the export market for “in natura” meats. On January 20, 2010, the Brazilian antitrust authorities authorized our company and Sadia to jointly negotiate and acquire raw materials and services (such as grains, packaging material and “in natura” beef), although not purchases of poultry or hogs. However, for our other activities, we continue to be subject to our reversibility agreement during the review period by the Brazilian antitrust authorities. The Brazilian antitrust authorities may decide to impose significant conditions or performance commitments on the combined company, including commitments to divest from certain businesses, risks and product lines, trademarks or production facilities.

We have consolidated the results of operations of Sadia in our results of operations since July 8, 2009.

 

Our Industry

 

We manage our business to target both the Brazilian domestic market and the international export markets.

Domestic Market

 

Brazil is the fifth largest country in the world, both in terms of land mass and population. As of July 1, 2009, Brazil had an estimated population of 191.5 million people, according to data from the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or “IBGE.” According to IBGE, Brazil had a gross domestic product, or “GDP,” of R$3.1 trillion for 2009, representing an increase of 4.6% over GDP of R$2.9 trillion for 2008, in each case in nominal terms. GDP per capita increased 1.2% in 2009 to R$16,414. Fiscal and monetary policies, such as reductions of taxes and interest rates were important to mitigate the impacts of the international crisis over the Brazilian economy. Since the third quarter of 2009, industry and services, optimistic about the perspectives for the economy in 2010, began to hire again, which raised consumer confidence, leading customers to return to buy durables and non-durable products. As a consequence, many economists are confident that Brazil’s economy will grow at a high rate in 2010. The Central Bank of Brazil (Banco Central do Brasil), or the “Central Bank,” forecasts that the Brazilian GDP in 2010 will increase 5.5% compared to 2009. The inflation rate, as measured by the National Extended Consumer Price Index (Índice Nacional de Preços ao Consumidor Ampliado), or “IPCA,” published by the IBGE, was 5.9% in 2008 and 4.3% in 2009, continuing a trend of moderate inflation rates when compared with Brazil’s historical experience of high rates of inflation.

 

Brazil is a large consumer of meat, with per capita meat consumption of 89.2 kilograms in 2009, according to the USDA. However, demand for poultry, pork and beef products in the domestic market is directly affected by economic conditions in Brazil. The overall trend towards improved economic conditions in recent years has generally supported increased demand for processed food products, as well as traditional fresh and frozen poultry and pork products.

 

According to the USDA, Brazil is the world’s sixth largest producer and consumer of milk, with 28.8 million tons of milk produced in 2009. The USDA projects a 5% growth in Brazilian production for 2010.

 

Export Markets

 

The global trade in poultry, pork and beef products has been growing in recent years, according to the USDA, but the global economic crisis in 2009 interrupted that trend. Last year, Brazilian exports of chicken and beef did not have the same performance such as pork exports. According to ABEF, volume of exports of chicken meat in 2009 was 0.3% lower than 2008, totaling 3.6 million tons. Data from the Brazilian Beef Exporters Association (Associação Brasileira de Produtores e Exportadores de Frango), or “ABIEC,” shows that the volume of beef meat exports decreased 9.9% from 2008 to 2009 (1.382 million tons to 1.245 million tons).  In terms of sales revenues in dollars, chicken exports decreased 16.3% and beef exports dropped 22.7% in 2009. On the other hand, exports of pork meat in 2009 were 14.7% higher than 2008 sales volumes, according to ABIPECS. In volume, Brazil exported 607 thousand tons of pork meat in 2009, and 529 thousand tons in 2008, but reflecting a decrease of 17.7% in sales revenues. We believe that sales of poultry, pork and beef products will continue to expand over the next years and that the 2009 performance should not be seen as a long-term trend.

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Brazil has become a leading participant in export markets for food products on a global basis because of natural competitive advantages, including low animal feed and labor costs, and gains in efficiencies in animal production. We, like other large Brazilian producers, have built on these advantages to develop the scope and scale of our businesses.

 

Traditionally, Brazilian producers have emphasized exports of frozen whole and cut poultry, and frozen pork and beef cuts. These products, which are similar to commodities in nature, continue to account for a substantial portion of export volumes in recent years. More recently, Brazilian food companies have begun to expand sales of processed food products. We anticipate that, over the next several years, we will sell higher volumes of frozen whole and cut poultry and frozen pork and beef cuts, and increasingly more substantial volumes of processed food products.

 

Forward-Looking Statements

 

This Annual Report on Form 20-F contains statements that constitute forward-looking statements. Those statements appear in a number of places and include statements regarding the intent, belief or current expectations of the Company, its directors or its executive officers with respect to (i) the implementation of the principal operating strategies of the Company, including integration of current acquisitions as well as the conclusion of acquisition or joint venture transactions or other investment opportunities that may occur in the future, (ii) general economic, political and business conditions in our company’s markets, both in Brazil and abroad, (iii) the cyclicality and volatility of raw materials and selling prices, (iii) health risks related to the food industry, (iv) the risk of outbreak of animal diseases, in particular avian influenza and swine flu, (v) more stringent trade barriers in key export markets and increased regulation of food safety and security, (vi) strong international and domestic competition, (vii) interest rate fluctuations, inflation and exchange rate movements of the real in relation to the U.S. dollar and other currencies, (viii) the declaration or payment of dividends, (ix) the direction and future operation of the Company, (x) the implementation of the Company’s financing strategy and capital expenditure plans, (xi) the factors or trends affecting the Company’s financial condition or results of operations and (xii) other factors identified or discussed under “Item 3. Key Information¾D. Risk Factors.” Prospective investors are cautioned that any such forward looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward looking statements. The accompanying information contained in this Annual Report, including without limitation the other information set forth under the heading “Item 5. Operating and Financial Review and Prospects,” identifies important factors that could cause such differences. The Company undertakes no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.

 

ITEM 1.   IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

 

ITEM 2.   OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3.   KEY INFORMATION

A.  Selected Financial Data

 

The following summary financial data (not including the operating data) at December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008 and 2007 have been derived from our consolidated financial statements included in this Annual Report. The summary financial data at December 31, 2007, 2006 and 2005 and for the years ended December 31, 2006 and 2005 have been derived from our consolidated financial statements that are not included in this Annual Report.

 

Our consolidated financial statements are prepared in accordance with accounting practices adopted in Brazil, or “Brazilian GAAP,” which differ in significant respects from the accounting principles generally accepted in the United States, or “U.S. GAAP.” For a discussion of the significant differences relating to these consolidated financial statements and a reconciliation of net income (loss) and shareholders’ equity from Brazilian GAAP to U.S. GAAP, see Note 26 to our consolidated financial statements.

Our consolidated results of operations for the year ended December 31, 2009 have included results of operations of Sadia since July 8, 2009 and are, therefore, not fully comparable to our results of operations for the year ended December 31, 2008 or for prior periods. In addition, we have included unaudited combinedfinancial information in this Annual Report for the year ended December 31, 2009 to illustrate the effects of our business combination with Sadia, as if it had occurred on January 1, 2008.

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In addition, Brazilian GAAP has recently changed pursuant to Law No. 11,638, dated December 28, 2007, and Provisional Executive Act No. 449, dated December 3, 2008 (converted into Law No. 11,941, dated May 27, 2009) or “Provisional Measure No. 449/08.” These legislative initiatives are aimed at ultimately enabling the convergence of Brazilian GAAP with International Financial Reporting Standards issued by the International Accounting Standards Board. Consequently, our financial statements for the years ended December 31, 2009 and 2008 are not fully comparable to our results of operations for prior periods. See Note 2 to our consolidated financial statements for more information about these changes.

The summary financial data should be read in conjunction with our consolidated financial statements and the notes thereto contained in this Annual Report, as well as the information set forth under the heading “Item 5. Operating and Financial Review and Prospects.”

 

 

  For the Year Ended December 31,
  2009  2008  2007  2006  2005 
  (in millions of reais, except per share and per ADS amounts and share numbers) 
Income Statement Data           
Brazilian GAAP           
Net sales  15,905.8  11,393.0  6,633.4  5,209.8  5,145.2 
Cost of sales  (12,270.6)  (8,634.1)  (4,760.1)  (3,865.7)  (3,685.9) 
Gross profit  3,635.2  2,758.9  1,873.3  1,344.1  1,459.3 
Operating expenses:           
    Selling  (3,054.3)  (1,891.1)  (1,279.0)  (1,070.8)  (845.6) 
    General and administrative  (205.1)  (140.4)  (76.9)  (72.3)  (56.9) 
    Management compensation  (25.6)  (18.8)  (13.5)  (9.6)  (9.5) 
 
Operating income before financial income (expense), equity interest and other  350.2  708.6  503.9  191.4  547.3 
     Financial income (expenses), net (1)  241.2  (630.4)  (105.4)  (129.3)  (82.7) 
     Equity interest income of associated company  2.5  —  —  —  — 
     Other operating income (expense), net  (259.9)  (261.9)  (14.7)  12.2  (13.5) 
Income (loss) before taxes, profit sharing and participation of non-controlling shareholders           
334.0  (183.7)  383.8  74.3  451.1 
    Income and social contribution taxes (expense) benefit  (197.2)  255.4  (32.1)  61.6  (62.5) 
    Employees’ profit sharing  (18.1)  (13.5)  (24.6)  (9.9)  (22.8) 
    Management profit sharing  (2.7)  (3.4)  (2.6)  (1.6)  (4.8) 
    Non-controlling shareholders  4.4  (0.4)  (3.2)  (7.1)  — 
Net income  120.4  54.4  321.3  117.3  361.0 
    Earnings per share (2)(5)  0.14  0.13  0.87  0.35  4.05 
    Dividends per share (2)  0.23  0.37  0.54  0.21  2.43 
    Dividends per ADS (3)  0.46  0.74  1.08  0.42  4.87 
    Dividends per ADS (in U.S. dollars)  0.26  0.32  0.61  0.20  2.08 
    Average shares outstanding (in millions) (4)  435.0  206.5  185.5  165.5  44.5 
    U.S. GAAP           
    Net sales  15,903.1  11,357.2  6,632.7  5,209.8  5,145.2 
    Net (loss) income attributable to BRF  56.2  (89.7)  313.0  141.8  356.5 
    Basic and diluted (loss) earnings per share (2) (5)  0.09  (0.22)  0.94  0.59  4.06 
    Basic and diluted (loss) earnings per ADS(5)  0.09  (0.22)  0.94  0.59  4.06 

 

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  2009  2008  2007  2006  2005 
Operating Data           
Poultry slaughtered (million heads per year)  1,200.0  863.2  627.3  547.4  487.1 
Hogs/beef slaughtered (thousand heads per year)  7,620.1  4,7132  3,775.0  3,656.0  3,570.0 
Total sales of meat and other processed products (thousand tons per year)  4,383.4  3,359.0  1,812.5  1,350.4  1,141.3 
Milk collected from producers (millions of liters)  1,396.5  1,605.6  247.0  147.9  — 
Employees (at year end)  114,273  59,008  44,752  39,048  31,406 
 

(1) For purposes of this Annual Report on Form 20-F, our non-operating results and financial expenses for 2005, 2006, 2007, 2008 and 2009 were reclassified to operating (expenses) income, net and differ from the presentation we use in the financial statements we file publicly in Brazil.

(2) Earnings (loss) per share, or “EPS,” is computed under Brazilian GAAP based on the outstanding shares at the end of each period. Under U.S. GAAP, EPS is calculated based on weighted average shares outstanding over the period. For U.S. GAAP purposes, in all years presented, basic EPS is equal to diluted EPS.

(3) Dividends are calculated based on net income determined in accordance with Brazilian GAAP and adjusted in accordance with the Brazilian Corporation Law (Law No. 6,404/76, as amended). Each American Depositary Share, or “ADS,” represents two common shares.

(4) Includes common shares represented by ADSs.

(5) All historical periods are presented reflecting the three-for-one share split that became effective on April 12, 2006 and the one-for-one share split that became effective on March 31, 2010.

 

 

  As of December 31,
  2009  2008  2007  2006  2005 
  (in millions of reais, except as otherwise indicated)
Balance Sheet Data           
Brazilian GAAP           
Cash and cash equivalents  1,898.2  1,233.5  1,108.0  336.6  778.6 
Marketable securities  2,345.5  742.5  665.6  783.9  39.1 
Trade accounts receivable, net  1,787.3  1,378.0  803.9  701.6  555.7 
Inventories  3.101,3  1,689.0  865.1  643.2  558.7 
Other current assets  1,314.0  943.1  325.6  286.3  169.1 
Total current assets  10,446.3  5,986.1  3,768.2  2,751.6  2,101.2 
Marketable securities  676.7  0.2  63.3  80.0  91.6 
Investments  17.2  1.0  1.0  1.0  15.6 
Property, plant and equipment, net  9,275.0  2,918.5  2,136.9  1,663.8  1,194.2 
Intangible assets  3,098.3  1,545.7  269.5  84.5  0.0 
Deferred charges, net  201.9  172.0  113.4  89.8  93.8 
Other non-current assets  1,998.9  600.4  191.0  158.7  128.6 
Total non-current assets  15,268.0  5,237.8  2,775.1  2,077.8  1,523.8 
Total assets  25,714.3  11,223.9  6,543.3  4,829.4  3,625.0 
Short-term debt (including current portion of long-term debt)  2,913.7  1,646.4  1,051.8  547.0  548.7 
Trade accounts payable  1,905.4  1,083.4  575.6  486.6  332.6 
Other current liabilities  1,057.6  352.0  313.8  218.0  248.6 
Total current liabilities  5,876.7  3,081.8  1,941.2  1,251.6  1,129.9 
Long-term debt  5,884.4  3,719.7  1,214.1  1,287.1  1,125.4 
Other non-current liabilities  813.9  311.1  162.0  146.8  146.9 
 
Total non-current liabilities  6,698.3  4,030.8  1,376.1  1,433.9  587.7 
Non-controlling shareholders  4.7  0.7  —  39.0  — 
Shareholders’ equity  13,134.6  4,110.6  3,225.2  2,104.9  1,222.8 
Paid-in capital  12,461.8  3,445.0  2,500.0  1,600.0  800.0 
Profit reserves  724.9  704.5  726.0  505.7  423.6 
Equity valuations adjustments  (24.5)  (38.1)  —  —  — 
Treasury shares  (27.6)  (0.8)  (0.8)  (0.8)  (0.8) 
Total liabilities and shareholders’ equity  25,714.3  11,223.9  6,542.5  4,829.4  3,625.0 
U.S. GAAP           
Total assets  26,243.7  11,354.4  6,495.7  4,790.8  3,572.0 
Property, plant and equipment  9,522.4  3,176.3  2,294.7  1,658.0  1,145.9 
Long-term debt  5,844.8  3,715.5  1,206.2  1,282.0  1,124.5 
Shareholders’ equity (1)  13,001.2  3,974.1  3,159.0  2,105.8  1,196.1 
 

(1) Non-controlling interest has been included in shareholders’ equity for all years presented.

6

 


 

 

Exchange Rates

 

Until March 4, 2005, 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 foreign trade transactions and transactions that generally required prior approval from Brazilian monetary authorities, such as registered investments by foreign persons and related remittances of funds abroad (including the payment of principal and interest on loans, notes, bonds and other debt instruments denominated in foreign currencies and registered with the Central Bank). The Floating Market rate generally applied to specific transactions for which Central Bank approval was not required. Both the Commercial Market rate and the Floating Market rate were reported by the Central Bank on a daily basis.

The Brazilian National Monetary Council (Conselho Monetário Nacional), or “CMN,” has since then introduced several changes in the Brazilian foreign exchange regime, including: (1) unification of the Commercial Market and the Floating Market; (2) relaxation of rules for the acquisition of foreign currency by Brazilian residents; (3) extension of the period to report proceeds derived from Brazilian exports to the Central Bank; (4) permission for exporters to retain their proceeds from exports outside Brazil; and (5) authorization to receive export proceeds in any currency (including reais), regardless of the specific currency registered with the Central Bank, among others.

 

In 2005, 2006 and 2007, on average the real appreciated in relation to the U.S. dollar 11.8%, 8.7% and 17.2%, respectively. In 2008, due to the world’s financial crisis, the real depreciated against the U.S. dollar by 31.9% and in 2009 it appreciated by 25.5%. Although the Central Bank has intervened occasionally to control unstable movements in the foreign exchange rates, the exchange market has continued to be volatile in 2010 and may continue to be volatile in the future.

 

The following table shows the selling rate for U.S. dollars for the periods and dates indicated. The information in the “Average” column represents the average of the exchange rates on the last day of each month during each year presented. The numbers in the “Period End” column are the quotes for the exchange rate as of the last business day of the period in question.

 

  Reais per U.S Dollar
        Period End 
Year  High  Low  Average 
2005  2.7621  2.1633  2.4341  2.3407 
2006  2.3711  2.0586  2.1771  2.1380 
2007  2.1556  1.7325  1.9498  1.7713 
2008  2.5004  1.5593  1.8352  2.3370 
2009  2.4218  1.7024  1.9959  1.7412 

 

  Reais per U.S. Dollar 
Month  High  Low 
October 2009  1.7844  1.7037 
November 2009  1.7588  1.7024 
December 2009  1.7879  1.7096 
January 2010  1.8748  1.7227 
February 2010  1.8773  1.8046 
March 2010  1.7820  1.7637 
April 2010 (through April 22, 2010)  1.7798  1.7438 
Source: Central Bank / Bloomberg

 

 

B.  Capitalization and Indebtedness

 

Not applicable.

7

 


C.  Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

D.  Risk Factors

 

Risks Relating to Our Business and Industry

 

The global economic crisis is adversely affecting our business and financial performance.

 

Our business has been materially affected by the global economic crisis in 2008 and 2009, which has resulted in increased volatility in our markets and contributed to the net losses we recorded in the fourth quarter of 2008 and in the first quarter of 2009. We have been affected in the following respects, among others:

 

          we experienced increases in prices for our commodity raw materials, such as corn and soybeans, throughout 2008 and 2009, which we could not pass on through selling prices;

 

          because the global economic crisis affected demand, we were forced to decrease selling prices, particularly in our export markets;

 

          we were affected by negative macroeconomic trends in our domestic market starting in the fourth quarter of 2008 as the global economic crisis began to affect the Brazilian economy and domestic consumer confidence;

 

          we announced a 20% cut in meat production for export for the first quarter of 2009 due to weak demand in our export markets. Temporary shutdowns of production of some facilities adversely affected our margins;

 

          the Brazilian real depreciated 22% against the U.S. dollar in the fourth quarter of 2008 compared to the third quarter of 2008, reflecting uncertainty regarding the effect of the global economic crisis on Brazil and other emerging market economies. This devaluation in the real caused us to incur net foreign exchange variation expenses (recorded as part of our net financial expenses) of R$416.0 million in 2008, of which R$318.0 million was attributable to the fourth quarter of 2008; and 

 

          uncertainties engendered by the crisis and the challenges of managing inventories, accounts receivable, accounts payable and other items required us to reinforce our working capital, leading to approximately R$3.4 billion increase in our total debt to approximately R$8.8 billion as of December 31, 2009, compared to approximately R$5.4 billion as of December  31, 2008, including R$2.9 billion of short-term debt.

 

Although we seek to manage our selling prices and production costs, volumes, inventories and working capital through the global economic crisis, we cannot predict whether the global economic crisis will have any long-term effects on consumer confidence, selling prices and production costs, demand for particular types of products, volatility of raw material prices or the equilibrium between our domestic and export markets. These factors may therefore continue to adversely affect our business, results of operations and the market price of our common shares and ADSs.

 

Our results of operations are subject to cyclicality and volatility affecting both our raw material prices and our selling prices.

 

Our business is largely dependent on the cost and supply of corn, soy meal, soybeans, hogs, cattle, milk and other raw materials, as well as the selling prices of our poultry, pork, beef and dairy products, all of which are determined by constantly changing market forces of supply and demand, which may fluctuate significantly, even in the absence of a global economic crisis, and other factors over which we have little or no control.

 

These other factors include, among others, fluctuations in local and global poultry, hog, cattle and milk production levels, environmental and conservation regulations, economic conditions, weather, animal and crop diseases, cost of international freight and exchange rate fluctuations. Our industry, both in Brazil and abroad, is also characterized by cyclical periods of higher prices and profitability, followed by overproduction, leading to periods of lower prices and profitability. We are not able to mitigate these risks by entering into long-term contracts with our customers and most of our suppliers because such contracts are not customary in our industry. Our financial performance is also affected by domestic and international freight costs, which are vulnerable to volatility in the price of oil. We may not be successful in addressing the effects of cyclicality and volatility on costs and expenses or the pricing of our products, and our overall financial performance may be adversely affected.

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The decreases in demand and selling prices in 2009, which were exacerbated by the global economic crisis, illustrate the susceptibility of our business to cyclical market forces. In 2009, the average corn price on the Chicago Board of Trade (CBOT) was 28.0% lower than the average price in 2008 after increasing 42.2% in 2008 compared to 2007. Soybean prices also decreased by 16.2% in 2009 after increasing 40.5% in 2008 compared to 2007. Similarly, we significantly increased our selling prices of certain of our products in 2008 to reflect increased production costs but were then forced to decrease prices for many products in the fourth quarter of 2008 and throughout 2009. Besides that, the exchange rate volatility and export performance adversely affected our financial performance in those periods.

 

Health risks related to the food industry could adversely affect our ability to sell our products.

 

We are subject to risks affecting the food industry generally, including risks posed by contamination or food spoilage, evolving nutritional and health-related concerns, consumer product liability claims, product tampering, the possible unavailability and expense of liability insurance and the potential cost and disruption of a product recall. Among such risks are those related to raising animals, including disease and adverse weather conditions. Meat is subject to contamination during processing and distribution. Contamination during processing could affect a large number of our products and therefore could have a significant impact on our operations.

 

Our sales are dependent on consumer preferences, and any actual or perceived health risks associated with our products, including any adverse publicity concerning these risks, could cause customers to lose confidence in the safety and quality of our products, reducing the level of consumption of those products.

Even if our own products are not affected by contamination, our industry may face adverse publicity if the products of other producers become contaminated, which could result in reduced consumer demand for our products in the affected category. We maintain systems designed to monitor food safety risks throughout all stages of the production process (including the production of poultry, hogs, cattle and dairy products).

 

However, our systems for compliance with governmental regulations may not be fully effective in mitigating risks related to food safety. Any product contamination could have a material adverse impact on our business, results of operations, financial condition and prospects.

 

Raising animals and meat processing involve animal health and disease control risks, which could have an adverse impact on our results of operations and financial condition.

 

Our operations involve raising poultry and hogs and processing meat from poultry, hogs and cattle, as well as the purchase of milk and the sale of milk and dairy products, which require us to maintain animal health and control disease. We could be required to destroy animals or suspend the sale of some of our products to customers in Brazil and abroad in the event of an outbreak of disease affecting animals, such as: (1) in the case of poultry, avian influenza (discussed below) and Newcastle disease, (2) in the case of hogs, cattle and certain other animals, foot-and-mouth disease, classic swine fever “blue ear” disease and A(H1N1) influenza (discussed below) and (3) in the case of cattle, foot-and-mouth disease and bovine spongiform encephalopathy, known as “mad cow disease.” Destruction of poultry, hogs or other animals would preclude recovery of costs incurred in raising or purchasing these animals and result in additional expense for the disposal of such animals. In 2005, foot-and-mouth disease cases in the States of Mato Grosso do Sul and Paraná affected only cattle, although hogs can also be contaminated. An outbreak of foot-and-mouth disease could have an effect on livestock we own, the availability of livestock for purchase, consumer perception of certain protein products or our ability to access certain markets, which would adversely impact our results of operations and financial condition. In addition, although Brazilian cattle is generally grass-fed and at less risk of contracting mad cow disease than cattle raised in some other countries, increases in Brazilian cattle production could lead to the use of cattle feed containing animal byproducts that could heighten the risk of an outbreak of mad cow disease.

 

Outbreaks, or fears of outbreaks, of any of these or other animal diseases may lead to cancellation of orders by our customers and, particularly if the disease has the potential to affect humans, create adverse publicity that may have a material adverse effect on consumer demand for our products. Moreover, outbreaks of animal disease in Brazil may result in foreign governmental action to close export markets to some or all of our products, relating to some or all of our regions. For example, due to foot-and-mouth disease cases affecting cattle in the States of Mato Grosso do Sul and Paraná, certain major foreign markets, including Russia (which has been the largest importer of Brazilian pork) banned imports of pork from the entire country in November 2005. Russia partially lifted this ban in the second quarter of 2006 for pork products from the State of Rio Grande do Sul, and this ban was completely lifted in December 2008. Any future outbreaks of animal diseases could have a material adverse effect on our results of operations and financial condition.

9

 


 

 

Our pork business in our Brazilian and export markets could be negatively affected by concerns about A(H1N1) influenza, also called “swine flu.”

 

In 2009, A(H1N1) influenza, also called “swine flu,” spread to many countries. In April 2009, the analysis of samples collected in cases of flu symptoms by the U.S. and Mexican governments identified a new subtype of the Influenza A(H1N1) virus, classified as “A/CALIFORNIA/04/2009,” which had not been previously detected in humans or swine. Influenza A(H1N1) is transmitted from one person to another mainly through coughing, sneezing and contact with nasal secretions from infected individuals. According to the World Health Organization, or “WHO,” there is no relation between those infected with Influenza A(H1N1) and contact with persons living near swine or the consumption of pork and pork-derived products.

 

More than 17,000 deaths worldwide have been recorded since the outbreak of A(H1N1) influenza in Mexico, and on June 11, 2009, the WHO declared a flu alert level six, signaling a “global pandemic.” Many countries, including Russia and China, have prohibited imports of pork from countries reporting a significant number of cases (Mexico, United States and Canada), but, as the WHO and other independent sources have stated that influenza A(H1N1) is not transmitted by pork consumption, those countries reopened their markets to producers from Mexico, the United States and Canada. Even so, some states in the importing countries continue to impose restrictions on pork imports from Mexico, the United States and Canada.

 

To date, Brazil has a number of documented cases of A(H1N1) influenza. A significant outbreak of A(H1N1) influenza in Brazil could lead to pressure to destroy our hogs, even if no link between the influenza cases and pork consumption is shown. Any such destruction of our hogs would result in decreased sales of pork, prevent recovery of costs incurred in raising or purchasing our hogs, and result in additional expense for the disposal of destroyed hogs. In addition, any outbreak of A(H1N1) influenza in Brazil could lead to restrictions on the export of some of our products to key export markets. Whether or not an outbreak of A(H1N1) influenza occurs in Brazil, further outbreaks of the disease anywhere in the world could have a negative impact on the consumption of pork in key export markets or in Brazil, and a significant outbreak would negatively affect our net sales and overall financial performance. Any further outbreak of A(H1N1) influenza could lead to the imposition of costly preventive controls on pork imports in our export  markets. Accordingly, any spread of A(H1N1) influenza, or increasing concerns about this disease, may have a material and adverse effect on our company.

 

Our poultry business in Brazilian and export markets could be negatively affected by avian influenza.

 

Chicken and other birds in some countries, particularly in Asia but also in Europe and Africa, have become infected by highly pathogenic avian influenza (the H5N1 virus). In a small number of cases, the avian influenza has been transmitted from birds to humans, resulting in illness and, on occasion, death. Accordingly, health authorities in many countries have taken steps to prevent outbreaks of this viral disease, including destruction of afflicted poultry flocks.

 

From January 1, 2003 to December 31, 2009, there have been over 492 confirmed human cases of avian influenza and over 291 deaths, according to the WHO. Various countries in Asia, the Middle East and Africa reported human cases in 2006, 2007, 2008 and 2009, and several countries in Europe reported cases of avian influenza in birds. For example, Indonesia became the focus of international attention when the largest cluster of human H5N1 virus cases so far was identified. The H5N1 virus is considered firmly entrenched in poultry throughout much of Indonesia, and this widespread presence has resulted in a significant number of human cases. In 2009, 73 cases were reported worldwide, with 32 deaths, according to the WHO.

 

To date, Brazil has not had a documented case of avian influenza, although there are concerns that an outbreak of avian influenza may occur in the country in the future. Any outbreak of avian influenza in Brazil could lead to required destruction of our poultry flocks, which would result in decreased sales of poultry by us, prevent recovery of costs incurred in raising or purchasing such poultry, and result in additional expense for the disposal of destroyed poultry. In addition, any outbreak of avian influenza in Brazil would likely lead to immediate restrictions on the export of some of our products to key export markets. Preventive actions adopted by Brazilian authorities, if any, may not be effective in precluding the spread of avian influenza within Brazil.

 

Whether or not an outbreak of avian influenza occurs in Brazil, further outbreaks of avian influenza anywhere in the world could have a negative impact on the consumption of poultry in our key export markets or in Brazil, and a significant outbreak would negatively affect our net sales and overall financial performance. Any outbreak could lead to the imposition of costly preventive controls on poultry imports in our export markets. Accordingly, any spread of avian influenza, or increasing concerns about this disease, may have a material and adverse effect on our company.

10

 


 

 

More stringent trade barriers in key export markets may negatively affect our results of operations.

 

Because of the growing market share of Brazilian poultry, pork and beef products in the international markets, Brazilian exporters are increasingly being affected by measures taken by importing countries to protect local producers. The competitiveness of Brazilian companies has led certain countries to establish trade barriers to limit the access of Brazilian companies to their markets. Some countries, such as Russia, impose quotas on Brazilian pork and poultry products, and delays in allocating these quotas or changes in laws or policies regarding these quotas can adversely affect our exports. For example, Ukraine restricted pork imports for the retail market, on which higher taxes were levied for a period through December 2008. In March 2009, Ukraine initiated an anti-dumping investigation regarding imports of halves and quarters of poultry, as well as legs and cuts of poultry, in each case originating in the United States and Brazil. We were asked to answer a questionnaire from the Ministry of Economy of the Ukraine in connection with the investigation, and we complied with that request. The investigation is ongoing.

 

The European Union charges protective tariffs designed to mitigate the effects of Brazil’s lower production costs on local European producers. In addition, the European Union has a ban on certain types of Brazilian beef that affects sales of fresh premium cuts and some frozen hindquarter cuts. Developed countries also sometimes use direct and indirect subsidies to enhance the competitiveness of their producers in other markets. For example, French producers receive subsidies for their sales of poultry to countries such as Saudi Arabia, a major importer of poultry products. Trade barriers are sometimes applied indirectly to other parties that are crucial to the export of our products. In addition, local producers in a specific market sometimes exert political pressure on their governments to prevent foreign producers from exporting to their market. Any of the above restrictions could substantially affect our export volumes and, consequently, our export sales and financial performance. If new trade barriers arise in our key export markets, we may face difficulties in reallocating our products to other markets on favorable terms, and our business, financial condition and results of operations might be adversely affected.

 

We face significant competition from Brazilian and foreign producers, which could adversely affect our financial performance.

 

We face strong competition from other Brazilian producers in our domestic markets and from Brazilian and foreign producers in the export markets in which we sell our products. The Brazilian market for whole poultry and poultry and pork cuts is highly fragmented, and we face competition from small producers, some of which operate in the informal economy and are able to offer lower prices by meeting lower quality standards. Competition from small producers is a primary reason why we sell a majority of our whole chickens and poultry and pork cuts in the export markets and is a barrier to expanding our sales of those products in the domestic market. In our export markets, we compete with other major vertically integrated Brazilian producers that have the ability to produce quality products at low cost, as well as with foreign producers. In the Brazilian milk and dairy products markets, our main competitors are Nestlé Brasil Ltda., Danone Ltda. – Indústria de Alimentos and Itambé Ltda. To varying degrees, our competitors may have strengths in specific product lines and regions as well as greater financial resources. In addition, our poultry and pork cuts, in particular, are highly price-competitive and sensitive to product substitution. Even if we remain a low-cost producer, customers may seek to diversify their sources of supply by purchasing a portion of the products they need from producers in other countries, as some of our customers in key export markets have begun to do. We expect that we will continue to face strong competition in all of our markets and anticipate that existing or new competitors may broaden their product lines and extend their geographic scope. Any failure by us to respond to product, pricing and other moves by competitors may negatively affect our financial performance.

 

Increased regulation of food safety could increase our costs and adversely affect our results of operations.

 

Our manufacturing facilities and products are subject to regular Brazilian federal, state and local, as well as foreign, governmental inspections and extensive regulation in the food safety area, including governmental food processing controls. Changes in government regulations relating to food safety could require us to make additional investments or incur other costs to meet the necessary specifications for our products. Our products are often inspected by foreign food safety officials, and any failure to pass those inspections can result in our being required to return all or part of a shipment to Brazil, destroy all or part of a shipment or incur costs because of delays in delivering products to our customers. Any tightening of food safety regulations could result in increased costs and could have an adverse effect on our business and results of operations.

 

11

 


 

Our export sales are subject to a broad range of risks associated with international operations. Export sales account for a significant portion of our net sales, representing 41.1% of our total net sales in 2009, 43.6% in 2008 and 47.5% in 2007. Our major export markets include the European Union, the Middle East (particularly Saudi Arabia) and the Far East (particularly Japan and Russia), where we are subject to many of the same risks described below in relation to Brazil. Our future financial performance will depend, to a significant extent, on economic, political and social conditions in our main export markets.

 

Our future ability to conduct business in export markets could be adversely affected by factors beyond our control, such as the following:

 

          exchange rate fluctuations;

 

          deterioration in international economic conditions;

 

          imposition of increased tariffs, anti-dumping duties or other trade barriers;

 

          strikes or other events affecting ports and other transport facilities;

 

          compliance with differing foreign legal and regulatory regimes; and

 

          sabotage affecting our products.

 

The market dynamics of our important export markets can change quickly and unpredictably due to these factors, the imposition of trade barriers of the type described above and other factors, which together can significantly affect our export volumes, selling prices and results of operations.

 

Our export sales are highly dependent on conditions at a small number of ports in southern Brazil. We export our products primarily through ports in southern Brazil (Paraná, Santa Catarina and Rio Grande do Sul). We have been affected from time to time by strikes of port employees or customs agents, sanitary inspection agents and other government agents at the Brazilian ports from which we export our products. For example, in the third quarter of 2007 and in March 2008, Brazilian federal government sanitary inspectors went on strike for approximately a month. A widespread or protracted strike in the future could adversely affect our business and our results of operations.

 

In the fourth quarter of 2008, flooding and damage at the ports of Itajaí and Navegantes damaged port infrastructure and required us to divert all our exports in the region of Santa Catarina to three other ports: Rio Grande in the State of Rio Grande do Sul, Paranaguá and São Francisco. These events resulted in reduced shipment levels in November 2008 and led to delays in exports that adversely affected our export revenues for the fourth quarter of 2008.

 

Environmental laws and regulations require increasing expenditures for compliance.

 

We, like other Brazilian food producers, are subject to extensive Brazilian federal, state and local environmental laws, regulations, authorizations and licenses concerning, among other things, the handling and disposal of waste, discharges of pollutants into the air, water and soil, and clean-up of contamination, all of which affect our business. Any failure to comply with these laws and regulations or any lack of authorizations or licenses could result in administrative and criminal penalties, such as fines, cancellation of authorizations or revocation of licenses, in addition to negative publicity and liability for remediation or for environmental damage. We cannot operate a plant if the required environmental permit is not valid or current.

 

We have incurred, and will continue to incur, capital and operating expenditures to comply with these laws and regulations. Because of the possibility of unanticipated regulatory measures or other developments, particularly as environmental laws become more stringent in Brazil, the amount and timing of future expenditures required to maintain compliance could increase from current levels and could adversely affect the availability of funds for capital expenditures and other purposes. Compliance with existing or new environmental laws and regulations, as well as obligations in agreements with public entities, could result in increased costs and expenses.

 

Our plants are subject to environmental licensing, based on their pollution potential and usage of natural resources. If, for example, one of our plants is built or expanded without an environmental license or if our environmental licenses expire, are not renewed or have their solicitation of renewal dismissed by the competent environmental authority, we may incur in administrative penalties, such as a fine ranging between R$500 and R$10 million, suspension of operations or closing of the facilities in question. Those same penalties may also be applicable in the case of failure to fulfill the conditions of validity foreseen in the environmental licenses already held by us. Currently, some of our environmental licenses are being renewed, and we cannot guarantee that environmental agencies will approve our renewal requests.

12

 


 

 

Acquisitions may divert management resources or prove to be disruptive to our company.

 

We regularly review and pursue opportunities for strategic growth through acquisitions and other business ventures. We have completed several acquisitions in recent years, as described under “Item 4. Information on the Company¾A. History and Development of the Company¾Recent Acquisitions and Investments.” Acquisitions, especially involving sizeable enterprises, may present financial, managerial and operational challenges, including diversion of management attention from existing businesses, difficulty with integrating personnel and financial and other systems, increased compensation expenses for newly hired employees, assumption of unknown liabilities and potential disputes with the sellers. We could also experience financial or other challenges if any of the businesses that we have acquired or may acquire in the future give rise to liabilities or problems of which we are not aware. Acquisitions outside of Brazil may present additional difficulties, such as compliance with foreign legal and regulatory systems and integration of personnel to different managerial practices and would increase our exposure to risks associated with international operations.

 

In recent years, the size of our acquisitions has increased significantly, which has increased the magnitude of the challenges described above. In 2008, we completed three acquisitions for an aggregate purchase price of R$1.8 billion, consisting primarily of our acquisitions of Eleva (complementing our dairy product and meat businesses), Plusfood (providing meat processing capabilities in Europe) and Cotochés (adding to the scope of our dairy products business), compared to four acquisitions for an aggregate purchase price of R$348.0 million in 2007. In 2009, we completed a much larger business combination with Sadia, which poses specific risks and challenges discussed under “—Risks Affecting Our Company as a Result of the Sadia Transaction.”

 

We are influenced by a group of shareholders that control a significant percentage of our common shares.

 

Currently, five pension funds hold a significant percentage of our common shares and, acting together pursuant to a shareholders’ voting agreement, have the ability to significantly influence our decisions. The pension funds owned 28.0% of our total capital as of December 31, 2009. They are parties to a shareholders’ voting agreement that sets forth voting arrangements with respect to, among other matters, (1) the election of officers and members of our board of directors and of the fiscal council and (2) the matters set forth in Article 136 of the Brazilian Corporation Law, including decisions relating to dividends, corporate restructurings, our corporate purpose and other matters.

 

As a result, these shareholders have, and will continue to have, the power to influence significantly the outcome of important corporate decisions or matters submitted to a vote of our shareholders. The interests of these shareholders may conflict with, or differ from, the interests of other holders of our common shares. Some of our major shareholders are also shareholders of Sadia. See “—Risks Affecting Our Company as a Result of the Sadia Transaction.”

 

Unfavorable outcomes in legal proceedings may reduce our liquidity and negatively affect us.

 

We are defendants in civil, labor and tax proceedings and are also subject to consent agreements (termo de ajustamento de conduta). Under Brazilian GAAP, we classify the risk of adverse results in these proceedings as “remote,” “possible” or “probable.” We disclose the aggregate amounts of these proceedings that we have judged possible or probable, and we record provisions only for losses that we consider probable. These disclosures for the year ended December 31, 2009 are included in Note 16 to our consolidated financial statements.

 

We are not required to disclose or record provisions for proceedings in which our management judges the risk of loss to be remote. However, the amounts involved in certain of the proceedings in which we believe our risk of loss is remote are substantial, and the losses to us could, therefore, be significantly higher than the amounts for which we have recorded provisions. Even for the amounts recorded as provisions for probable losses, a judgment against us would have an effect on our cash flow if we are required to pay those amounts.

 

We cannot assure you that we will obtain favorable decisions in these proceedings or that our reserves will be sufficient to cover potential liabilities resulting from unfavorable decisions. In the ordinary course of business, we outsource labor to third parties. See “Item 4. Information on the Company—B. Business Overview—Production Process.”  If it were to become necessary to revisit this contractual structure, we could incur additional operating expenses. Unfavorable decisions in these proceedings may, therefore, reduce our liquidity and adversely affect our business, financial condition and results of operations.

13

 


 

 

We depend on members of our senior management and on our ability to recruit and retain qualified professionals to implement our strategy.

 

We depend on members of our senior management and other qualified professionals to implement our business strategies. Efforts to recruit and retain professionals may result in significant additional expenses, which could adversely affect us. In addition, the loss of key professionals may adversely affect our ability to implement our strategy.

 

Damages not covered by our insurance might result in losses for us, which could have an adverse effect on our business.

 

As is usual in our business, our plants, distribution centers, transports, vehicles, and our directors and officers, among others, are insured. However, certain kinds of losses cannot be insured, and our insurance policies are subject to liability limits and exclusions. If an event that cannot be insured or a liability higher than those covered by our insurance policies occurs, the investment we made may be lost or we may incur a significant cost. In addition, we can be held judicially liable for any indemnification payments to potential victims in such events.

 

Risks Affecting Our Company as a Result of the Sadia Transaction

 

Our business combination with Sadia is subject to antitrust approvals, and any antitrust approval could be conditioned on divestment of a portion of our business.

 

Although we have completed our business combination with Sadia and Sadia is now our wholly-owned subsidiary, the business combination remains subject to approval by the Brazilian antitrust authorities. Brazilian antitrust law does not prevent parties from closing a transaction on a provisional basis until the Brazilian antitrust authorities render a final decision. In accordance with Brazilian law, we and Sadia submitted a summary of the terms and conditions of the business combination and other information about each company to the Brazilian Conselho Administrativo de Defesa Econômica (the Brazilian government agency with antitrust decision making authority, or “CADE”) on June 8, 2009. After an analysis by the Secretaria de Acompanhamento Econômico (the Economic Policy Bureau of the Ministry of the Treasury) and the Secretaria de Direito Econômico (the Economic Law Office of the Ministry of Justice), the CADE will determine whether the business combination negatively impacts consumer conditions in the relevant markets in which we and Sadia compete or whether they would negatively affect consumers. On July 7, 2009, we entered into an agreement (Acordo de Preservação da Reversibilidade da Operação) with the CADE, under which we agreed to ensure the reversibility of the business combination until a final decision is made by such authorities. The agreement, among other things, prevents our company and Sadia from integrating their administrative, production and commercial operations. On September 18, 2009, the Brazilian antitrust authorities authorized the coordination of the companies’ activities directed towards the export market for “in natura” meats. On January 20, 2010, the Brazilian antitrust authorities authorized our company and Sadia to jointly negotiate and acquire raw materials and services (such as grains, packaging material and “in natura” beef), although not purchases of poultry or hogs. However, for our other product lines and markets, during the review period by the Brazilian antitrust authorities, we expect to continue to be subject to our reversibility agreement in the foreseeable future.

 

If the business combination is approved, it will be retroactive to the date the transaction closed; however, if the business combination is not approved, it will be unwound retroactively to the closing date. As a condition to approving the transaction, the Brazilian antitrust authorities could impose significant conditions or performance commitments on the combined company, including commitments to divest from certain businesses, risks and product lines, trademarks or production facilities. Any such conditions could materially adversely affect our financial performance and prospects.

 

We may not realize the expected benefits of our business combination with Sadia, in the timeframe anticipated or at all, because of integration or other challenges.

 

We are currently in the ongoing process of integrating our business with Sadia, subject to our reversibility agreement. Achieving the expected benefits of the business combination with Sadia depends on the timely and efficient integration of the operations, business cultures, marketing practices, branding and personnel of BRF and Sadia. This integration process is ongoing, and any failure to effectively integrate the two companies or any delay in that integration could increase our costs, adversely affect our margins, adversely affect our financial condition or have other negative consequences. We currently face the following integration challenges, among others:

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          devising a coherent marketing and branding strategy in our domestic market and our export markets that takes into account the relative strengths of BRF’s and Sadia’s marketing and brands in each of those markets and across their many product lines;

 

          integrating two of the largest customer distribution networks in Brazil, as well as distribution networks in BRF’s and Sadia’s export markets;

 

          integrating the extensive production facilities of BRF and Sadia in several Brazilian states;

 

          the potential loss of key customers of BRF or Sadia, or both;

 

          the potential loss of key officers of BRF or Sadia, or both;

 

          distraction of management from the ongoing operations of the company;

 

          aligning the standards, processes, procedures and controls of BRF and Sadia in the operations of the combined companies; and

 

          increasing the scope, geographic diversity and complexity of our operations.

 

The business combination with Sadia is significantly larger than any other transaction we or Sadia has undertaken in the past, and any combination of the challenges described above could adversely affect our results of operations and prospects and the market price of our common shares or ADSs.

 

Sadia is subject to significant potential liabilities in connection with litigation, which have now become potential liabilities of our combined company.

 

Sadia’s businesses are subject to regulation under a wide variety of Brazilian, U.S. federal, state and foreign laws, regulations and policies. Sadia, in particular, is subject to a variety of legal proceedings and legal compliance risks. Sadia’s businesses and the industries in which we operate are at times reviewed or investigated by regulators, which could lead to enforcement actions, fines and penalties or the assertion of private litigation claims and damages. Sadia is a party to a wide range of agreements, contracts and joint ventures with other companies, which could potentially result in litigation if the parties cannot find a common understanding on the issues in dispute.

 

In the fall of 2008, the real suffered a strong devaluation, including in relation to the U.S. dollar. As a result of such devaluation, Sadia sustained significant losses on foreign exchange derivative transactions. In connection therewith, Sadia sold certain of its long-term financial investments to be able to make deposits in margin accounts related to the currency derivatives, which resulted in further losses due to the decrease in the value of such financial instruments as a result of the global economic crisis. In connection with these losses, Sadia, as well as certain individuals who were officers and/or directors of Sadia during the events at issue, were named in five lawsuits in U.S. courts alleging various violations of U.S. federal securities laws related to losses that Sadia incurred with respect to foreign exchange derivative contracts. These five actions have since been consolidated in a single class action lawsuit.

 

In addition, on May 15, 2009, Sadia received a letter from the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários), or “CVM,” informing Sadia that the CVM had initiated a preliminary analysis of possible liability of certain individuals who were officers and/or directors of Sadia for losses in connection with the derivative transactions in 2008. The letter states that the proceeding is still at a preliminary stage, and the CVM has not yet specified whether any of these individuals may be subject to liability. On August 21, 2009, Sadia received an additional letter from the CVM requesting that Sadia provide certain documents to the CVM in connection with its investigation, which was complied with by Sadia. This investigation currently relates only to these individuals, and Sadia itself is not a part to such investigation; accordingly, no contingency has been recorded.

 

It is not possible to predict whether additional suits will be filed in connection with such derivative losses or what the outcome of any such litigation will be. Although Sadia intends to contest the current lawsuits vigorously, it is possible that there could be unfavorable outcomes in these or other proceedings. At the current stage of the proceedings, it is not possible to determine the probability of loss and/or the amounts involved in any potential loss and the expenses that will be incurred in defending these lawsuits.

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Adverse results in proceedings involving Sadia and/or the incurrence of significant litigation expenses could be material to our consolidated business, operations, financial position, profitability or cash flows. Since Sadia is now our wholly-owned subsidiary, we will be subject to any adverse outcomes arising out of proceedings involving Sadia. Any such adverse results could therefore be material to our business, operations, financial position, profitability or cash flows.

 

We may incur additional costs in relation to Sadia’s internal controls and information systems.

 

We are subject to Section 404 of the Sarbanes-Oxley Act of 2002 as well as SEC rules relating to internal controls over financial reporting, which require that our management annually evaluate the effectiveness of our internal control over financial reporting and disclose the results of that evaluation in this Annual Report. In addition, SEC rules require that our independent auditors prepare an attestation report regarding the effectiveness of our internal control over financial reporting. Our management’s report, and our independent auditors’ attestation report, on internal controls for the year ended December 31, 2009 do not address Sadia’s internal control over financial reporting. We may find it necessary to incur expenses and spend time to correct deficiencies and implement additional training. If these deficiencies are serious, and if we cannot remedy them before the filing of our Annual Report on Form 20-F for the next fiscal year, we may not be able to conclude that our internal controls are effective. If this were to occur, investors might lose confidence in our financial statements.

 

Risks Relating to Our Indebtedness

 

We are highly leveraged, especially since our business combination with Sadia, and our leverage could negatively affect our ability to refinance our indebtedness and grow our business.

 

At December 31, 2009, we had total consolidated debt of R$8.8 billion (U.S.$5.1 billion). A significant portion of our consolidated indebtedness was incurred by Sadia.  As of December 31, 2008, Sadia had total debt of R$8,844.3 million, of which 42.2% (R$3,729.6 million) was denominated in Brazilian reais and 57.8% (R$5,114.7 million) was denominated in foreign currency (primarily U.S. dollars). In addition, as of December 31, 2008, Sadia had R$913.6 million of negative working capital (defined as total current assets minus total current liabilities) and off-balance sheet obligations in the aggregate amount of R$537.7 million. Although, during the year ended  December 31, 2009, Sadia repaid real-denominated debt in the amount of R$930.2 million and U.S. dollar-denominated debt in the amount of U.S.$1,362.7 million, its outstanding indebtedness remains substantial.

 

Our significant level of indebtedness could have important consequences for us, including:

 

         requiring that a substantial portion of our cash flows from operations be used for the payment of principal and interest on our debt, reducing the funds available for our operations or other capital needs;

 

         limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate because our available cash flow after paying principal and interest on our debt might not be sufficient to make the capital and other expenditures necessary to address these changes;

 

         increasing our vulnerability to general adverse economic and industry conditions because, during periods in which we experience lower earnings and cash flows, we would be required to devote a proportionally greater amount of our cash flows to paying principal and interest on debt;

 

         limiting our ability to obtain additional financing in the future to fund working capital, capital expenditures, acquisitions and general corporate requirements;

 

         making it difficult for us to refinance our indebtedness or to refinance such indebtedness on terms favorable to us, including with respect to existing accounts receivable securitizations;

 

         placing us at a competitive disadvantage compared to competitors that are relatively less leveraged; and

 

         that may be better positioned to withstand economic downturns; and

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          exposing our current and future borrowings made at floating interest rates to increases in interest rates.

 

We have substantial debt that matures in each of the next several years and may not be able to comply with our upcoming payment obligations.

 

As of December 31, 2009, we had R$2.9 billion of debt that matures through December 31, 2010, R$1.8 billion of debt that matures in 2011, R$2.2 billion of debt that matures in 2012, R$0.9 billion of debt that matures in 2013 and R$1.0 billion of debt that matures in 2014 and thereafter. We may face difficulties in paying that debt as it matures.

 

A substantial portion of our outstanding debt is denominated in foreign currencies, primarily U.S. dollars. As of December 31, 2009, we had R$4.6 billion of foreign currency debt, including R$1.0 billion of short-term foreign currency debt. Our U.S. dollar-denominated debt must be serviced by funds generated from sales by our subsidiaries, the majority of which are not denominated in U.S. dollars. Consequently, when we do not generate sufficient U.S. dollar revenues to cover that debt service, we must use revenues generated in reais or other currencies to service our U.S. dollar-denominated debt. Depreciation in the value of the real or any of the other currencies of the countries in which we operate, compared to the U.S. dollar, could adversely affect our ability to service our debt. For example, in 2009, the real appreciated approximately 25.5% against the U.S. dollar, the Euro appreciated approximately 2.5% against the U.S. dollar and the British sterling pound appreciated approximately 10.8% against the U.S. dollar. Foreign currency hedge agreements may not be effective in covering these currency-related risks.

 

The global stock and credit markets have recently experienced extreme disruption, including severely diminished liquidity, constrained credit availability and extreme volatility in securities prices. The global economic and financial crisis has also significantly affected demand in our principal foreign markets, leading to decreases in our average selling prices. These factors and the continuing market disruption may have an adverse effect on our ability to refinance future maturities. Continued uncertainty in the stock and credit markets may also negatively impact our ability to access additional short-term and long-term financing, which could negatively impact our liquidity and financial condition. If, in future years:

 

         the current pressures on credit continue or worsen,

 

         our operating results worsen significantly,

 

         we are unable to complete any necessary divestitures of non-core assets and our cash flow or capital resources prove inadequate, or

 

         we are unable to refinance any of our debt that becomes due,

 

we could face liquidity problems and may not be able to pay our outstanding debt when due, which could have a material adverse effect on our consolidated business and financial condition.

 

The terms of our indebtedness impose significant operating and financial restrictions on us.

 

The instruments governing our consolidated indebtedness impose significant operating and financial restrictions on us. These restrictions may limit, directly or indirectly, our ability, among other things, to undertake the following actions:

 

          borrow money;

 

          make investments;

 

          sell assets, including capital stock of subsidiaries;

 

          guarantee indebtedness;

 

          enter into agreements that restrict dividends or other distributions from certain subsidiaries;

 

          enter into transactions with affiliates;

 

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          create or assume liens; and

 

          engage in mergers or consolidations.

 

Although the covenants to which we are subject have exceptions and qualifications, the breach of any of these covenants could result in a default under the terms of other existing debt obligations. Upon the occurrence of such an event of default, all amounts outstanding under the applicable debt instruments and the debt issued under other debt instruments containing cross-default or cross-acceleration provisions, together with accrued and unpaid interest, if any, might become or be declared immediately due and payable. If such indebtedness were to be accelerated, we may have insufficient funds to repay in full any such indebtedness. In addition, in connection with the entry into new financings or amendments to existing financing arrangements, our subsidiaries’ financial and operational flexibility may be further reduced as a result of more restrictive covenants, requirements for security and other terms.

 

Risks Relating to Brazil

 

Brazilian economic, political and other conditions, and Brazilian government policies or actions in response to these conditions, may negatively affect our business and results of operations.

 

The Brazilian economy has historically been characterized by interventions by the Brazilian government and unstable economic cycles. The Brazilian government has often changed monetary, taxation, credit, tariff and other policies to influence the course of Brazil’s economy. For example, the government’s actions to control inflation have at times involved setting wage and price controls, blocking access to bank accounts, imposing exchange controls and limiting imports into Brazil. We have no control over, and cannot predict, what policies or actions the Brazilian government may take in the future.

 

Our business, results of operations, financial condition and prospects, as well as the market prices of our common shares or the ADSs, may be adversely affected by, among others, the following factors:

 

          exchange rate movements;

 

          exchange control policies;

 

          expansion or contraction of the Brazilian economy, as measured by rates of growth in GDP;

 

          inflation;

 

          tax policies;

 

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

 

          interest rates;

 

          energy shortages;

 

          liquidity of domestic capital and lending markets; and

 

          social and political instability.

 

These factors, as well as uncertainty over whether the Brazilian government may implement changes in policy or regulations relating to these factors, may adversely affect us and our business and financial performance and the market price of our common shares and ADSs.

 

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Inflation, and government measures to curb inflation, may adversely affect the Brazilian economy, the Brazilian securities market, our business and operations, financial condition and the market prices of our common shares or the ADSs.

 

Brazil experienced high rates of inflation in the past. According to the General Market Price Index (Índice Geral de Preços do Mercado) or “IGP-M,” a general price inflation index, the inflation rates in Brazil were 1.2% in 2005, 3.8% in 2006, 7.7% in 2007, 9.8% in 2008 and (1.7)% in 2009. In addition, according to the IPCA, published by the IBGE, the Brazilian consumer price inflation rates were 5.7% in 2005, 3.1% in 2006, 4.5% in 2007, 5.8% in 2008 and 4.3% in 2009 and 2.1% in the three months ended March 31, 2010.

 

The Brazilian government’s measures to control inflation have often included maintaining a tight monetary policy with high interest rates, thereby restricting availability of credit and reducing economic growth. Inflation, actions to combat inflation and public speculation about possible additional actions have also contributed materially to economic uncertainty in Brazil in the past and to heightened volatility in the Brazilian securities markets.

 

Brazil may experience high levels of inflation in future periods. Periods of higher inflation may slow the rate of growth of the Brazilian economy, which could lead to reduced demand for our products in Brazil and decreased net sales. Inflation also is likely to increase some of our costs and expenses, which we may not be able to pass on to our customers and, as a result, may reduce our profit margins and net income. In addition, high inflation generally leads to higher domestic interest rates, and, as a result, the costs of servicing our debt may increase, resulting in lower net income. Inflation and its effect on domestic interest rates can, in addition, lead to reduced liquidity in the domestic capital and lending markets, which could affect our ability to refinance our indebtedness in those markets and may have an adverse effect on our business, results of operations, financial condition and the market price of our common shares and the ADSs.

 

Exchange rate movements may adversely affect our financial condition and results of operations.

 

The Brazilian currency has been devalued frequently over the past four decades. Throughout this period, the Brazilian government has implemented various economic plans and 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. From time to time, there have been significant fluctuations in the exchange rate between the Brazilian currency and the U.S. dollar and other currencies. In 2005, 2006 and 2007 the real appreciated 13.4%, 9.5% and 16.3%, respectively, against the U.S. dollar. In 2008, the real depreciated 31.9% against the U.S. dollar. In 2009, the real appreciated 25.5% against the U.S. dollar.

 

Any appreciation of the real against the U.S. dollar may lead to a deterioration of the country’s current account and the balance of payments, as well as to a dampening of export-driven growth. Our production costs are denominated in reais, but our export sales are mostly denominated in U.S. dollars or Euros. Financial revenues generated by exports are reduced when translated to reais in the periods in which the real appreciates in relation to the U.S. dollar. Any such appreciation could reduce the competitiveness of our exports and adversely affect our net sales and our cash flows from exports.

 

Devaluation of the real against the U.S. dollar could create additional inflationary pressures in Brazil by increasing the price of imported products and requiring deflationary government policies. In addition, the prices of soy meal and soybeans, important ingredients of our animal feedstock, are closely linked to the U.S. dollar, and many of the mineral nutrients added to our feedstock must be purchased in U.S. dollars.

 

The price of corn, another important ingredient of our feedstock, is also linked to the U.S. dollar to a lesser degree. In addition to feedstock ingredients, we purchase sausage casings, breeder eggs, packaging and other raw materials, as well as equipment for use in our production facilities, from suppliers located outside Brazil whom we must pay in U.S. dollars or other foreign currencies. When the real depreciates against the U.S. dollar, the cost in reais of our U.S. dollar-linked raw materials and equipment increases, and these

increases could materially adversely affect our results of operations.

 

We had total foreign currency-denominated debt obligations in an aggregate amount of R$4,579.6 million at December 31, 2009, representing 52% of our total consolidated indebtedness at that date. A significant portion of our consolidated debt is denominated in foreign currencies because export credit facilities available in foreign currencies often have attractive financing conditions and costs compared to other financing sources.

 

However, these foreign-currency denominated credit facilities also expose us to a greater degree of foreign exchange risk. We manage a portion of our exchange rate risk through foreign currency swaps and investments, and cash flows from export sales are in U.S. dollars and other foreign currencies, but our foreign currency debt obligations are not completely hedged. At December 31, 2009, our short-term consolidated exchange rate exposure was R$1,000.1 million of the amount described above. A significant devaluation of the real in relation to the U.S. dollar or other currencies could increase the debt service requirements of our foreign currency-denominated obligations.

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Fluctuations in interest rates may have an adverse effect on our business, financial condition and the market prices of our common shares or the ADSs.

 

The Central Bank establishes the basic interest rate target for the Brazilian financial system by reference to the level of economic growth of the Brazilian economy, the level of inflation and other economic indicators. The basic interest rate increased in 2003 until June when the Central Bank began to decrease it, reaching 11.25% in April 2008. In 2008, the Central Bank reversed the trend, increasing the basic interest rate to 13.75%. In 2009, the Central Bank decreased the basic interest rate to 8.75%.

At December 31 2009, approximately 62% of our total liabilities from indebtedness and derivative instruments of R$8,798.1 was either (1) denominated in (or swapped into) reais and bears interest based on Brazilian floating interest rates, such as the Long-Term Interest Rate (Taxa de Juros de Longo Prazo), or “TJLP,” the interest rate used in our financing agreements with Brazilian National Bank for Economic and Social Development (Banco Nacional de Desenvolvimento Econômico e Social — BNDES), or “BNDES,” and the Interbank Deposit Certificate Rate (Certificado de Depósito Interbancário), or “CDI” rate, an interbank certificate of deposit rate that applies to our foreign currency swaps and some of our other real-denominated indebtedness, or (2) U.S. dollar-denominated and bears interest based on LIBOR. Any increase in the CDI, TJLP or LIBOR rates may have an adverse impact on our financial expenses and our results of operations.

Changes in tax laws may increase our tax burden and, as a result, negatively affect our profitability.

 

The Brazilian government regularly implements changes to tax regimes that may increase our and our customers’ tax burdens. These changes include modifications in the rate of assessments and, on occasion, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. The Brazilian government has presented certain tax reform proposals, which have been mainly designed to simplify the Brazilian tax system, to avoid internal disputes within and between the Brazilian states and municipalities, and to redistribute tax revenues. The tax reform proposals provide for changes in the rules governing the federal Social Integration Program (Programa de Integração Social), or “PIS,” the federal Contribution for Social Security Financing (Contribuição para Financiamento da Seguridade Social — COFINS), or “COFINS,” the state Tax on the Circulation of Merchandise and Services (Imposto Sobre a Circulação de Mercadorias e Serviços), or “ICMS,” and some other taxes. For example, in early 2008, the Brazilian Federal Government submitted to appreciation of the legislature a new tax reform proposal to change the structure of the current corporate income tax and replace a series of existing taxes for a new value-added tax, among other things. These proposals are not assured to be approved and passed into law. The effects of these proposed tax reform measures and any other changes that result from enactment of additional tax reforms have not been, and cannot be, quantified. However, some of these measures, if enacted, may result in increases in our overall tax burden, which could negatively affect our overall financial performance.

 

Restrictions on the movement of capital out of Brazil may adversely affect your ability to receive dividends and distributions on, or the proceeds of any sale of, our common shares and the ADSs.

 

Brazilian law permits the Brazilian government to impose temporary restrictions on conversions of Brazilian currency into foreign currencies and on remittances to foreign investors of proceeds from their investments in Brazil, whenever there is a serious imbalance in Brazil’s balance of payments or there are reasons to expect a pending serious imbalance. The Brazilian government last imposed remittance restrictions for approximately six months in 1989 and early 1990. The Brazilian government may take similar measures in the future. Any imposition of restrictions on conversions and remittances could hinder or prevent holders of our common shares or the ADSs from converting into U.S. dollars or other foreign currencies and remitting abroad dividends, distributions or the proceeds from any sale in Brazil of our common shares. Exchange controls could also prevent us from making payments on our U.S. dollar-denominated debt obligations and hinder our ability to access the international capital markets. As a result, exchange controls restrictions could reduce the market prices of our common shares and the ADSs.

 

Risks Relating to Our Common Shares and the ADSs

 

Holders of ADSs may find it difficult to exercise voting rights at our shareholders’ meetings.

 

Holders of ADSs may exercise voting rights with respect to our common shares represented by ADSs only in accordance with the deposit agreement governing the ADSs. Holders of ADSs face practical limitations in exercising their voting rights because of the additional steps involved in our communications with ADS holders. For example, we are required to publish a notice of our shareholders’ meetings in specified newspapers in Brazil. Holders of our common shares are able to exercise their voting rights by attending a shareholders’ meeting in person or voting by proxy. By contrast, holders of ADSs will receive notice of a shareholders’ meeting by mail from the ADR depositary if we give notice to the depositary requesting the depository to do so. To exercise their voting rights, holders of ADSs must instruct the ADR depositary on a timely basis. This voting process necessarily takes longer for holders of ADSs than for holders of our common shares. If the ADR depositary fails to receive timely voting instructions for all or part of the ADSs, the depositary will assume that the holders of those ADSs are instructing it to give a discretionary proxy to a person designated by us to vote their ADSs, except in limited circumstances.

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Holders of ADSs also may not receive the voting materials in time to instruct the depositary to vote our common shares underlying their ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions of the holders of ADSs or for the manner of carrying out those voting instructions. Accordingly, holders of ADSs may not be able to exercise voting rights, and they have little, if any, recourse if the common shares underlying their ADSs are not voted as requested.

 

Non-Brazilian holders of ADSs and common shares may face difficulties in protecting their interests because we are subject to different corporate rules and regulations as a Brazilian company and our shareholders may have less extensive rights.

 

Holders of ADSs are not direct shareholders of our company and are unable to enforce the rights of shareholders under our bylaws and the Brazilian Corporation Law.

 

Our corporate affairs are governed by our bylaws and the Brazilian Corporation Law, which differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States, such as the State of Delaware or New York, or elsewhere outside Brazil. Even if a holder of ADSs surrenders its ADSs and becomes a direct shareholder, its rights as a holder of our common shares under the Brazilian Corporation Law to protect its interests relative to actions by our board of directors or executive officers may be fewer and less well-defined than under the laws of those other jurisdictions.

 

Although insider trading and price manipulation are crimes under Brazilian law, the Brazilian securities markets are subject to different levels of regulations and supervision than the U.S. securities markets or the markets in some other jurisdictions. In addition, rules and policies against self-dealing or for preserving shareholder interests may be less well-defined and enforced in Brazil than in the United States and certain other countries, which may put holders of our common shares and the ADSs at a potential disadvantage. Corporate disclosures also may be less complete or informative than for a public company in the United States or in certain other countries.

 

Non-Brazilian holders of ADSs and common shares may face difficulties in serving process on or enforcing judgments against us and other persons.

 

We are a corporation (sociedade anônima) organized under the laws of Brazil, and all of our directors and executive officers and our independent public accountants reside or are based in Brazil. Most of the assets of our company and of these other persons are located in Brazil. As a result, it may not be possible for non-Brazilian holders of ADSs and common shares to effect service of process upon us or these other persons within the United States or other jurisdictions outside Brazil or to enforce against us or these other persons judgments obtained in the United States or other jurisdictions outside Brazil. Because judgments of U.S. courts for civil liabilities based upon the U.S. federal securities laws may only be enforced in Brazil if certain conditions are met, holders may face greater difficulties in protecting their interests in the case of actions by us or our directors or executive officers than would shareholders of a U.S. corporation.

 

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

 

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

 

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Holders of ADSs and non-Brazilian holders of our common shares may be unable to exercise preemptive rights and tag-along rights with respect to our common shares underlying the ADSs.

 

Holders of ADSs and non-Brazilian holders of our common shares may be unable to exercise the preemptive rights and tag-along rights relating to our common shares (including common shares underlying ADSs) unless a registration statement under the U.S. Securities Act of 1933, as amended, or the “Securities Act,” is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement with respect to the shares relating to these preemptive rights, and we cannot assure you that we will file any such registration statement. Unless we file a registration statement or an exemption from registration is available, a holder may receive only the net proceeds from the sale of his or her preemptive rights or tag-along, or if these rights cannot be sold, they will lapse and the holder will receive no value from them.

 

Provisions in our bylaws may prevent efforts by our shareholders to change our control or management.

 

Our bylaws contain provisions that may discourage, delay or make more difficult a change in control of our company or removal of our directors. Subject to limited exceptions, these provisions require any shareholder that acquires shares representing 20% or more of our share capital to, within 30 days from the date of such acquisition, commence a tender offer with respect to all of our share capital for a price per share equivalent to the greatest of: (1) the economic value of our company, which shall be equivalent to the arithmetic average of the mean points of the economic value ranges obtained in two appraisal reports prepared based on the discounted cash flow method, as long as the variation between these mean points shall not exceed 10%, in which case the economic value shall be determined through arbitration; (2) 135% of the issue price of the shares issued in any capital increase through a public offering that takes place within the 24-month period before the date on which the public offering shall become mandatory, duly adjusted in accordance with the IPCA variation up to the date of payment; and (3) 135% of the unit price of our shares within the 30-day period before the public offering. These provisions of our bylaws may delay, defer or prevent a transaction or a change in control that might otherwise be in the best interests of our shareholders.

 

Holders of ADSs could be subject to Brazilian income tax on capital gains from sales of ADSs.

 

Historically, any capital gain realized on a sale or other disposition of ADSs between non-Brazilian holders outside Brazil was not subject to Brazilian income tax. However, a December 2003 Brazilian law (Law No. 10,833) provides that “the acquirer, individual or legal entity resident or domiciled in Brazil, or the acquirer’s attorney-in-fact, when such acquirer is resident or domiciled abroad, shall be responsible for the retention and payment of the income tax applicable to capital gains earned by the individual or legal entity resident or domiciled abroad who disposes of property located in Brazil.” The Brazilian tax authorities have issued a normative instruction confirming that they intend to assess income tax on capital gains earned by non-Brazilian residents whose assets are located in Brazil. It is unclear whether ADSs representing our common shares, which are issued by the ADR depositary outside Brazil, will be deemed to be “property located in Brazil” for purposes of this law. Accordingly, we cannot determine whether Brazilian tax authorities will attempt to tax any capital gains arising from the sale or other disposition of the ADSs, even when the transaction is consummated outside Brazil between non-Brazilian residents.

 

Brazilian taxes may apply to a gain realized by a non-Brazilian holder on the disposition of common shares to another non-Brazilian holder.

 

The gain realized by a non-Brazilian holder on the disposition of common shares to another non-Brazilian holder (other than a disposition of shares held pursuant to Resolution No. 2,689, as amended, of the CMN) is generally viewed as being subject to taxation in Brazil. Pursuant to Law No. 10,833/03, Brazilian tax authorities may assess income tax on capital gains earned by non-Brazilian residents in transactions involving assets that are located in Brazil. In this case, the tax rate applicable on the gain would be 15% (or 25% in the case of a non-Brazilian holder organized under the laws of or a resident of a tax haven). For additional discussion of the tax consequences of a disposition of our common shares, see “Item 10. Additional Information¾Taxation.”

 

The relative volatility and limited liquidity of the Brazilian securities markets may negatively affect the liquidity and market prices of our common shares and the ADSs.

 

The Brazilian securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States. The BM&F Bovespa - Securities, Commodities & Futures Exchange, or the “São Paulo Stock Exchange,” had a total market capitalization of R$2,334.7 billion, or U.S.$1,340.9 billion, at December 31, 2009 and an average daily trading volume of R$5,286.8 million in 2009. By contrast, the New York Stock Exchange had a market capitalization of U.S.$12.9 trillion at December 31, 2009 (U.S. domestic listed companies) and an average daily trading volume of U.S.$69.7 billion in 2009. The Brazilian securities markets are also characterized by considerable share concentration.

 

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The ten largest companies in terms of market capitalization represented approximately 56.4% of the aggregate market capitalization of the São Paulo Stock Exchange at December 31, 2009. In addition, the ten most widely traded stocks in terms of trading volume accounted for approximately 50.4% of all shares traded on the São Paulo Stock Exchange in 2009. These market characteristics may substantially limit the ability of holders of the ADSs to sell common shares underlying ADSs at a price and at a time when they wish to do so and, as a result, could negatively impact the market prices of these securities.

 

Developments and the perception of risks in other countries, especially emerging market countries, may adversely affect the market prices of our common shares and the ADSs.

 

The market for securities issued by Brazilian companies is influenced, to varying degrees, by economic and market conditions in other emerging market countries. Although economic conditions are different in each country, the reaction of investors to developments in one country may cause the capital markets in other countries to fluctuate. Developments or adverse economic conditions in other emerging market countries have at times resulted in significant outflows of funds from, and declines in the amount of foreign currency invested in, Brazil. For example, in 2001, after a prolonged recession, followed by political instability, Argentina announced that it would no longer continue to service its public debt. The economic crisis in Argentina negatively affected, for several years, investors’ perceptions of Brazilian securities. Economic or political crises in Latin America or other emerging markets may significantly affect perceptions of the risk inherent in investing in the region, including Brazil.

 

The Brazilian economy also is affected by international economic and market conditions generally, especially economic and market conditions in the United States. Share prices on the São Paulo Stock Exchange, for example, have historically been sensitive to fluctuations in U.S. interest rates as well as movements of the major U.S. stock indexes.

 

Developments in other countries and securities markets could adversely affect the market prices of our common shares or the ADSs and could also make it more difficult for us to access the capital markets and finance our operations in the future on acceptable terms or at all.

 

We may become a passive foreign investment company, which could result in adverse U.S. tax consequences to U.S. investors.

 

Based on our financial statements, relevant market and shareholder data, and the projected composition of our income and valuation of our assets, including goodwill, we do not believe that we were a passive foreign investment company, or “PFIC,” for U.S. federal income tax purposes for 2009, and we do not expect to be a PFIC for 2010 or in the future, although we can provide no assurances in this regard. If we become a PFIC, U.S. holders of our common shares or ADSs may become subject to increased tax liabilities under U.S. tax laws and regulations and will become subject to burdensome reporting requirements. The determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and assets from time to time. Specifically, for any taxable year we will be classified as a PFIC for U.S. tax purposes if either (i) 75% or more of our gross income in that taxable year is passive income or (ii) the average percentage of our assets (which includes cash) by value in that taxable year which produce or are held for the production of passive income is at least 50%. The calculation of the value of our assets will be based, in part, on the quarterly market value of our common shares and ADSs, which is subject to change. See “Item 10. Additional Information¾E. Taxation¾U.S. Federal Income Tax Considerations¾Passive Foreign Investment Company.”

 

ITEM 4.   INFORMATION ON THE COMPANY

A.  History and Development of the Company.

 

Corporate History

 

BRF-Brasil Foods S.A. is a publicly held company in Brazil and is, therefore subject to the requirements of the Brazilian Corporation Law and the rules and regulations of the CVM.

 

We were founded by the Brandalise and Ponzoni families in 1934 as Ponzoni, Brandalise e Cia, in the southern State of Santa Catarina and remained under the Brandalise family’s management until September 1994. In 1940, we expanded our operations from general trading, with an emphasis on food and food-related products, to include pork processing. During the 1950s, we entered the poultry processing business. During the 1970s, we broadened the distribution of our products to include export markets, starting with Saudi Arabia. From 1980 through 1990, we expanded our export markets to include Japan in 1985 and Europe in 1990. We also undertook a series of acquisitions in the poultry and pork processing business and made investments in other businesses.

 

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From 1990 through 1993, we suffered substantial losses because of increased financial expenses, underinvestment in product development, limited capacity and modest marketing of our products. By September 1994, we faced a liquidity crisis, as a result of which the Brandalise family sold their interest in our company, consisting of 80.68% of our common shares and 65.54% of our preferred shares, to eight pension funds:

 

•     PREVI-Caixa de Previdência dos Funcionários do Banco do Brasil, or “PREVI,” the pension fund of employees of Banco do Brasil S.A.;

 

•     Fundação Telebrás de Seguridade Social-SISTEL, or “SISTEL,” the pension fund of employees of Telecomunicações Brasileiras S.A.-Telebrás;

 

•     PETROS-Fundação Petrobras de Seguridade Social, or “PETROS,” the pension fund of employees of Petróleo Brasileiro S.A.-Petrobras;

 

•     Real Grandeza Fundação de Assistência e Previdência Social, or “Real Grandeza,” the pension fund of employees of Furnas Centrais Elétricas S.A.-Furnas;

 

•     Fundação de Assistência e Previdência Social do BNDES-FAPES, or “FAPES,” the pension fund of employees of Banco Nacional de Desenvolvimento Economico e Social-BNDES;

 

•     PREVI-BANERJ-Caixa de Previdência dos Funcionários do Banerj, or “PREVI-BANERJ,” the pension fund of employees of Banco do Estado do Rio de Janeiro S.A.;

 

•     VALIA-Fundação Vale do Rio Doce, or “VALIA,” the pension fund of employees of Companhia Vale do Rio Doce; and

 

•     TELOS-Fundação Embratel de Seguridade Social, or “TELOS,” the pension fund of employees of Empresa Brasileira de Telecomunicações-Embratel.

 

Upon acquiring control of our company, the eight original pension funds hired a new team of executive officers who restructured management and implemented capital increases and modernization programs. Our new management engaged in a corporate restructuring, disposed of or liquidated non-core business operations and improved our financial structure.

 

Five of the eight original pension funds remain our shareholders, TELOS and PREVI-BANERJ sold all of their shares in our company in 2003 and October 2007, respectively. Real Grandeza sold its shares in 2008 and 2009. See “Item 7.  Major Shareholders and Related Party Transactions¾A. Major Shareholders.”

 

On March 6, 2006, the Pension Funds entered into a shareholders’ voting agreement related to the common shares they, directly or indirectly, held at the date of its first amendment executed on April 12, 2006, which represented 49.0% of our common shares. We no longer have outstanding preferred shares following our April 2006 share reclassification. As of December 31, 2009, the Pension Funds, directly or indirectly, held 28.0% of our common shares.

 

On May 19, 2009, we signed a merger agreement with Sadia for a business combination of the two companies. Under the business combination, Sadia became our wholly-owned subsidiary. See “—Recent Acquisitions and Investments¾Sadia.”

 

Corporate Structure

 

We are an operating company incorporated under Brazilian law, and we conduct business through our operating subsidiaries. The following table sets forth our significant subsidiaries.

 

Subsidiary  Country of Incorporation  Business  Interest in Equity As of December 31, 2009 
Crossban Holdings GMBH  Austria  Holding company of international subsidiaries  100% 
Perdigão International Ltd.  Cayman Islands  Principal export subsidiary  100% 
Perdigão Europe Ltd.  Portugal  Distributor for exports to the European Union  100% 
Plusfood Group BV  The Netherlands  Holding company of international subsidiaries  100% 
HFF Participações S.A.  Brazil  Holding company formed by the controlling shareholders of Sadia  100% 
Sadia S.A.  Brazil  Operating subsidiary  66.85% 


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The chart below shows the simplified corporate structure of our company.

 

 

Our principal executive offices are located at Avenida Escola Politécnica, 760, Jaguaré, 05350-901, São Paulo, SP, Brazil, and our telephone number at this address is +55-11-3718-5301/5306. Our internet address is www.brasilfoods.com/ir. The information on our website is not incorporated by reference into this Annual Report.

 

Recent Acquisitions and Investments

 

Since 2006, the Company has experienced significant changes guided by its growth plan, which is based on several acquisitions and entry into new businesses. As result of these acquisitions, the Company has grown and diversified its business, increasing its share in the chicken and pork products markets and entering into the milk, margarine and beef markets.

 

Within this process of growth, the Company has undergone a comprehensive corporate reorganization, aimed at maintaining the sustainability of the Company’s business by simplifying its corporate structure and reducing costs of operation, tax and financing, and those related to the reorganization of its operational activities. The relevant transactions since January 1, 2009 are described below.

 

Business Combination with Sadia

 

On May 19, 2009, we signed a merger agreement with Sadia for a business combination of the two companies. Under the business combination, Sadia became our wholly-owned subsidiary. Holders of common shares and preferred shares of Sadia received common shares of our company, and holders of American Depositary Shares representing preferred shares of Sadia received ADSs representing common shares of our company.

 

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A number of steps of the merger were approved at separate extraordinary general meetings held on July 8, 2009 of the common shareholders of Perdigão, Sadia, and HFF, a holding company formed by the controlling shareholders of Sadia for purposes of the acquisition. As a result of these meetings:

 

•    Perdigão changed its corporate name to BRF – Brasil Foods S.A., moved its headquarters to Itajaí in the State of Santa Catarina, and changed its certificate of incorporation so that its Board of Directors has eleven members and a co-chairman structure;

 

•    Concórdia Holding, parent company of Concórdia Corretora (a broker-dealer owned by Sadia) and Concórdia Bank (a bank owned by Sadia), is not part of the merger and, consequently, was sold to Sadia’s shareholders before the business combination with BRF;

 

•    holders of common shares of HFF received 0.166247 common shares of BRF for each share they held without any further action by those holders; and

 

•    HFF became a wholly-owned subsidiary of BRF.

 

Additional separate extraordinary meetings of the common shareholders of Perdigão and Sadia took place on August 18, 2009. As a result of these meetings, holders of common and preferred shares of Sadia received 0.132998 common shares of BRF for each common share or preferred share, respectively, they held without any further action by those holders.  In addition, Sadia became our wholly-owned subsidiary. The business combination became fully effective on September 22, 2009.

 

We believe the merger aligns with the strategic growth plan of the two companies in both the domestic and foreign markets and will allow BRF and Sadia to coordinate their operations. We believe that this business combination will be a positive step, by allowing the companies to generate economic synergies.

 

As described above, BRF amended its certificate of incorporation to expand the Board of Directors, three of whom were elected by the former controlling shareholders of Sadia and are expected to serve until the 2011 general shareholders’ meeting. The Board of Directors of BRF currently has a co-chairman structure, where neither of the co-chairmen has a casting vote in the case of a tie.

 

The business combination remains subject to review by the antitrust authorities in Brazil. On July 7, 2009, we entered into an agreement with the Brazilian antitrust authorities under which we agreed to ensure the reversibility of the business combination until a final decision is made by these authorities. The agreement, among other things, prevents our company and Sadia from integrating their administrative, production and commercial operations. On September 18, 2009, the Brazilian antitrust authorities authorized the coordination of the companies’ activities directed towards the export market for “in natura” meats. On January 20, 2010, the Brazilian antitrust authorities authorized our company and Sadia to jointly negotiate and acquire raw materials and services (such as grains, packaging material and “in natura” beef), although not purchases of poultry or hogs. However, for our other activities, we continue to be subject to our reversibility agreement during the review period by the Brazilian antitrust authorities. The Brazilian antitrust authorities may decide to impose significant conditions or performance commitments on the combined company, including commitments to divest from certain businesses, risks and product lines, trademarks or production facilities.

In Europe, analysis by the relevant antitrust authorities was a pre-condition to closing a business combination. On June 29, 2009, the European antitrust authority formally agreed to the association as set forth in the merger agreement.

 

Construction Projects

 

The most significant investment of Sadia in the period between 2007 and 2009 was the agroindustrial site of Lucas do Rio Verde, in the State of Mato Grosso. This project contemplated the construction of a poultry slaughtering unit, one pork slaughtering unit and one processing unit. The total estimated investment amounted to approximately R$869.7 million, most of which came from the Company and the remaining from a group of outgrowers. The outgrowers were indirectly financed by BNDES to build the pork and poultry farms that feed the agroindustrial plant. Construction started in the second half of 2006, and the plant start-up occurred in the second half of 2008 with the slaughtering of poultry and the production of processed products. It is estimated that this project will be fully operational by the end of 2010. The project contemplates that 190 broiler modules (which together produce 500,000 day-old chicks per day) and 115 hog modules (which together produce 5,000 piglets per day) will be equipped with advanced technology to ensure animal wellness, higher productivity and, therefore, better competitiveness. Currently, the plant operates at 67% of its full capacity utilization. By the end of 2009, the total investment in the Lucas do Rio Verde project was R$838.9 million.


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Besides starting up its largest plant in Brazil in Lucas do Rio Verde (State of Mato Grosso), Sadia is building its first plant in the northeast region, in Vitória de Santo Antão (State of Pernambuco). By the end of 2009, the total investment in this plant was R$242.1 million, and its expected completion is in 2010.

 

Sadia Joint Venture with Kraft

 

In 2008, Sadia and Kraft entered into an association agreement to form a joint venture called K&S Alimentos S.A. (“K&S”).  K&S’s main purpose is to produce and distribute cheese and spreadable products, such as cream cheese and “requeijão,” a Brazilian soft cheese.  Sadia and Kraft also entered into licensing agreements with K&S in 2008.  Sadia has licensed its trademarks, such as “Sadia,” “S,” “Sadia Speciale,” and “Sadia Vita Light,” to K&S, and Kraft has licensed its “Philadelphia” trademark to K&S.

Capital Expenditures

 

In 2009, we recorded capital expenditures of R$693.2 million, a 9.3% increase compared to 2008.  Sadia’s capital expenditures represented R$114.2 million, and 38.5% of this amount is related to the construction of the Lucas do Rio Verde and Vitória de Santo Antão agroindustrial units.

 

The remaining R$579.0 million in 2009 was allocated to (1) expansion and enhancement of productivity projects and (2) new projects, such as new lines of products.  In addition, we spent R$368 million to replenish poultry/hog breeder stock, which is not included in the table below.

 

On May 26, 2009, we received R$107.0 million from the BNDES for investment projects relating to capacity expansion in production facilities in the states of Rio Grande do Sul and Santa Catarina, distribution centers in the states of Ceará, Paraná and São Paulo as well as corporate projects in the São Paulo and Itajaí, Santa Catarina offices.

Currently, we are concentrating our investments in the construction of our facilities in Três de Maio, Rio Grande do Sul, Lucas do Rio Verde, Mato Grosso and Vitória de Santo Antão, Pernambuco, as well as in our improvement and necessary maintenance projects.

 

We also have projects funded by FINEP (a government provider of funds for studies and projects) relating to technological improvements such as (1) optimization of technological systems for production and processing poultry and swine products in the amount of over R$100.0 million and (2) for dairy products, study and development of a pilot program for the integration and retention of milk producers, in the amount of over R$67.3 million.

 

The table below sets forth our capital expenditures for the periods indicated, which do not include business combinations or other acquisitions of businesses:

 

  Year Ended December 31, 
  2009  2008  2007 
  (in millions of reais)
Expansion and enhancement of production facilities  464.1  250.5  164.3 
Araguaia Project - Mineiros Agroindustrial Complex  0.5  6.4  85.7 
Bom Conselho Agroindustrial Complex  73.0  84.6  – 
Três de Maio – powdered milk processing unit  27.9  –  – 
Lucas do Rio Verde – agroindustrial unit  27.2  –  – 
Vitória de Santo Antão – agroindustrial unit  16.9  –  – 
New projects  25.1  286.9  259.7 
Other capital expenditures  58.5  6.1  – 
Total capital expenditures  693.2  634.5  509.7 

Major capital expenditures since January 1, 2007 include the following:

 

Construction of a Plant (dairy products). On June 10, 2008, we announced the construction of the sixth powdered milk processing tower in Três de Maio, State of Rio Grande do Sul. This plant will have the capacity to process 2,000 tons of powdered milk per month. We already have a mozzarella cheese plant in the municipality. In 2009, R$27.9 million was invested in this unit.

 

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Bom Conselho Agroindustrial Complex. Following the September 2007 announcement of our plan to build this new agro-industrial complex, construction work continued on schedule until the second quarter of 2009, when the processing unit for dairy products was completed. Capital expenditures in 2009 amounted to approximately R$73 million.

 

Mineiros Agroindustrial Complex. The construction of the agro-industrial complex for processing special poultry and turkeys, with more than two-thirds of its output expected to be exported, was completed in September 2008 and is now operating at full capacity of 81,000 tons of processed products per year.

 

Distribution Centers in Embu, State of São Paulo. Construction of the second phase of the Embu distribution center was completed in the third quarter of 2009, consisting of the installation of a transelevator system, involving robotic inventory processing. This distribution center is responsible for storage and distribution to the entire Southeast region of Brazil and uses the integrated warehouse management system, upgraded with state-of-the art technology and including two mega antechambers, one for delivery and the other for dispatch of merchandise. Capital expenditures in 2009 amounted to R$12.3 million.

 

Automation of cutting room in Capinzal, State of Santa Catarina and expansion of slaughtering capacity in Lajeado, Rio Grande do Sul, and in Mirassol D’Oeste, Mato Grosso. The automation of the cutting room in the processing unit of Capinzal, State of Santa Catarina began in 2009 and is expected to be completed in 2010.

 

The expansion of the pork slaughtering capacity in Lajeado, Rio Grande do Sul, included improvements and technology innovation in the unit. This processes began in October 2008 and was completed in September 2009. In Mirassol D’Oeste, the improvements targeted the expansion of cattle slaughtering unit, which was also completed in 2009, and the expenditures in the year amounted to R$26.4 million.

 

Agroindustrial sites in Lucas do Rio Verde, State of Mato Grosso, and in Vitória do Santo Antão, State of Pernambuco. Since the acquisition, Sadia invested R$44.1 million in its main construction projects in the Midwest and Southeast regions of Brazil.

 

In the first quarter of 2009, we concluded the consolidation of the SAP information technology system involving operations resulting from the acquisition of Eleva (meats and dairy products) with the objective to capture synergies through the integration of processes.

 

As a further measure for optimizing processes to reduce the costs of the dairy product business, the Company reallocated production from Cotochés in Rio Casca in the State of Minas Gerais and Elegê in Ivoti in the State of Rio Grande do Sul to other dairy production units with consequent operational improvement but without reducing volumes.

 

Additionally, meat production was transferred from the Cavalhada unit in the Porto Alegre area in the State of Rio Grande do Sul to the neighboring unit of Lajeado in the State of Rio Grande do Sul where investments were made in expanding productive capacity and in the modernization of installations. This decision will enhance the value added content in the product mix and improve industrial processes and production costs. It will also be instrumental in socio-environmental preservation since the Cavalhada unit was located in a major economic center.

 

In 2010, we expect to make capital expenditures of approximately R$600 million (and an additional estimated R$368.0 million in breeder stock and Sadia’s investment projects).

 

On April 29, 2010, we signed a services agreement with Cooperativa Coopercampos from Santa Catarina under which the cooperative will provide additional hog slaughter capacity to us at a plant that it is constructing in Campos Novos in the State of Santa Catarina. Cooperativa Coopercampos expects to invest a total of R$145 million in the plant, and over time we expect to support their investment by advancing amounts in payment for services rendered, to be secured by a pledge of fixed assets. When it is operational, the plant is expected to have a hog slaughtering capacity of 7,000 heads per day and to help us meet the needs of our export markets.

 

We expect to focus our capital expenditures on finishing projects that are currently in progress and focusing on organic growth and maximizing synergies and integration of the two companies.

Competitive Strengths

 

We believe our major competitive strengths are as follows:

 

•     Leading Brazilian Food Company with Strong Brands and Global Market Presence. We are one of Brazil’s largest food industry companies, with a size and scale that enable us to compete in Brazil and globally. We believe that our leading position allows us to take advantage of market opportunities by enabling us to expand our business and increase our share of international markets.  In 2009 and in 2008, on a combined basis, we slaughtered 1,561.9 million and 1,704.0 million chickens and other poultry and 10.3 million and 9.7 million hogs and cattle, respectively. We sold nearly 5.3 million tons and 5.5 million tons of poultry, pork, beef, milk and processed food products, including dairy products, on a combined basis in the same periods. Our own and licensed brands are highly recognized in Brazil, and the brands that we use in our export markets are well established in those markets.

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•     Extensive Distribution Network in Brazil and in Export Markets. We believe we are one of the only companies with an established distribution network capable of distributing frozen and refrigerated products in virtually any area of Brazil. In addition, we export products to over 140 countries, and we have begun to develop our own distribution capability in Europe, where we sell directly to food processing and food service companies and to local distributors. Our established distribution capabilities and logistics expertise enable us to expand both our domestic and foreign business, resulting in increased sales volumes and broader product lines.

 

•     Low-Cost Producer in Increasingly Global Market. We believe that we have a competitive advantage over producers in some of our export markets due to generally lower feed and labor costs and gains in efficiencies in animal production in Brazil. We have also achieved a scale and quality of production that enables us to compete effectively with major producers in Brazil and other countries. We have implemented a number of programs designed to maintain and improve our cost-effectiveness, including our ATP- Total Service program to optimize our supply chain by integrating demand, production, inventory management and client service functions; our CSP- Shared Services Center, which centralizes our corporate and administrative functions; and MVP-More Value  program to provide our managers with more efficient use of fixed and working capital; and matrix-based budget intended to improve the efficiency of cost management.

 

•     Diversified and Strategic Geographical Location. In the meat business, our slaughterhouses are strategically located in different regions of Brazil (South and Mid-West), which enables us to mitigate the risks arising from export restrictions that may occur in certain regions of the country due to sanitary concerns. Furthermore, the geographical diversity of our plants in 11 Brazilian states enables us to reduce transportation costs due to the proximity to grain-producing regions. Additionally, the geographic diversity of our plants present in 11 states lowers our transportation costs due to the proximity to grain-producing regions, while also being close to the country’s principal export ports. Our dairy operations are based in the principal milk-producing areas of different regions of Brazil, permitting easy access to the consumer market.

 

•     Emphasis on Product Quality and Safety and on a Diversified Product Portfolio. We focus on quality and food safety in all our operations in order to meet customers’ specifications, prevent contamination and minimize the risk of outbreaks of animal diseases. We employ traceability systems that allow us to quickly identify and isolate any farm on which a quality or health concern may arise. We also monitor the health and treatment of the poultry and hogs that we raise at all stages of their lives and throughout the production process. We were the first Brazilian company approved by the European Food Safety Inspection System as qualified to sell processed poultry products to European consumers. We have a diversified product range, which gives us the flexibility to channel our production according to market demand and the seasonality of our products.

 

•     Experienced Management Team. Our senior management is highly experienced and has transformed our company during the last decade into a global business. Most members of our senior management have worked with us for over ten years, and the members of our senior management who joined our company during that period have seasoned experience in their professional capacities. Our management seeks to emphasize best practices in our operations as well as corporate governance, as demonstrated by the listing of our common shares on the Novo Mercado of the São Paulo Stock Exchange, which requires adherence to the highest corporate governance standards of that Exchange.

 

Business Strategy

 

Our overall strategy is to use our competitive advantages as a food company with one of the most diversified chilled and frozen food product portfolios to pursue opportunities for long-term growth, diversifying our sales and reducing our costs with the aim of reducing volatility in our results. We will continue to seek balanced growth and consolidation among the business segments in which we operate (poultry, pork, beef, dairy products and processed food products) and with regard to the domestic and external market, while seeking growth opportunities through food processing activities overseas. The main points of our strategy, applicable to the poultry, pork and beef business segments and to the milk, dairy product, margarine and processed food products are:

 

          Expand Our Core Businesses. We intend to further develop our core businesses of producing and selling poultry, pork, beef, milk, dairy and processed food products by, among other methods, investing in additional production capacity to gain scale and efficiency. For example, we are expanding our Rio Verde Agroindustrial Complex in the mid-western State of Goiás, and we have built a new agroindustrial complex for the processing of turkey, also in Goiás. We have also enlarged our Nova Mutum poultry plant in the State of Mato Grosso to meet long-term demand for chicken meat exports.

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          Diversify Our Product Lines, Focusing on Value-Added Processed Food Products. We intend to continue diversifying our product lines, focusing on processed food products whose prices tend to fluctuate less than our unprocessed poultry and pork cuts and that can be targeted to specific markets. Recent acquisitions include Batávia (milk and dairy products), a beef slaughterhouse, Sino dos Alpes (a specialty meats producer), Paraíso Agroindustrial (which owns a poultry slaughterhouse and animal feed mill) and the Doriana, Delicata and Claybom margarine brands, from Unilever, as well as the assets used in manufacturing them, among others. In 2008, we announced the construction of a dairy and processed products plant in Bom Conselho, in the State of Pernambuco (which started operating in 2009 according to the plan), and the purchase of control of Eleva, in order to include products like powdered milk and cheese in our portfolio and increase our market share in milk and dairy products. In addition, we acquired Cotochés in the State of Minas Gerais. We may pursue other selective acquisitions and/or build new industrial plants to support these strategic goals.

 

          Further Develop Our Domestic and International Customer Base. We seek to continue to strengthen our domestic and international customer base through superior service and quality as well as increased product offerings. We believe there are considerable opportunities to increase penetration of export markets, particularly as we broaden our product lines to include beef products, milk and dairy products and additional processed food products. We are also positioning our company to enter new export markets when existing trade barriers are relaxed or eliminated. Our objective is to pursue balanced growth of our domestic and export businesses. Domestic market sales represented 58.1% of our combined net sales (our net sales added to those of Sadia for the portion of 2009 prior to the business combination), while export market sales represented 41.9% in 2009.

 

          Strengthen Our Global Distribution Network. We are developing our distribution capabilities outside Brazil to enable us to improve our services to existing customers and to expand our foreign customer base. We are focusing on expanding our distribution network in Europe and in the Middle East, so as to broaden our coverage and to support more targeted marketing efforts in these key regions. We are also considering processing some products abroad, to allow us to deliver those products directly to customers in those markets. We may consider selective acquisitions as one way to achieve this goal. In early December 2007, we entered into a purchase agreement with the Dutch holding company Cebeco for the acquisition of Plusfood. Plusfood has three industrial plants in Europe for the manufacture of poultry- and beef-based processed food products, with an installed capacity for manufacturing approximately 20,000 tons per year of finished products.

 

          Continue to Seek Leadership in Low Costs. We are continuing to improve our cost structure in order to remain a low-cost producer and enhance the efficiency of our operations. We seek to achieve greater economies of scale by increasing our production capacity, and we are concentrating our expansion efforts primarily in the mid-western region of Brazil because the availability of raw materials, land, labor, favorable weather and other features allows us to minimize our production costs. We are also continuing to implement new technologies to streamline our production and distribution functions.

 

          Synergies. Our acquisitions during the past two years, especially the incorporation of Eleva, have created important synergies. The business combination with Sadia expanded our businesses in both the Brazilian and international markets. We believe that we will achieve commercial, operational, financial and production synergies in both the medium and long term. We believe our business combination with Sadia aligns with our strategies set forth above in both the domestic and export markets. The business combination brought us a diverse array of processed food, meat and dairy products and customer relationships in both our domestic and export markets that can be integrated with ours. Sadia has distribution networks in Europe, the Middle East and elsewhere around the world, which are consistent with our strategy of focusing on expanding our distribution network in those markets.

 

 

B.  Business Overview

 

Products

 

We are a food company that focuses on the production and sale of poultry, pork, beef cuts, milk, dairy products and processed food products. Our Processed Products include marinated, frozen, whole and cut Chester® rooster and turkey meats, specialty meats, frozen processed meats, frozen prepared entrees, portioned products and sliced products. We also sell margarine, juices, soy products, animal feed, fresh pasta, sweet specialties and sandwiches.

 

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Poultry

 

We produce frozen whole and cut poultries, partridges and quail. We sold 1,315.9 thousand tons of frozen chicken and other poultry products in 2009, compared to 892.9 thousand tons in 2008. Most of our poultry sales are to our export markets.

 

Pork and Beef

 

We produce frozen pork and beef cuts, such as loins and ribs, and whole carcasses. As part of our strategy to diversify our product lines, we introduced beef cuts in December 2005 and intend to increase our sales of beef, particularly to export customers who already purchase poultry or pork from us. We sold 308.4 thousand tons of pork and beef cuts in 2009, compared to 180.9 thousand tons of pork and beef cuts in 2008. Most of our sales of pork cuts are to our export markets. We are developing our export customer base for beef cuts, and we expect that most of our sales of beef cuts will ultimately be in our export markets. We raise hogs but do not raise cattle at our facilities.

 

Milk

 

We entered the dairy business in the second quarter of 2006 through our acquisition of a controlling interest in Batávia. In 2008, we expanded our presence in this market through the acquisition of Eleva. We produce pasteurized and UHT milk, which we sell in our domestic market. We sold 800.8 thousand tons of pasteurized and UHT milk in 2009, and 892.8 thousand tons in 2008, most of it in the domestic market.

 

Processed Food Products

 

We produce processed foods, such as marinated, frozen chicken, Chester® rooster and turkey meat, specialty meats, frozen processed foods, frozen prepared entrees, dairy products, portioned products and sliced products. Part of our strategy is to develop additional processed food products in these and other categories because these products tend to be less price-sensitive than our frozen poultry and pork products. We sold 1,760 thousand tons of processed foods in 2009, compared to 1,196 thousand tons in 2008. Most of our sales of processed foods are to our domestic market. We believe there are opportunities to market value-added products like these to targeted regions and other market segments in Brazil, as well as expanding our sales in the export market.

 

Specialty Meats

 

We process pork to produce specialty meats, such as sausages, ham products, bologna, frankfurters, salamis, bacon and cold meats. We also process chicken and other poultry to produce specialty meats, such as chicken sausages, chicken hot dogs and chicken bologna.

 

Frozen Processed Meats

 

We produce a range of frozen processed poultry, beef and pork products, including hamburgers, steaks, breaded meat products, kibes (a type of Middle Eastern beef patty popular in Brazil), meatballs and ready-to-eat snacks. We also produce soy-based vegetarian products, such as hamburgers and breaded products. We purchase the refined soy meal used to produce these products from third parties.

 

Marinated Poultry

 

We produce marinated and seasoned chickens, roosters (under the Chester® brand) and turkeys. We originally developed the Chester® breed of rooster to maximize the yield of breast and leg cuts. In 2004, we sold our rights to the Chester® breed of rooster to Cobb Vantress, a U.S. poultry research and development company engaged in the production, improvement and sale of broiler breeding stock, and entered into a technology agreement under which Cobb Vantress manages the Chester® breed of rooster. We continue to oversee the production of Chester® roosters in Brazil from hatching to distribution, and we own the trademarks for the Chester® line of products.

 

Dairy Products

 

In the second quarter of 2006, through our acquisition of a controlling interest in Batávia, we entered the dairy products business. In early December 2007, we acquired the remaining 49% interest in Batávia not held by us. In 2008, we expanded our presence in this market through the acquisition of Eleva. We produce and sell a wide range of dairy-based and dairy processed products, ranging from flavored milks, yogurts, fruit juices, soybean-based drinks, cheeses and desserts. We sold 212.3 thousand tons of dairy processed products in 2009 and 250.6 thousand tons in 2008.

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Frozen Prepared Entrees

 

We produce a range of frozen prepared entrees, some of which contain poultry, beef and pork meat that we produce, including those listed below.

 

•     Lasagnas and Pizzas. We produce several varieties of lasagna and pizza. We produce the meat used in these products and buy other raw materials in the domestic market, except for the durum flour used to make the noodles for the lasagna, which we import.

 

•     Vegetables. We sell a variety of frozen vegetables, such as broccoli, cauliflower, peas, French beans, French fries and cassava fries. These products are produced by third parties that deliver them to us packaged, almost all for our Escolha Saudável (“Healthy Choice”) line of products. We purchase most of these products in the domestic market, but we import French fries and peas.

 

•     Cheese Bread. We produce cheese bread, a popular Brazilian bread infused with cheese. We purchase the ingredients in the domestic market, except for the parmesan cheese, which we import.

 

•     Pies and Pastries. We produce a variety of pies and pastries, such as chicken and heart-of-palm pies and lime pies. We produce the meat, sauces and toppings used in our pies and pastries, and we purchase other raw materials, such as heart-of-palm, lime and other fillings from third parties.

 

Margarine

 

We commenced sales of margarine in December 2005. We purchase margarine from an agricultural cooperative supplier for resale by us. We initially sold margarine under two brand names (Turma da Mônica and Borella). In June 2007, we acquired from Unilever the margarine brands Doriana, Delicata and Claybom, as well as the equipment to produce such margarines. We also entered into an strategic agreement with Unilever for the management of the margarine brands Becel and Becel ProActiv in Brazil. We began to sell margarine as part of our strategy to diversify our product lines and to take advantage of our distribution network for refrigerated products.

 

Other

 

We produce animal feed principally to feed poultry and hogs raised by us. However, we also sell less than 4% of the animal feed produced by us to our integrated outgrowers or to unaffiliated customers. In addition, in April 2007, we launched a line of pet food for dogs under the brands Balance and Supper.

 

We produce a limited range of soy-based products, including soy meal and refined soy flour. We also produced soybean oil until July 2005, when we sold our soybean oil plant in Marau in the State of Rio Grande do Sul to Bunge Alimentos because we determined that soybean oil was not a core product of our business.

 

Overview of Brazil’s Poultry, Pork and Beef Position in the World

 

The potential growth of the Brazilian domestic market for processed food, poultry, pork and beef, and Brazil’s low production costs are attractive to international competitors. The main barrier to such companies has been the need to build a comprehensive distribution network in Brazil, as well as to establish a network of outgrowers.

 

Poultry

 

Brazil is the third largest producer, and the leading exporter, of poultry in the world, according to tonnage data compiled by the USDA as of October 2009. Brazil’s production, consumption and export volumes for poultry have increased significantly over the past years, and Brazil was the number one global poultry exporter in 2009. This development can be explained by the production shift of large Brazilian companies’ exports, as well as by the competitiveness of Brazilian poultry. Sanitary problems in the main producing countries such as the Bovine Spongiform Encephalophy (“BSE”) cases in Europe, avian influenza problems in Thailand and both BSE and avian influenza cases in the United States have changed the world poultry trade dynamics. The reduced competition from major exporting countries affected by sanitary issues and the competitive cost of Brazilian poultry favors Brazil as the most competitive exporter of quality poultry cuts. Additionally, several new markets in Eastern Europe, Africa and the Middle East have opened to Brazilian chicken, and the number of markets to which Brazil has access was approximately 140 in 2009. The USDA projects an increase in global production, exports and consumption volumes for poultry for 2010. For Brazil, the USDA estimates volume growth of 4.2% in production, 6.2% in exports and 3.4% in consumption compared to 2009.

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In 2009, the Middle East was the largest market for Brazilian poultry exports, mainly whole poultry. In spite of bad financial conditions to import, countries of the Middle East took the opportunity of lower poultry prices to import more. In 2009, Hong Kong was again the second largest market for Brazil’s poultry exports, mostly poultry parts. Saudi Arabia, traditionally Brazil’s largest single export market for poultry, continues to rank first. Saudi Arabia accounted for nearly 36% of all Brazilian poultry exports to the Middle East. Japan was the third largest destination for Brazilian poultry in 2009, also mainly poultry parts.

 

The following tables identify Brazil’s position within the global poultry industry for the years indicated:

 

 

Primary Poultry Producers  2007  2008(2)  2009(2)  2010(3) 
  (In thousands of tons - “ready to cook” equivalent) 
U.S.A.  18,889  19,357  18,547  18,829 
China  11,296  11,845  12,105  12,506 
Brazil  10,763  11,471  11,417  11,900 
European Union (27 countries)  10,110  10,365  10,440  10,465 
Mexico  2,698  2,868  2,825  2,895 
Others  19,647  20,835  21,443  22,299 
Total  73,403  76,741  76,777  78,894 
 
Primary Poultry Exporters  2007  2008(2)  2009(2)  2010(3) 
  (In thousands of tons - “ready to cook” equivalent) 
Brazil  3,099  3,446  3,313  3,520 
U.S.A.  2,926  3,464  3,232  3,105 
European Union (27 countries)  759  863  830  825 
China  358  285  250  254 
Thailand  296  383  385  420 
Others  527  633  705  766 
Total  7,965  9,074  8,715  8,890 
 
Primary Poultry Consumers  2007  2008(2)  2009(3)  2010(3) 
  (In thousands of tons - “ready to cook” equivalent) 
U.S.A.  15,982  15,858  15,406  15,783 
China  11,450  12,004  12,250  12,637 
European Union (27 countries)  10,127  10,339  10,440  10,470 
Brazil  7,665  8,026  8,105  8,381 
Mexico  3,280  3,508  3,475  3,582 
Russia  2,678  2,847  2,750  2,890 
Others  21,913  23,223  23,687  24,459 
Total  73,095  75,805  76,113  78,202 
(1)   Includes chicken, special poultry and turkey         
(2)   Preliminary data         
(3)   Estimated         
 
Source: USDA, October 2009         

 

Pork

 

Brazil is the fourth largest producer and exporter, and the sixth largest consumer, of pork in the world, according to tonnage data compiled by the USDA. Brazil’s production, consumption and exports of pork have increased over the last  years, except in 2008 and in 2009, when domestic prices were more attractive than export prices, so producers decided to sell their products to internal markets. The USDA projects an increase in global production and consumption of pork in 2009, and an increase of approximately of 8.5% in Brazil’s pork exports for 2010. Higher Brazilian exports reflect better financial conditions of the import countries, mainly Russia and Ukraine, major destinations for Brazilian pork meat.

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Brazilian pork breeding and slaughtering companies continue to increase their efficiency of production. Measured by the average birth rate of piglets, productivity doubled since the 1970s, and the birth rate reached 24 animals per female. Research developments have also contributed to help reduce fat by 31%, cholesterol by 10% and calories by 14% in pork produced in Brazil. This enhancement allows for better productivity of prime cuts, more meat per carcass and more nutritious and healthier meat. In addition, the production increase was also due to better genetic potential of breeders.

 

Russia remains Brazil’s major destination as demand growth exceeds Russian meat producers’ ability to respond. Brazil has been affected less than its competitors by the sharp rise in the price of soy meal and corn as its large processing companies have built large new facilities in the Midwest where soy and corn are more cost competitive than in traditional meat-producing states in the southern part of Brazil. Hong Kong is the second largest market for Brazilian pork exports with a 20.5% market share by volume, followed by Ukraine, the third largest market for Brazilian pork exports, with 9.3% of market share by volume.

 

The following tables identify Brazil’s position within the global pork industry for the years indicated:

 

  World Pork Panorama
Main Pork Producers  2007  2008(1)  2009(2)  2010(2) 
  (In thousands of tons - weight in equivalent carcass) 
China  42,878  46,205  48,500  50,300 
European Union (27 countries)  22,858  22,596  22,000  21,900 
U.S.A.  9,962  10,599  10,446  10,185 
Brazil  2,990  3,015  3,123  3,249 
Russian Federation  1,910  2,060  2,205  2,290 
Vietnam  1,832  1,850  1,850  1,850 
Others  12,155  12,203  12,112  12,109 
Total  94,585  98,528  100,236  101,853 
 
Main Pork Exporters  2007  2008(1)  2009(2)  2010(2) 
  (In thousands of tons - weight in equivalent carcass) 
U.S.A.  1,425  2,117  1,887  2,018 
European Union (27 countries)  1,286  1,726  1,250  1,200 
Canada  1,033  1,129  1,130  1,100 
Brazil  730  625  645  700 
China  350  223  230  240 
Chile  148  142  142  150 
Others  190  185  181  200 
Total  5,162  6,147  5,465  5,608 
 
Main Pork Consumers  2007  2008(1)  2009(2)  2010(2) 
  (In thousands of tons - weight in equivalent carcass) 
China  42,726  46,412  48,300  50,300 
European Union (27 countries)  21,507  21,025  20,800  20,750 
U.S.A.  8,965  8,806  8,925  8,557 
Russian Federation  2,803  3,112  2,954  3,039 
Japan  2,473  2,487  2,494  2,487 
Brazil  2,260  2,390  2,478  2,549 
Others  13,700  14,125  14,071  14,185 
Total  94,434  98,357  100,022  101,867 
(1)    Preliminary data         
(2)    Estimated         
 
Source: USDA, October 2009

 

 

Beef

 

We began to produce beef cuts in the fourth quarter of 2005 for sale in our export markets and in the Brazilian market. Brazil is the largest exporter, the second largest producer and the third largest consumer of beef in the world, according to tonnage data compiled by the USDA. The USDA projects a decrease in global production, consumption and an increase in exports of beef in 2010. We believe that the effects of the economic crisis of 2009 did not fade significantly in the developed countries, and that is why consumption of beef is not expected to grow in 2010. Exports are expected to grow mainly in the developing countries, where economic activity is recovering at a faster pace in comparison to the U.S. and EU-27 economies.

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  World Beef Panorama
Main Beef Producers  2007  2008(1)  2009(1)  2010(2) 
  (In thousands of tons - weight in equivalent carcass) 
United States  12,096  12,163  11,816  11,631 
Brazil  9,303  9,024  8,935  9,290 
China  6,134  6,132  5,764  5,530 
EU-27  8,188  8,090  8,000  7,950 
Argentina  3,300  3,150  3,200  2,800 
India  2,413  2,525  2,660  2,795 
Others  16,925  16,966  16,407  16,409 
Total  58,359  58,050  56,782  56,405 
 
  World Beef Panorama
Main Beef Consumers  2007  2008(1)  2009(1)  2010(2) 
  (In thousands of tons- weight in equivalent carcass)
U.S.A.  12,829  12,452  12,310  12,158 
European Union (27 countries)  8,690  8,352  8,310  8,280 
Brazil  7,144  7,252  7,410  7,445 
China  6,065  6,080  5,751  5,530 
Argentina  2,771  2,732  2,642  2,420 
Mexico  1,961  1,966  1,880  1,920 
Others  18,487  18,616  17,813  18,219 
Total  57,947  57,450  56,116  55,972 
_______________
  World Beef Panorama
Main Beef Exporters  2007  2008(1)  2009(1)  2010(2) 
  (In thousands of tons- weight in equivalent carcass)
Brazil  2,189  1,801  1,555  1,870 
Australia  1,400  1,407  1,390  1,350 
India  678  672  675  700 
U.S.A.  650  856  785  837 
New Zealand  496  533  525  517 
Others  2,158  2,221  2,180  1,932 
Total  7,571  7,490  7,110  7,206 
 
 
(1) Preliminary data         
(2) Estimated         
 
Source: USDA, October 2009         

 

Production Process

 

We are a vertically integrated producer of poultry and pork products. We raise poultry and hogs, produce animal feed, slaughter the animals, process poultry, pork and beef meat to produce processed food products, and distribute unprocessed and processed products throughout Brazil and in our export markets.

 

The following graphic is a simplified representation of our meat production chain.

 

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Meat Production Chain

 

Poultry

 

At the beginning of the poultry production cycle, we purchase breeder chicks in the form of eggs from Cobb of Brazil, an affiliate of Cobb Vantress, Hybrid, Aviagen do Brasil and sometimes from Agrogen. We send these eggs to our grandparent stock farms, where the chicks are hatched and raised, constituting our grandparent breeding stock. The eggs produced by our grandparent breeding stock are then hatched, and our parent breeding stock is produced. In 2009, we maintained an average parent breeding stock of approximately 11.4 million breeders that produce hatchable eggs. We also buy a small percentage of our parent stock from another supplier. The parents produce the hatchable eggs that result in day-old chicks that are ultimately used in our poultry products. We produced 1,588.6 million day-old chicks, including chickens, Chester® roosters, turkeys, partridge and quail in 2009. We hatch these eggs in our 25 hatcheries.

 

We send the day-old chicks, which we continue to own, to outgrowers (i.e., outsourced farmers), whose operations are integrated with our production process. The farms operated by these outgrowers vary in size and are near our slaughtering facilities. These integrated outgrowers are responsible for managing and growing the poultry in their farms under the supervision of our veterinarians. The payments to outgrowers are based on performance rates determined by bird mortality and the feed-to-meat ratio and are designed to cover their production costs and provide net profits. We provide feed, veterinary and technical support to the outgrowers throughout the production process. We have partnership agreements with approximately 26,097 integrated poultry outgrowers. Many of these outgrowers also produce and sell corn that we use to produce animal feed.


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At December 31, 2009, we had a fully automated slaughtering capacity of 30.0 million heads of poultry per week.

 

Pork

 

We produce the majority of the pork we use in our products. We also purchase some pork from local producers (7.5% of our total pork needs in 2009). We purchase the remainder of our pork on the spot market (2.7% of our total pork needs in 2009).

 

To produce pork, we generally purchase piglets from integrated outgrowers near our production facilities, which raise the piglets until they reach a specified weight. The piglet producers either purchase parent breeder hogs from producers such as Agroceres, Dalland, DanBred, Agropecuária Imbuial and Master Agropecuária or purchase young piglets from farmers who own breeder hogs. We transfer these piglets to separate integrated outgrowers who raise the hogs until they reach slaughtering weight. We then transport the hogs from these outgrowers to our slaughtering facilities. We have agreements with a total of approximately 19,345 integrated outgrowers, including piglet producers and hog raisers. We monitor the production of the hogs by these outgrowers and provide support from our veterinarians.

 

The local producers from whom we purchase a portion of our pork needs are also located near our production facilities but are not parties to partnership agreements with us. These producers generally raise the hogs from birth until they reach slaughtering weight, and we provide limited technical support. We purchase the hogs raised by these local producers pursuant to contracts.

 

We slaughter the hogs raised by our outgrowers or purchased from local producers or on the spot market. After they are slaughtered, the hogs are immediately cut in half. The half-carcasses are then partitioned according to their intended use. These parts become the raw material for the production of pork cuts and specialty meats.

 

At December 31, 2009, we had a pork slaughtering capacity of 189,213 heads per week.

 

Beef

 

We do not raise cattle at our facilities. We purchase cattle primarily from local producers in the region of Mirassol D’Oeste and Várzea Grande in the State of Mato Grosso. Although we purchase cattle on the spot market to the extent necessary, we expect to be able to purchase the majority of our cattle from local producers. We transport the cattle to our facilities, where we slaughter the cattle and cut and package the beef.

 

At December 31, 2009, we had a beef slaughtering capacity of 9,000 heads per week.

 

Processed Foods

 

We sell a variety of processed foods, some of which contain poultry, pork and beef meat that we produce. We produce lasagnas, pizzas, pastas, desserts and other frozen prepared entrees, as well as cheese bread, at our plants in Lages in the State of Santa Catarina, Rio Verde in the State of Goiás.  In Tatuí, in the State of São Paulo, we produce ready-to-eat sandwiches, lasagnas, pizzas, cheese breads and other items of pasta and bakery.  In Ponta Grossa, in the State of Paraná, we produce pizzas, pastas, desserts (Miss Daisy) and other industrialized products. Our Rio Verde plant is adjacent to our Rio Verde poultry and pork slaughtering facilities, and we transport pork from other production facilities to be used as raw materials at our Lages plant. We purchase most of the remaining ingredients for our lasagnas, pizzas, pies and pastries in the domestic market from third parties. Such seasonings and secondary raw materials are applied to each product type or line according to established criteria and procedures to ensure consistency of color, texture and flavor. The presentation of final products is achieved by shaping, casing, cooking and freezing in special machines. Products are then subjected to quality controls and distributed to the consumer market after having been packaged, labeled and boxed.

 

We sell a variety of frozen vegetables, such as broccoli, peas, French fries and cassava fries. These products are produced for us by a third party that delivers them to us packaged, almost all for our Escolha Saudável (“Healthy Choice”) line of products. We purchase most of these products in the domestic market, but we import French fries from Belgium and peas from Chile, France and Argentina. We also produce soy-based products, such as soy meal and refined soy flour, at our plants in Videira, located in the State of Santa Catarina in Dois Vizinhos, in the State of Paraná and in Toledo, also in the State of Paraná. We also produced soybean oil until July 2005, when we sold our soybean oil plant in Marau in the State of Rio Grande do Sul to Bunge Alimentos because we determined that the production of soybean oil was not a core product of our business. We receive royalties from Bunge Alimentos for the use of the Perdigão brand for soybean oil under a licensing agreement.

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The raw material for margarine is crude soybean oil, which is subjected to refining and bleaching processes. We purchase margarine from an agricultural cooperative supplier for resale by us. In June 2007, we acquired from Unilever the margarine brands Doriana, Delicata and Claybom, as well as the equipment to produce such margarines in Valinhos in the State of São Paulo. We also entered into an strategic agreement with Unilever for the management of the margarine brands Becel and Becel ProActiv in Brazil. We also produce margarines in our plant in Paranaguá, State of Paraná, under the brands Qualy and Deline.  We began to sell this product as part of our strategy to diversify our product lines and to take advantage of our distribution network for refrigerated products.

 

Dairy Products

 

The following graphic is a simplified representation of our dairy products chain.

 

Dairy Products Production Chain

 

Through the acquisition of Batávia and Eleva, we produce dairy products in 15 plants. We receive milk from a network of 11,737 milk producers in more than 553 cities. The milk is purchased mainly from local producers and supplemental purchases are made on the spot market, depending on market price conditions and demand levels. In the event that there is a lack of fresh milk in the market, we are capable of using powdered milk for part of our supply needs.

 

BRF – Brasil Foods is the second largest milk collector in Brazil based on volume, according to information compiled from Leite Brasil, the Brazilian National Agriculture Confederation (Confederação Nacional da Agricultura), the Brazilian Confederation of Dairy Cooperatives (Confederação Brasileira de Cooperativas de Laticínios) and the Brazilian Agricultural Research Corporation (Empresa Brasileira de Pesquisa Agropecuária).

 

Feed

 

We produce most of the feed consumed at the farms operated by our integrated outgrowers of poultry and hogs. We provide feed to most of our integrated poultry and hog outgrowers as part of our partnership arrangements with them. We also sell animal feed to local producers of hogs at market rates. Animal feed sales accounted for R$133.5 million in 2009 (0.8% of our net sales), R$135.6 million in 2008 (1.2% of our net sales) and R$99.3 million in 2007 (1.5% of our net sales).

 

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We own 23 feed production plants. The basic raw materials used in animal feed production are corn and soy meal mixed with preservatives and micronutrients.  In 2009, we purchased approximately 45% of our corn from rural producers and small merchants, 24% through cooperatives and 31% from trading companies such as Coamo, Bunge, Cargill, ADM and others. The corn is grown primarily in the states of Santa Catarina, Paraná, Rio Grande do Sul and the central-west region of Brazil. We buy soy meal from major producers such as Coamo, Bunge and Cargill, primarily pursuant to long-term contracts.

 

The prices of corn, soybeans and soy meal fluctuate significantly. See “Item 5. Operating and Financial Review and Prospects¾A. Operating and Financial Review and Prospects¾Principal Factors Affecting our Results of Operations¾Commodity Prices.”

 

 

Other Raw Materials

 

We purchase other materials required for our products, such as prepared animal intestines (for sausage casings), cardboard boxes and plastic (for packaging), micronutrients for animal feed, spices and veterinary drugs from third parties, both in the domestic and international markets. We must import and therefore pay for some of these products in U.S. dollars.

 

 

Suppliers

 

We generally use a bidding process to select our suppliers based on technical and commercial requirements. We have had long relationships with many of our suppliers, both in Brazil and abroad. We periodically evaluate the efficiency of our suppliers in terms of quality, lead time and service levels.

 

 

Brazilian Domestic Market

 

Brazil is the fifth largest country in the world, both in terms of land mass and population. As of July 1, 2009, Brazil had an estimated population of 191.5 million people, according to data from the IBGE. According to IBGE, Brazil had a GDP of R$3.1 trillion for 2009, representing an increase of 4.6% over GDP of R$2.9 trillion for 2008, in each case in nominal terms. GDP per capita increased 1.2% in 2009 to R$16,414. The Brazilian government implemented fiscal and monetary policies, such as reductions of taxes and interest rates, designed to mitigate the impacts of the international crisis over the Brazilian economy. Since the third quarter of 2009, the industry and services sectors began to hire again, which raised consumer confidence, leading customers to return to buy durables and non-durable products. As a consequence, many economists believe that Brazil’s economy will grow at a strong rate in 2010. The Central Bank forecasts that the Brazilian GDP in 2010 will increase 5.5% compared to 2009. The inflation rate, as measured by the IPCA, published by the IBGE, was 5.9% in 2008 and 4.3% in 2009, continuing a trend of moderate inflation rates when compared with Brazil’s historical experience of high rates of inflation.

 

Brazil is a large consumer of meat, with estimated per capita meat consumption of 89.9 kilograms in 2009, according to the USDA. Poultry and beef are a major food staple and protein source in the Brazilian domestic market. Pork is also an important protein source in the country, although Brazilians consume considerably more beef and poultry than pork.

 

Demand for poultry, pork and beef products is directly affected by economic conditions in Brazil. The overall trend toward improved economic conditions in recent years has generally supported increased demand for processed food products, as well as traditional fresh and frozen poultry and pork products. In the fourth quarter of 2008, the worsening of the global economic and financial crisis began to affect demand for our products in general in the Brazilian market. These negative trends began to affect domestic consumer confidence in the fourth quarter of 2008 and continued to do so in 2009. For information about certain expected macroeconomic trends for 2010, see “Item 5. Operating Financial Review and Prospects—D. Trend Information.”

 

The Brazilian domestic market is highly competitive, particularly for fresh and frozen poultry and pork products. There are several large producers, most notably our company and Sadia, but also Aurora-Cooperativa Central Oeste Catarinense Ltda., or “Aurora,” and Seara Alimentos S.A., or “Seara” (which is now owned by Marfrig). The large producers are subject to significant competition from a substantial number of small producers that operate in the informal economy and offer lower quality products at lower prices than do the major producers. For that reason, we and our main competitors have, in recent years, focused on producing and selling processed food products because these products support better margins. We and our major competitors are generally emphasizing processed food products rather than fresh and frozen poultry and pork products which are more similar to commodities in nature.

 

Among processed foods products, specialty meats and frozen processed meats have experienced considerable growth in recent years. Based upon information compiled by A.C. Nielsen do Brasil S.A., the specialty meats market in Brazil accounted for net sales of R$14.7 billion in 2009, representing a 5% increase over R$14.0 billion in 2008. Based upon information compiled by A.C. Nielsen do Brasil S.A., the frozen processed meats market represented net sales of approximately R$2.3 billion in Brazil in 2009, a 5% decrease over R$2.5 billion in net sales in 2008. The processed foods sector is more concentrated in terms of the number of players. Consumption of processed products is influenced by several factors, including the increase in consumer income, and marketing efforts, with a view to meeting consumer demand for more value-added products. We believe that processed food products represent an opportunity for further growth in coming years.


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In 2009, according to A.C. Nielsen do Brasil, the Brazilian market for dairy processed products totaled approximately R$4.0 billion, an increase of 8%, from R$3.7 billion in 2008. Brazil is one of the world’s largest consumers of dairy products. The size of the Brazilian margarine market was approximately R$2.2 billion in 2009, according to A.C. Nielsen do Brasil S.A.

 

Export Markets

 

The global trade in poultry, pork and beef products has grown in recent years, according to the USDA, and meat consumption among major countries has also grown. Brazilian exports of chicken decreased at an accumulated rate of 3.7% from January to December 2009, in terms of volume, from 3,446 thousand tons to 3,313 thousand tons. However, Brazilian exports of pork grew at an accumulated rate of 3.2% in 2009, from 625 thousand tons to 645 thousand tons. In addition, Brazilian exports of beef decreased at an accumulated rate of 13.7% in 2009, from 1,801 thousand tons to 1,555 thousand tons. The worsening of the global economic and financial crisis in the fourth quarter of 2008 led to significant weakness in demand for pork, beef and poultry at the end of 2008, and this weakness has continued 2009.

 

In the milk and dairy products industry, Brazil has been exporting various products, especially powdered milk, since 2000, as an alternative to the domestic market, and the sales volume of powdered milk increased from only 229 tons in 2000 to 12.7 thousand tons in 2009, according to SECEX.

 

Brazil has become a leading participant in global export markets due to natural advantages, including low feed and labor costs, and gains in efficiencies in animal production. We, like other large Brazilian producers, have built on these advantages to develop the scope and scale of our businesses.

 

Global demand for Brazilian poultry, pork and beef products is significantly affected by, depending on the export market, trade barriers, sanitary requirements and disease-related bans, religious considerations, economic conditions and other factors. Trade barriers may include quotas on imports from Brazil (e.g., in Russia), protective tariffs (e.g., in the European Union), direct and indirect subsidies for local producers, licensing requirements (e.g., in China) and outright bans on imports. Most countries require sanitary agreements with Brazil before Brazilian products may be imported (e.g., the United States, which has no sanitary agreement with Brazil covering poultry, beef and pork products and therefore will not accept Brazilian poultry, beef and pork for import). In addition, outbreaks of animal disease may result in bans on imports (e.g., in Russia, which banned imports of Brazilian pork products because of outbreaks of foot-and-mouth disease affecting cattle in two Brazilian states). The Middle East, which constitutes an active region for poultry sales by Brazilian producers, does not import pork products due to Muslim religious bans on the consumption of pork. Above all, economic conditions in a particular export market (whether national or regional) may influence levels of demand for all types of poultry, pork and beef products as well as processed products.

 

Global trade in poultry products has been negatively affected by the spread of highly pathogenic avian influenza (H5N1 virus), particularly in Asia but also in Europe and Africa. Since the beginning of 2003, there have been 492 confirmed human cases of avian influenza and 291 deaths, according to the WHO. Human cases were reported in various countries in Asia, the Middle East and Africa in 2006, and several countries in Europe reported cases of avian influenza in birds. Avian influenza has not yet been detected in Brazil or elsewhere in the Americas. A similar virus strain has been detected in North America, with low pathology. If this animal disease is detected in Brazil, or if it begins to be transmitted from human to human, global demand for poultry products is likely to decline for a period whose length cannot be predicted.

 

Similarly, global trade in pork products has been negatively affected in 2009 by the spread of A(H1N1) influenza, also called “swine flu,” in many countries. More than 17,000 deaths worldwide have been recorded since the outbreak of A(H1N1) influenza in Mexico, and on June 11, 2009, the WHO declared a flu alert level six, signaling a “global pandemic.” Many countries, including Russia and China, have prohibited imports of pork from countries reporting a significant number of cases (Mexico, United States and Canada), but, as the WHO and other independent sources have stated that influenza A(H1N1) is not transmitted by pork consumption, those countries reopened their markets to producers from Mexico, the United States and Canada. Still, some states in the importing countries continue to impose restrictions on pork imports from Mexico, the United States and Canada. Whether or not an outbreak of A(H1N1) influenza occurs in Brazil, further outbreaks of the disease anywhere in the world could have a negative impact on the consumption of pork in our export markets or in Brazil. Any further outbreak of A(H1N1) influenza could lead to the imposition of costly preventive controls on pork imports in our export markets.


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In export markets, we and other Brazilian producers compete with local and other foreign producers. Traditionally, Brazilian producers have emphasized exports of frozen whole and cut poultry, and frozen pork and beef cuts. These products, which are similar commodities in nature, continue to account for the substantial portion of export volumes in recent years. More recently, Brazilian food companies have begun to expand sales of processed food products. We anticipate that, over the next several years, we and our main Brazilian competitors will sell greater volumes of frozen whole and cut poultry and frozen pork and beef cuts but also increasing volumes of processed food products.

 

Sales

 

We sell our products both in the domestic Brazilian market and export markets around the world. Net sales to the Brazilian market, including most of our processed foods, accounted for 58.9% of our net sales in 2009, 56.4% in 2008 and 52.5% in 2007. Net sales to export markets, including most of our frozen whole and cut chickens and other poultry and frozen pork cuts and, more recently, beef cuts, accounted for 41.1%, 43.6% and 47.5% of our net sales in 2009, 2008 and 2007, respectively.

 

The table below demonstrates the breakdown of our net sales for the periods indicated:

 

  2009  2008  2007 
Domestic Market  58.9%  56.4%  52.5% 
Poultry  3.6%  3.6%  2.7% 
Pork/Beef  2.4%  1.4%  0.8% 
Processed food products  41.2%  35.1%  43.0% 
Milk  9.1%  13.0%  2.8% 
Other  2.6%  3.3%  3.2% 
Export  41.1%  43.6%  47.5% 
Poultry  26.2%  26.3%  28.0% 
Pork/Beef  6.4%  7.2%  8.0% 
Processed food products  8.4%  9.2%  11.5% 
Milk  0.1%  0.9%  — 
Total  100.0%  100.0%  100.0% 

 

Overall Comparison of the Company’s Net Sales for the Three Years Ended December 31, 2009, 2008 and 2007

 

Domestic Market

 

We cover substantially all of the Brazilian population through a nationwide distribution network. In the domestic market, we sell our products directly to supermarkets, wholesalers, retail stores, and food service and other institutional buyers. The table below sets forth our domestic net sales to supermarkets, retail stores, wholesalers and institutional buyers as a percentage of total domestic net sales for the periods indicated.

  2009  2008  2007 
  (percentage of domestic net sales) 
Supermarkets  57.7  63.2  63.9 
Wholesalers  19.0  20.1  19.1 
Food service and other institutional buyers  8.2  7.4  7.7 
Retail stores  15.1  9.3  9.3 
Total  100.0%  100.0%  100.0% 

 

In 2009, our five largest customers accounted for 16.2% of our domestic net sales, compared to 16.4% in 2008 and 14.5% in 2007. None of our customers accounted for more than 2.8% of our total net sales in 2009. One of our strategies is to continue to expand our food service client base, which already includes Burger King, Mc Donalds and the Brazilian fast food chains Giraffas and Habib’s, while continuing to provide quality products and services to supermarket and other customers. Other institutional buyers include hotels, hospitals and businesses.

Our domestic distribution network uses 36 distribution centers in 14 Brazilian states and the Federal District. Refrigerated trucks transport our products from our processing plants to the distribution centers and from the centers to our customers. We have 50 cross- docking points in several areas of the country that enable us to unload products from large refrigerated trucks onto smaller trucks or vans for transportation to our customers. We own 25 of our distribution centers and lease the remaining 11 centers, which are listed under “¾D. Property, Plant and Equipment.” We do not own the vehicles used to transport our products, and we contract with several carriers to provide this service for us on an exclusive basis.

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In certain areas of the country, we act through nine exclusive third-party distributors, which operate in Apucarana, Cascavel and Foz do Iguaçu in the State of Paraná; Cuiabá in the State of Mato Grosso; Campos dos Goytacazes, Três Rios and Nova Friburgo in the State of Rio de Janeiro; Vilhena in the State of Rondônia; and Rio Branco in the State of Acre.

Export Markets

 

We export our products to Europe, the Far East, Eurasia, the Middle East, Africa, the Americas and other regions. The table below sets forth a breakdown of our export net sales and sales volumes by region, excluding Sadia’s net sales and sales volumes, as percentages of total export net sales and total export sales volumes for the periods indicated.

  2009 2008 2007
  Export Net Sales    Total Tons  Export Net Sales    Total Tons  Export Net Sales    Total Tons 
  (%)    (%)  (%)    (%)  (%)    (%) 
Europe:                   
Germany  5.8    5.6  5.4    5.1  7.2    5.6 
England  6.4    3.6  6.0    3.8  6.5    4.0 
Netherlands  2.5    1.5  2.2    1.4  2.1    1.2 
Others  8.7    5.6  8.6    6.3  13.9    10.5 
Total  23.4    16.3  22.2    16.6  29.7    21.3 
Far East:                   
Japan  9.3    8.4  12.1    9.3  11.4    10.8 
Hong Kong  8.2    9.4  6.9    9.2  7.9    9.3 
Singapore  2.4    2.3  2.3    2.3  3.1    3.2 
Others  1.4    1.4  1.6    1.8  2.5    2.8 
Total  21.3    21.5  22.9    22.6  24.9    26.1 
Eurasia:                   
Russia  9.0    8.2  12.4    9.9  11.7    10.7 
Others  2.4    2.6  2.2    2.2  4.0    4.8 
Total  11.4    10.8  14.6    12.1  15.7    15.5 
Middle East:                   
Saudi Arabia  16.0    17.7  13.4    14.5  13.5    15.5 
United Arab Emirates  4.0    4.7  3.5    4.2  2.3    2.8 
Kuwait  1.6    1.9  2.5    3.3  2.3    2.9 
Others  6.6    7.4  6.2    7.7  4.5    5.5 
Total  28.2    31.7  25.6    29.7  22.6    26.7 
Africa, the Americas and Other  15.7    19.7  14.7    19.0  7.1    10.4 
Total  100.0    100.0  100.0    100.0  100.0    100.0 

Competition

 

Domestic Market

 

We face significant competition in the domestic market, particularly due to the recent growth in poultry and pork production capacity in Brazil.

 

In the specialty meats market, we (excluding Sadia) had a 27.2% market share by sales volume in 2009, Sadia had 28.8%, while Aurora and Seara had market shares of 8.7% and 4.0%, respectively, according to A.C. Nielsen do Brasil S.A. The specialty meats market accounted for estimated revenues of approximately R$14.7 billion in Brazil in 2009, compared to R$14.0 billion in 2008, an increase of 5%. Since 1995, this market has had annual average growth of 9.7% in terms of sales volume. The four largest players accounted for 68.7% of the market in 2009, while the remainder of the market represents several small players. This market has undergone recent consolidation due to the competitiveness of the largest players.


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The following graph shows the historical market share (in percentages) of our company and our major competitors, by sales volume, in specialty meats for the periods indicated.

 

 

By Volume

Source: A.C. Nielsen do Brasil S.A.

YTD: January 2009 -December 2009

 

In the frozen processed meats market (which includes hamburgers, steaks and breaded meat products, kibes and meatballs), we (excluding Sadia) had a 31.9% market share by sales volume from December 2008 through November 2009, Sadia had a market share of 38.4% and Seara, 4.6%, according to A.C. Nielsen do Brasil S.A. Marfrig is the fourth largest player in the market with a market share of 3.0% during that period. Since 1995, the market has had average annual growth of 14.2% in terms of sales volume. The frozen processed meat market accounted for estimated revenues of approximately R$2.3 billion in Brazil in 2009, compared to R$2.4 billion in 2008, an decrease of 5%.

 

The graph below shows the market share of our company and our major competitors, by volume, in frozen processed meats for the periods indicated.

 

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By Volume

Source: A.C. Nielsen do Brasil S.A.

YTD: December 2008 - November 2009

 

In the frozen pasta market (which includes lasagnas and other products), we (excluding Sadia) had a 32.6% market share by sales volume in December 2008 through November 2009, while Sadia had a market share of 51.7%, according to A.C. Nielsen do Brasil. The frozen pasta market accounted for estimated revenues of approximately R$515 million in 2009, compared to R$425 million in 2008, an increase of 21.2%. The frozen pasta market grew at an annual average rate of 22.4% from 1998, when we entered the market, to 2009, in terms of sales volume.

 

In the frozen pizza market, we (excluding Sadia) had a 33.1% market share by sales volume from January through December 2009, while Sadia had a market share of 34.2% according to A.C. Nielsen do Brasil S.A. The frozen pizza market accounted for estimated revenues of R$478 million in 2009, compared to R$387 million in 2008, an increase of 24%. The frozen pizza market grew at an annual average rate of 12.7% from 2000 to 2009 in terms of sales volume.

 

In the dairy products market, we had a 12.8% market share by sales volume from December 2008 through November, 2009, while Danone, Nestlé and Paulista had market shares of 18.4%, 16.2% and 6.5%, respectively, according to A.C. Nielsen do Brasil S.A. The dairy products market accounted for estimated revenues of approximately R$4.0 billion in Brazil in 2009, compared to R$3.7 billion in 2008, an increase of 8%. Since 2003, this market has had annual average growth of 6.5% in terms of sales volumes.

 

The following graph shows the market share (in percentages) of our Company and our major competitors, by sales volume, in dairy products for the periods indicated.

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By volume

Source: A.C. Nielsen do Brasil S.A.

YTD: December 2008 - November 2009

____________

 

*    Includes Batavo and Elegê beginning in 2006

 

In the margarine market, we (excluding Sadia) had a 19.0% market share by sales volume from December 2008 through November 2009, Sadia had 44.6%, while  Bunge had a market share of 28.0%, according to A.C. Nielsen do Brasil S.A. The margarine market accounted for estimated revenues of approximately R$2.4 billion in Brazil in 2009, according to A.C. Nielsen do Brasil S.A.

 

In the Brazilian market for whole poultry and poultry and pork cuts, we face competition from small producers, some of which operate in the informal economy and offer lower quality products at lower prices. This competition from small producers is a significant reason that we sell a majority of our whole chickens and poultry and pork cuts in the export markets and is a barrier to expanding our sales of those products in the domestic market.

 

In the domestic market, we compete primarily based on brand recognition, distribution capabilities, selling prices, quality and service to our customers. Due to the characteristics of processed food products, with production concentrated among a smaller number of companies and supply aimed at a more restricted group of consumers, we believe the sales volume of processed food products will maintain its trend of growth registered between 2005 and 2007. In addition, since the market for processed food products is still growing in Brazil, we believe that the medium and long-term prospects for this segment are positive based on the trend over the preceding years.

 

Export Markets

 

We face significant competition in our export markets, both from other Brazilian producers and from producers in other countries. For example, Seara competes with us internationally and has many of the same competitive advantages that we have over producers from some other countries, including lower labor and feed costs. In addition, our poultry and pork cuts, in particular, are highly price-competitive and sensitive to product substitution. Customers sometimes seek to diversify their sources of supply by purchasing products from producers in other countries, even when we may be a lower cost producer.

 

Protectionist measures among Brazil’s trade partners are also an important competitive factor. Brazilian poultry and pork exports are increasingly affected by measures taken by other countries to protect local producers.

 

The table below sets forth the main Brazilian exporters’ percentage of poultry and pork markets in 2008, by total sales volumes. ABEF and ABIPECS, associations that consolidate companies export data, have not yet released updated statistics for 2009.

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Company  Percentage of Brazilian Exports - Poultry 
 
Sadia  23.31% 
Perdigão  21.93% 
Seara  11.86% 
Frangosul  10.01% 
Marfrig  4.72% 
 
Source: ABEF   

 

Company  Percentage of Brazilian Exports - Pork 
 
Perdigão  21.64% 
Sadia  17.41% 
Aliben  14.20% 
Seara  11.15% 
Plamplona  8.41% 
Aurora  6.84% 
 
Source: ABIPECS   

 

In our export markets, we compete primarily based on quality, cost, selling price and service to our customers.

 

Distribution of Products

 

Domestic Market

 

We have focused on our logistical operations and seek to improve efficiency and reduce distribution costs by building distribution centers to cover long distances through our cross-docking facilities. We reach approximately 98% of the Brazilian territory through a nationwide distribution network. As of December 31, 2009, we operated 36 distribution centers and 50 cross-docking points.

 

Shipment of Products

 

We export our products primarily through the ports of Itajaí and Navegantes in the State of Santa Catarina and, to a lesser degree, through the ports of São Francisco do Sul in the State of Santa Catarina and Paranaguá in the State of Paraná. We store our products in refrigerated warehouses that we lease under long-term leases and that are located near the ports. We contract with exclusive third-party carriers to transport our products from our production facilities to the ports, and we ship our products to the export markets through independent shipping companies.

 

In the fourth quarter of 2008, flooding and damage at the ports of Itajaí and Navegantes damaged port infrastructure and required us to divert all our exports in the region of Santa Catarina to three other ports: Rio Grande in the State of Rio Grande do Sul, Paranaguá and São Francisco. These events resulted in reduced shipment levels in November and led to delays in exports that adversely affected our export revenues for the fourth quarter of 2008.

 

The Itajaí port is owned and administered by the municipal government of Itajaí, while the port of São Francisco do Sul is owned and administered by the Brazilian federal government and the port of Paranaguá is owned and administered by the State of Paraná. However, shipments through the ports of Itajaí and Paranaguá are made through private terminals at these ports that are operated as concessions. The dock workers and other port employees at all these facilities are generally members of labor unions. In addition, each shipment of our products requires clearance by customs agents, sanitary inspectors and other agents of the Brazilian federal government, who are also generally members of labor unions. From time to time, we have been affected by strikes of these port employees and government agents. Strikes by Brazilian federal government agents generally affect all Brazilian ports, whereas strikes by port employees sometimes affect only one port, but they also tend to last longer than strikes by government agents. In the third quarter of 2007 and in March 2008, for example, sanitary inspectors struck for approximately a month. Although these strikes did not have a material adverse effect on our results of operations, a widespread or lengthy strike in the future could adversely affect our business and our results of operations.


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Export Markets

 

Our sales and distribution efforts abroad are coordinated through sales offices in England, Japan, The Netherlands, Russia, Singapore, Italy, Hungary, Austria, Portugal, France, Germany, Turkey,  Argentina, Chile, Uruguay, Cayman Islands, Venezuela. China  and the United Arab Emirates. We coordinate our marketing efforts in our principal export markets through these offices, and we provide sales support to customers. Our distribution arrangements in our export markets vary according to the market.

 

Europe. In Europe, we have developed our own distribution network and sell directly to food processing and food service companies as well as local distributors. We are currently able to distribute products in 31 European countries, and in 15 of those countries, we are able to deliver products within approximately two days of receiving an order. We intend to expand our distribution network to broaden and deepen our coverage in Europe and to support more targeted marketing efforts. In limited cases, we may explore the processing of some products in Europe where doing so would allow us to distribute those products more effectively, as we have done with the Plusfood acquisition.

 

Far East. In Japan, our biggest market in the Far East, we sell primarily to trading companies, which resell our products to Japanese distributors. We primarily supply special cuts of chicken, including boneless legs and wing cuts, produced specifically for the Japanese market, which has helped us foster customer loyalty. We also believe that our quality standards and product range have made us one of the preferred suppliers of chicken products in the Japanese market. In addition to Japan, we sell a significant amount of products in Hong Kong and Singapore, where we believe our brands are well recognized. Our most popular products in these latter markets include chicken wings and feet.

 

Eurasia. In Russia and other areas of Eurasia, we sell primarily to distributors, which resell our products to supermarkets and other customers. Our Fazenda brand of pork and poultry products is carried in many supermarkets, and we believe it is a well-recognized brand in Russia. We have historically sold approximately two-thirds of our frozen pork cuts to Russia and also supply significant volumes of frozen whole and cut chickens. Russia imposes quotas on imports of poultry and pork products from Brazil and other exporting countries. It is not uncommon for Russian quotas for poultry and pork products to be subject to changes in policy and delays in allocation, and a delay in allocating quotas for poultry products in the first half of 2006 led to a significant decline in our sales volumes of poultry products to Russia during that period.

 

Middle East. In Saudi Arabia and other countries of the Middle East, we sell to large distributors, some of which have been our customers for decades. We sell primarily frozen whole and cut chickens in these markets. We believe that we are one of the preferred suppliers of these products in this region due to our quality standards and our long-standing customer relationships.

 

Africa, the Americas and Other Countries. We sell modest amounts of our products to several countries in Africa, South America and other regions, primarily through trading companies that resell our products to distributors. We also sell chicken cuts, including breasts and wings, to processing companies in Canada. We are currently developing relationships with distributors in South America in order to expand our exports in this region. Our sales to many of these countries are subject to significant fluctuations in demand.

Intellectual Property

Our principal intellectual property consists of our domestic and international brands. We sell our products mainly under the Perdigão and Batavo brands in the domestic market and under the Perdix, Fazenda, Borella, Confidence and other brands in our export markets, as described below in “¾Marketing.”

We also use several brands for specific products or product lines. In the domestic market, these brands include Chester®, Turma da Mônica (license trademark, with contract until 2013), Confiança, Escolha Saudável, Toque de Sabor (for Lasagnas), Doriana, Claybom, Pense Light, Bio Fribas, Naturis, Ouro and Nabrasa.

In foreign markets, we use the following brands: Halal (in the Middle East other than Saudi Arabia), Unef (in Saudi Arabia), Sulina (in Hong Kong and Singapore) and Alnoor (in several Middle Eastern countries).

We commenced sales of margarine in December 2005. We purchase margarine from an agricultural cooperative supplier for resale by us. We initially sold margarine under two brand names (Turma da Mônica and Borella). In June 2007, we acquired from Unilever the margarine brands Doriana, Delicata and Claybom, as well as the equipment to produce such margarines. We also entered into an strategic agreement with Unilever for the management of the margarine brands Becel and Becel ProActiv in Brazil.

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In February 2008, we completed the acquisition of Eleva, assuming all its rights and obligations, including the trade mark Elegê. In April 2008, we also acquired Maroca e Russo Indústria e Comércio Ltda. (Cotochés) and assumed all its rights and obligations, including the regional brand Cotochés.

In 2009, we entered into a business combination with Sadia, and Sadia became our wholly-owned subsidiary. Sadia sells its products mainly under the brands Sadia, Hot Pocket, Miss Daisy, Fiesta, Resende, Texas, Texas Burger, Speciale Sadia, Sadilar, Nuggets, Tekitos, Wilson, Deline and Qualy (for margarines) in the domestic market. In foreign markets, Sadia uses the following brands: Sadia, Resende, Hilal, Corcovado and Sahtein.

Sadia has applied to have the Sadia trademark recognized as a “well known trademark” with the Brazilian National Institute for Industrial Property (Instituto Nacional de Propriedade Industrial), which is reviewing the application. The Sadia trademark is registered in more than 90 countries in the Middle East, the Caucasus and Latin America, including Saudi Arabia, United Arab Emirates, Egypt, Bahrain, Yemen, Iran, Iraq, Israel, Lebanon and Oman. Sadia’s mascot is protected both as a registered trademark and copyright pursuant to a registration with the Brazilian National Library, and this protection extends to countries other than Brazil. Sadia maintains an active marketing program using both electronic and printed media. In addition, Sadia has patents registered in Brazil and more than 20 other countries.

 

Finally, we are owners of several domain names in Brazil, registered with the competent authority, such as “perdigao.com.br,” “chester.com.br,” “escolhasaudavel.com.br,” “perdix-international.com.br,” “toquedesabor.com.br,” doriana.com.br,” “delicate.com.br,” “claybom.com.br.” Our subsidiary Sadia is also the owner of several names in Brazil, registered with the competent authority, such as “sadia.com.br,” “sadiainstitute.org,” “missdaisy.com.br,” “resendenet.com.br,” “hotpoket.com.br,” “clubequaly.com.br” and “sadiafoodservices.com.br.”

 

Regulation

The Brazilian Ministry of Agriculture regulates our activities through the Secretary for Agriculture and Cattle Breeding Defense (Secretaria de Defesa Agropecuária) and the Animal Products Inspection Department (Departamento de Inspeção de Produtos Animais). This department is responsible for issuing regulations, conducting inspections and providing legal support relating to livestock, animal breeding, food processing and any other activity involving animal-related affairs in the Brazilian territory. Under applicable regulations, facilities that handle animal products must obtain permits and authorizations from the Federal Inspection Service of the Federal Office of the Ministry of Agriculture (Serviço de Inspeção Federal da Delegacia Federal do Ministério da Agricultura, Pecuária e Abastecimento), including a license to operate each facility, and must submit to periodic monitoring by the Brazilian state where the facility is located.

In addition, animal products are required to be identified using labels that have been registered with or approved by the Ministry of Agriculture. Ready-to-eat products that contain animal ingredients are also subject to technical, chemical and microbiological inspections. Violations of regulations of animal products may give rise to penalties, fines, seizure of products or temporary suspensions or permanent injunctions of a company’s activities.

Marketing

Our marketing efforts are based on (1) diversifying our product lines, including focusing on value-added processed foods that tend to be less price-sensitive than our poultry and pork cuts and can be targeted to specific markets; (2) using a coherent brand strategy so that our brands are recognized and associated with premium products; and (3) reinforcing our reputation for quality by emphasizing superior service to our customers. We intend to further consolidate our brands, while continuing to tailor our appeal to specific export markets and domestic market segments.

 

In the domestic market, we have historically marketed our products primarily under the Perdigão brand, which we believe is associated with quality and innovative products. We also use a secondary brand, Batavo, which is especially recognized in the State of Paraná. Although we previously used the Batavo brand under license, we acquired a controlling interest in the brand through the Batávia acquisition. We also have well known brands for specific products, such as our Chester® roosters, one of the most popular brands for premium poultry products in Brazil. In addition, we offer a popular Turma da Mônica line of processed foods for children. We have a licensing agreement to use the name and image of Mônica, a well known cartoon character in Brazil, and we use this brand for a wide variety of products, including our Turma da Mônica brand margarine for kids. Batávia also uses the Parmalat brand for processed refrigerated dairy products, such as yogurt. Upon the acquisition of Batávia, we entered into a license agreement with Parmalat S.p.A. to use the Parmalat brand for processed dairy products and other products for a period of three years until the end of 2009, renewable for subsequent one-year periods, if there is no communication otherwise.  In 2007, we acquired from Unilever the margarine brands Doriana, Delicata and Claybom, and also established a joint venture with Unilever for us of the margarine brand Becel.

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In our export markets, our premium brand is the Perdix brand, but we use other brands in specific markets for historical reasons, such as the Fazenda brand in Russia. In each case, we pair the two-partridge image with the applicable brand name for that market to maintain a coherent international brand. In addition, we have secondary brands in some of our export markets. Our Borella brand, for example, is well-known in Saudi Arabia, and we use the Halal brand in some Middle Eastern markets to indicate that we slaughter poultry for those products in accordance with Islamic guidelines. We also use the Confidence brand for selected lower-priced products, such as bologna and frankfurters, in a small number of export markets. We work with a single marketing agency internationally to help us market consistently around the world. 

 

In addition, Sadia sells its products in the domestic market mainly under the brands Sadia, Qualy, Rezende, Miss Daisy, Texas, Texas Burger, Speciale Sadia, Sadilar, Deline, Nuggets, Tekitos, Hot Pocket and Wilson, all of which are registered with the Brazilian Trademark Office (INPI) . In foreign markets, Sadia uses the brands Sadia, Resende, Hilal, Corcovado and Sahtein. Sadia also has a license for the use of the Excelsior trademark, owned by Excelsior Alimentos S.A., pursuant to an agreement valid until September 1, 2013.

 

      For more information, see “Item 4. Information on the Company—B. Business Overview—Intellectual Property.”

 

C.  Organizational Structure

See “¾A. History and Development of the Company¾Corporate Structure.”

D.            Property, Plant and Equipment

Production

We have a number of production facilities throughout Brazil. We currently operate 42 meat processing plants, one pizza, pasta, dessert and industrialized processing plant, two margarine plants, 25 hatcheries, 23 animal feed mills, 14 dairy/dessert processing plants, 13 milk collection points and one soybean processing plant.

We also operate 31 grain purchasing branches, through which we purchase corn needed for our animal feed production.

 

The table below sets forth our production facilities.

 

Production Plant  State of Location  Activities 
Bom Retiro do Sul  Rio Grande do Sul  Meat processing 
Braço do Norte*  Santa Catarina  Pork slaughtering 
Brasília  Distrito Federal  Poultry slaughtering, industrialized products processing and animal feed 
Buriti Alegre  Goiás  Poultry slaughtering and animal feed 
Capinzal  Santa Catarina  Poultry slaughtering and poultry processing 
Carambeí  Paraná  Pork and poultry slaughtering (including turkey); chicken, turkey and pork processing 
Caxias do Sul*  Rio Grande do Sul  Pork slaughtering 
Chapecó  Santa Catarina  Poultry (including Turkey) slaughtering, industrialized products processing and animal feed 
Concórdia  Santa Catarina  Poultry and pork slaughtering, industrialized products processing and animal feed 
Dois Vizinhos  Paraná  Poultry slaughtering, soybean processing and animal feed 
Dourados  Mato Grosso do Sul  Poultry slaughtering 
Duque de Caxias  Rio de Janeiro  Industrialized products processing 
Faxinal dos Guedes  Santa Catarina  Poultry slaughtering and animal feed 
Francisco Beltrão  Paraná  Poultry (including Turkey) slaughtering and animal feed 
Garibaldi*  Rio Grande do Sul  Hatchery, poultry slaughtering and animal feed 
Herval D’Oeste  Santa Catarina  Pork slaughtering and pork processing 
Jataí  Goiás  Poultry slaughtering and poultry processing 


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Production Plant  State of Location  Activities 
Lages  Santa Catarina  Pasta, pizza and cheese bread processing; beef processing 
Lajeado  Rio Grande do Sul  Pork and poultry slaughtering and pork processing 
Lajeado*  Rio Grande do Sul  Poultry slaughtering and animal feed 
Lucas do Rio Verde  Mato Grosso  Poultry and pork slaughtering, industrialized products processing and animal feed 
Marau (3 plants)  Rio Grande do Sul  Pork and poultry slaughtering and processing 
Mato Castelhano*  Rio Grande do Sul  Pork slaughtering 
Mineiros  Goiás  Special poultry (turkey and Chester®) slaughtering and processing 
Mirassol D’Oeste  Mato Grosso  Beef plant 
Nova Mutum  Mato Grosso  Poultry slaughtering and processing 
Ponta Grossa  Paraná  Pizzas, pasta, desserts (Miss Daisy), industrialized products processing 
Porto Alegre  Rio Grande do Sul  Poultry slaughtering 
Rio Verde  Goiás  Pork and poultry slaughtering; poultry, pork, pies and pasta processing 
Salto Veloso  Santa Catarina  Poultry, pork and beef processing 
Santa Cruz do Sul  Rio Grande do Sul  Industrialized Products 
São Gonçalo dos Campos  Bahia  Poultry slaughtering and processing 
Serafina Corrêa  Rio Grande do Sul  Poultry slaughtering 
Tatuí  São Paulo  Industrialized Products 
Toledo  Paraná  Poultry and pork slaughtering, industrialized products processing, animal feed, and soybean oil 
Três Passos  Rio Grande do Sul  Pork slaughtering and animal feed, 
Uberlândia  Minas Gerais  Poultry (including turkey) and pork slaughtering, industrialized products processing and animal feed 
Valinhos  São Paulo  Margarine processing 
Várzea Grande/Campo Verde  Mato Grosso  Poultry slaughtering, industrialized products processing and animal feed 
Videira  Santa Catarina  Pork and poultry slaughtering and processing 
Videira  Santa Catarina  Pork and poultry slaughtering 
Videira  Santa Catarina  Soybean crushing 
Vitória de Santo Antão  Pernambuco  Industrialized Products 
Dairy products:     
Amparo*  São Paulo  Dairy products 
Barra Mansa*  Rio de Janeiro  Dairy products 
Bom Conselho**  Pernambuco  Dairy products 
Carambeí  Paraná  Dairy products 
Conceição do Pará*  Minas Gerais  Dairy products 
Concórdia  Santa Catarina  Dairy products 
Ijuí Rio Grande do Sul  Dairy products 
Itatiba*  São Paulo  Dairy products 
Itumbiara  Goiás  Dairy products 
Ravena  Minas Gerais  Dairy products 
Santa Rosa  Rio Grande do Sul  Dairy products 
São Lourenço  Rio Grande do Sul  Dairy products 
Teutônia  Rio Grande do Sul  Dairy products 
Três de Maio**  Rio Grande do Sul  Dairy products 
Soybean and margarine:     
Valinhos  São Paulo  Margarine processing 
Videira  Santa Catarina  Soybean crushing 
* Production facilities owned and operated by third-party producers who produce according to our specifications. 
** Under construction. For more information, see “Item 4—Information on the Company—A. History and Development of the Company—Capital Expenditures.”

 


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Some of our real estate assets are subject to liens incurred to secure our obligations under financing agreements, as described in note 14 of our consolidated financial statements included elsewhere in this document, as well as liens with respect to payment of taxes and legal proceedings.

 

Distribution

 

We operate 36 distribution centers throughout Brazil, as set forth in the table below.

 

  Distribution Centers  Owned or Leased 
  Bauru, São Paulo  Owned 
  Belém, Pará  Leased 
  Belo Horizonte, Minas Gerais  Owned 
  Brasília - Distrito Federal  Owned 
  Campinas, São Paulo  Owned 
  Carambeí, Paraná  Owned 
  Cuiabá, Mato Grosso  Owned 
  Curitiba, Paraná  Leased 
  Duque de Caxias, Rio de Janeiro  Owned 
  Embú, São Paulo  Owned 
  Esteio, Rio Grande do Sul  Leased 
  Fortaleza, Ceará  Owned 
  Goiânia, Goiás  Leased 
  Itajaí, Santa Catarina  Leased 
  Jaguaré, São Paulo  Owned 
  Jundiaí, São Paulo  Owned 
  Manaus, Amazonas (2 distribution centers) Leased 
  Marau, Rio Grande do Sul  Owned 
  Paranaguá, Paraná (2 distribution centers) Owned 
  Ponta Grossa, Paraná  Owned 
  Porto Alegre, Rio Grande do Sul  Leased 
  Ravena, Minas Gerais  Owned 
  Recife, Pernambuco  Leased 
  Recife, Pernambuco  Owned 
  Rio de Janeiro, Rio de Janeiro  Owned 
  Rio de Janeiro, Rio de Janeiro  Leased 
  Santos, São Paulo  Owned 
  Salvador, Bahia  Owned 
  Salvador, Bahia  Owned 
  São José dos Pinhais, São Paulo  Leased 
  Teutônia, Rio Grande do Sul  Owned 
  Uberlândia, Minas Gerais  Owned 
  Videira, Santa Catarina  Owned 
  Vitória, Espírito Santo  Leased 

We operate 50 cross-docking points in Brazil, in the locations set forth in the table below.

 

Cross-Docking Points

Owned or Leased

Apucarana, Paraná (2 cross-docking points)

Leased

Aracajú , Sergipe

Leased

Araçatuba, São Paulo

Leased

Barreiras, Bahia

Leased

Bauru, São Paulo (2 cross-docking points)

Owned

Bauru, São Paulo

Leased

Belem, Pará

Leased

Belo Horizonte, Minas Gerais

Leased

Brasilia, Distrito Federal

Owned

Campo Grande, Mato Grosso do Sul

Owned

Campo Grande, Mato Grosso do Sul

Leased

Cascavel, Paraná

Leased

Catanduva, São Paulo

Leased

Cuiabá, Mato Grosso

Leased

Esteio, Rio Grande do Sul

Leased

Fortaleza, Ceará

Leased

Goiania, Goiás

Leased

Guarapuava, Paraná

Leased

Guarulhos, São Paulo

Owned

Imperatriz, Maranhão

Leased

Itabuna, Bahia (2 cross-docking points)

Leased

Itajai, Santa Catarina

Owned

Jardinópolis, São Paulo

Leased

Limeira, São Paulo

Leased

Macapá, Amapá

Leased

Maceió, Alagoas

Leased

Natal, Rio Grande do Norte (2 cross-docking points)

Leased

Paraiso do Tocantins, Tocantins

Leased

Passo Fundo, Rio Grande do Sul

Leased

Porto Velho, Rondonia

Leased

Pouso Alegre, Minas Gerais

Leased

Ribeirão Preto, São Paulo

Owned

Ribeirão Preto, São Paulo

Leased

S. Bernardo do Campo, São Paulo

Leased

S. José dos Campos, São Paulo

Owned

Santa Maria, Rio Grande do Sul

Owned

Santos, São Paulo

Leased

São Luís, Maranhão

Leased

São Paulo, São Paulo

Owned

Teresina, Piauí (2 cross-docking points)

Leased

Tocantins, Tocantins

Leased

Uberlândia, Minas Gerais

Leased

Varginha, Minas Gerais

Leased

Vitória, Espírito Santo

Leased

Vitória da Conquista, Bahia

Leased

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We also own administrative offices in São Paulo in the State of São Paulo and in Videira in the State of Santa Catarina, and we lease an administrative office in Itajaí in the State of Santa Catarina. We lease ten sales offices abroad.

 

Environment

 

Our activities are subject to stringent environmental laws and regulations at the local, state and federal levels regulating, among other things, the treatment and release of effluents and the management of industrial waste. In addition, our meat processing plants are subject to federal, state and/or local environmental licensing requirements.

 

We believe we are in material compliance with our environmental licensing requirements.

 

Noncompliance with environmental laws and regulations may result in the imposition of administrative and criminal penalties against the violator, in addition to the obligation to indemnify for environmental damages. Administrative penalties may include notices, fines, temporary or permanent injunctions, suspension of subsidies from public agencies and temporary or permanent closure of a business. Criminal sanctions include fines and imprisonment (for individuals) and dissolution (for legal entities). Fines may reach up to R$10 million if we operate without a license and R$50 million if we cause environmental damage. In addition, under Brazilian environmental law, the corporate structure of a company may be disregarded if it is deemed necessary to guarantee the payment of the costs related to environmental damage.

 

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We retain professionals with training in risk and waste management capable of prompt action in emergency situations. All our meat processing plants were built in compliance with applicable environmental laws relating to the disposal of effluents and waste. In addition, our Marau facility was the first Brazilian industrial plant in the meat processing sector to adopt the Integrated Management System (SGI), a management tool that seeks excellence in quality, the environment, and occupational health and safety. Its implementation has led to the certification under ISO 9001 and ISO 14001 (International Organization for Standardization), and OHSAS 18001 (Occupational Health and Safety Assessment Series), respectively.  In 2009, eight of BRF’s units were certified according to the ISO 14001 standards: Lages, Marau Aves, Marau Suínos, Herval d’Oeste,  Serafina Corrêa, Chapecó, Paranaguá and Ponta Grossa.

 

We have implemented an environmental policy based on ensuring that our activities and growth are developed in harmony with the environment. We have an Environmental Coordination Committee, composed of members from different functions within our company, that oversees implementation of our environmental policy and monitors our environmental practices.

 

We not only comply with all the environmental precautions required in the way we conduct our operations, but we also take part in environmental conservation initiatives and run a waste recycling system in conjunction with our integrated outgrowers. Although we endeavor to comply with all environmental laws and regulations, from time to time, we have been required to enter into environmental agreements with the Brazilian government relating to noncompliance with environmental licensing requirements governing the management of solid waste and effluents. Under these agreements, we must, among other things, remediate contaminated soils. If we do not comply with these obligations, we may be subject to the imposition of daily fines.

 

On October 7, 2008, we executed a consent agreement (termo de ajuste de conduta) with the municipality of Mirassol D’Oeste. Pursuant to this consent agreement, we agreed to pay R$100,000 in damages and make a donation of 100,000 forest seedlings to entities indicated by the Public Ministry of Mato Grosso State. On October 3, 2007, we executed a consent agreement (termo de ajuste de conduta) with the municipality of Rio Verde, in the State of Goiás, which requires us to pay indemnification of approximately R$1.5 million, for which we have recorded reserves, and to make investments to improve our rainwater capture systems to avoid accidents, such as the involuntary disposal of organic waste into a river close to one of our plants on September 14, 2007. We paid the indemnification in full and are currently in compliance with the other obligations to make investments and improvements under the consent agreement.

 

Partnerships with integrated outgrowers is one of the strategies we use to ensure that our activities and those of our suppliers are performed according to world environmental standards. We are responsible for our integrated outgrowers’ licensing projects and provide technical support and guidance on the best way to manage environmental issues.

 

We are also aware of the need to increase and expand our environmental control systems in line with the pace of growth and diversification expected over the next few years. All new investments involving an increase in production must build enhanced effluent treatment plants and fuel and steam generation capacity to meet standards already reached elsewhere and, if possible, improving these indicators. In 2009, we invested R$111.8 million in environmental projects. 

 

Insurance Coverage

 

We purchase insurance to cover the following risks: (1) fire, windstorm, lightning, explosions and other risks to our property, plant and equipment and inventories, with maximum coverage per occurrence of R$1.0 billion, subject to sub-limits; (2) damages for loss of profits, with maximum coverage per occurrence of R$350.0 million, in case of fire, lightning, explosions and floods; (3) domestic transportation risks, with maximum coverage per occurrence of R$8.2 million, for which the amounts are calculated based on the registered cargo; (4) international transportation risks for export, with maximum coverage of U.S.$134.5 million and transportation risks for import, with maximum coverage of U.S.$11.0 million, depending on the shipping terms; and (5) other coverage, including general civil liability, directors’ and officers’ liability and vehicle insurance. The total coverage of our property, plant and equipment and inventories described in items (1) and (2) above was R$15.9 billion at December 31, 2009, compared to R$4.3 billion at December 31, 2008 and R$2.1 billion at December 31, 2007.

 

ITEM 4A. Unresolved Staff Comments 

 

Not applicable.

 

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ITEM 5.   OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A.  Operating and Financial Review and Prospects

 

Unaudited Combined Statement of Operations Data for the Years Ended December 31, 2008 and 2009

 

The unaudited combined statement of operations data for the years ended December 31, 2009 and 2008 presented below have been derived by combining our results of operations data derived from our audited financial statements for those fiscal years to Sadia’s results of operations data derived from its historical consolidated statements of income for the years ended December 31, 2009 and 2008.  The unaudited combined statement of operations data does not reflect any pro forma adjustments that assume that the business combination with Sadia had been consummated as of the beginning of the period presented, nor does that information reflect what our results of operations would have been had we been a combined entity during that period.  The December 31, 2009 “Sadia BR GAAP” column below represents the results of Sadia’s operations from January 1, 2009 to July 7, 2009, which is the day before BRF acquired control of Sadia, and the “BRF BR GAAP” column includes the results of Sadia’s operations from the acquisition date (July 8, 2009).

 

We present this unaudited combined statement of operations as a supplement to our audited consolidated financial statements included in this Annual Report.  We believe this information may be useful in comparing our results of operations for the years ended December 31, 2009 and 2008.  However, presenting this combined data is not in accordance with Brazilian GAAP or U.S. GAAP and does not reflect the changes in our capital structure and other effects of the business combination with Sadia.  You should rely primarily on our audited consolidated financial statements included in this Annual Report and should use the following combined data only as a supplement to those financial statements.

 

  Year Ended December 31, 2009
  BRF  Sadia  BR GAAP 
  BR GAAP  BR GAAP  Combined 
      (unaudited) 
  (in millions of reais, except as otherwise indicated) 
 
Statement of Income Data       
Net sales  15,905.8  5,030.9  20,936.7 
Cost of sales  (12,270.6)  (3,936.1)  (16,206.7) 
Gross profit  3,635.2  1,094.8  4,730.0 
Operating expenses:       
Selling, general and administrative  (3,285.0)  (1,028.6)  (4,313.7) 
Other operating income (expense), net  (259.9)  (6.3)  (266.2) 
  (3,544.9)  (1,035.0)  (4,579.9) 
Operating income (expense) before financial income (expense) and equity pick-up  90.3  59.8  150.1 
Financial income (expenses), net  241.2  346.5  587.7 
Equity pick-up  2.5  0.4  3.0 
Income (loss) before taxes and participation of non-controlling shareholders  334.0  406.7  740.8 
Income and social contribution taxes (expense) benefit  (197.2)  (302.1)  (499.3) 
Management and employees’ profit sharing  (20.8)  (6.0)  (26.8) 
Non-controlling shareholders  4.4  8.5  12.9 
Net income  120.4  107.1  227.6 

 

 

  Year Ended December 31, 2008
  BRF  Sadia  BR GAAP 
  BR GAAP  BR GAAP  Combined 
      (unaudited) 
  (in millions of reais, except as otherwise indicated) 
 
Statement of Income Data       
Net sales  11,393.0  10,728.0  22,121.0 
Cost of sales  (8,634.1)  (7,866.4)  (16,500.5) 
Gross profit  2,758.9  2,861.6  5,620.5 
Operating expenses:       
Selling, general and administrative  (2,050.3)  (2,112.5)  (4,162.8) 
Other operating income (expense), net  (261.9)  (66.9)  (328.8) 
  (2,312.2)  (2,179.3)  (4,491.6) 
Operating income (expense) before financial income (expense) and equity pick-up  446.7  682.3  1,128.9 
Financial income (expenses), net  (630.3)  (3,891.9)  (4,522.2) 
Equity pick-up  (2.9)  (2.9) 
Income (loss) before taxes and participation of non-controlling shareholders  (183.7)  (3,212.5)  (3,396.2) 
Income and social contribution taxes (expense) benefit  255.4  717.6  972.9 
Management and employees’ profit sharing  (16.9)  (5.0)  (21.8) 
Non-controlling shareholders  (0.4)  10.3  9.9 
Net income (loss)  54.4  (2.489.6)  (2,435.3) 


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Overview

We are one of Brazil’s largest food companies, with a focus on the production and sale of poultry, pork, beef cuts, milk, dairy products and processed food products. We are a vertically integrated business that produces more than 3,000 SKUs, which we distribute to customers in Brazil and in more than 140 other countries. Our products currently include:

•     frozen whole and cut chickens;

 

•     frozen pork cuts and beef cuts;

 

•     processed food products, such as the following:

 

•     marinated frozen whole and cut chickens, roosters (sold under the Chester® brand) and turkeys;

 

•     specialty meats, such as sausages, ham products, bologna, frankfurters, salamis, bacon and other smoked products;

 

•     frozen processed meats, such as hamburgers, steaks, breaded meat products, kibes and meatballs, and frozen processed vegetarian foods;

 

•     frozen prepared entrees, such as lasagnas and pizzas, as well as other frozen foods, including vegetables, cheese bread, pies and pastries;

 

•     dairy products, such as cheeses, powdered milk and yogurts;

 

•     juices, soy milk and soy juices; and

 

•     margarine;

 

•     milk; and

 

•     soy meal and refined soy flour, as well as animal feed.

 

In the year ended December 31, 2009, we generated 29.8% of our net sales from poultry, 8.8% from pork and beef, 13.6% from milk and dairy products, 44.7% from processed foods, and 3.1% from other products.

In the domestic market, which accounts for 59% of the Company’s total net sales, the Company operates under such brand names as Perdigão, Sadia, Chester, Batavo, Elegê, Rezende, Confiança, Wilson, Fiesta, Miss Daisy, Qualy, Doriana and Becel (through a strategic joint venture with Unilever) and Turma da Mônica (under license), which are among the most recognized names in Brazil. In export markets, which take the remaining 41% of the Company’s total net sales, the leading brands are Perdix, Sadia, Hilal, Halal, Corcovado, Batavo, Fazenda, Borella and Confidence.

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We are a leading producer in Brazil of specialty meats (market share of approximately 56.0% from January to December 2009), frozen processed meats (market share of approximately 70.3% from December 2008 to November 2009), dairy processed products (market share of approximately 12.8% from December 2008 to November 2009), pizzas (market share of approximately 67.3% from January 2009 to December 2009), pastas ( with market share of approximately 84.3% from December 2008 to November 2009) and margarines (market share of approximately 60.1% from January 2009 to December 2009), in each case based on sales volume, according to A.C. Nielsen do Brasil S.A. We also sell our frozen poultry, pork and beef products in the domestic market. We are able to reach substantially all of the Brazilian population through a nationwide network of 36 distribution centers. As of March 31, 2010, we operate 42 meat processing plants, 36 of which are owned (six are owned by third parties but process meat for us according to our management), 25 hatcheries of which 23 are owned, 23 animal feed mills, 14 dairy processing plants of which nine are owned (one is under construction) and five are owned by third parties, two margarine processing plants (one of them through a joint venture with Unilever), 13 milk collecting centers, one soybean processing plant and one pizza, pasta, dessert and industrialized processing plant.

 

We are the largest Brazilian exporter of poultry products, based on export sales volumes in 2009, according to ABEF, and are among the largest such exporters in the world. We are also the leading Brazilian exporter of pork products, based on export sales volumes in 2009, according to ABIPECS.

 

In the milk and dairy product industry, we are a leader in sales of UHT milk in Brazil, with a 14.8% market share, based on volumes of sales from January 2009 to December 2009, according to A.C. Nielsen do Brasil S.A. As of December 31, 2009, we had a 6.5% market share of the Brazilian production of powdered milk, according to the USDA.

 

Principal Factors Affecting Our Results of Operations

 

Our results of operations, financial condition and liquidity have been, and will continue to be, influenced by a broad range of factors, including:

 

•     Brazilian and global economic conditions;

 

•     the effect of trade barriers and other import restrictions;

 

•     concerns regarding avian influenza and other animal diseases;

 

•     the effect of demand in our export markets on supply in the domestic market, including the effect of actions by our major Brazilian competitors and of temporary increases in supply by producers in other countries;

 

•     commodity prices;

 

•     exchange rate fluctuations and inflation;

 

•     interest rates; and

 

•     freight costs.

 

We describe these factors in greater detail below.

 

Brazilian and Global Economic Conditions

 

GDP growth was 5.4% in 2007, 4.2% in 2008 and (0.2)% in 2009 according to the IBGE. Although the Brazilian economy has shown positive growth trends in the past few years, the economy has recently been affected by factors that include:

 

•     the global economic crisis since late 2007, which first affected our export sales and later affected our domestic market sales;

 

•     the appreciation of the real against the U.S. dollar in 2007, followed by the sharp 31.9% devaluation of the real against the U.S. dollar in 2008 and an appreciation of 25.5% in 2009;


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•     volatility in commodity and oil prices, exacerbated by the global economic crisis.

 

In 2007, the devaluation of the US dollar against other currencies and the conservative monetary and fiscal policies of the current government led to an appreciation of the real in relation to the US dollar. The appreciation movement ceased in September 2008, beginning of the collapse of the world financial market. Due to the financial crisis the scenario was the opposite until the end of 2008 and with the recovery of the markets in 2009 the real again began to appreciate, reaching the levels of 2007.

 

The basic interest rate increased until June 2003, when the Central Bank began to decrease it, reaching 11.25% in April 2008. But the economic activity was so strong that the Central Bank was worried that the disequilibrium between supply and demand could lead to more inflation, deviating it from their annual inflation target of 4.5%. As a result, the Central Bank started increasing interest rates until December 2008, when the benchmark Selic rate reached 13.75% per year.  But fear that the global economic downturn could severely affect Brazil changed the course of interest rate in 2009. The Central Bank began easing monetary policy and, in July 2009, it set Selic at 8.75% per year.

 

The Brazilian economy remains susceptible to political and economic changes in Brazil, in other emerging markets and in the global economy.  In 2009, the global financial crisis had a more limited effect on Brazil’s economy than in many other large economies because of the high levels of foreign reserves, the controlled fiscal situation and strong domestic demand.

 

Brazilian macroeconomic factors have also had a direct effect on domestic demand for our products. For example, among the low-income population in Brazil, demand for our specialty meats, frozen processed meats and other frozen foods has increased due to the real income growth between 2005 to 2009. In 2009, real income and nominal salaries in Brazil were 2.4% and 8.4% higher, respectively, than those in 2008.

 

In recent years, the average unemployment rate in Brazil was also lower than historical levels.  According to IBGE, it reached 6.8% in December 2009, the same level observed in December 2008. As global economic conditions deteriorated significantly in the beginning of 2009, the Brazilian economy was increasingly affected, leading to decreases in industrial output and higher unemployment rates.  According to IBGE, unemployment reached its highest level of 9.0% in March of 2009.

The effectiveness of the government stimulus programs, including a reduction in taxes in the automobile and real estate sectors, led to lower prices of durable goods and increased consumption and industry confidence. From the third quarter of 2009 and on, the service and commerce sectors began hiring again.

Effects of Trade and Other Barriers

We monitor trade barriers and other import restrictions in the poultry, pork and beef markets outside Brazil because these restrictions significantly affect demand for our products and the levels of our export sales. These restrictions often change from period to period, as illustrated by these examples:

•     In 2005, in a proceeding before the World Trade Organization, Brazil obtained a favorable result in a panel against the European Union involving the classification of exports of salted chicken breast meat. The European Union has introduced quotas on imports of Brazilian salted chicken breast, marinated turkey breast and processed chicken. Since July 2007, Brazil has been granted a majority share of these quotas. While the quotas establish lower import tariffs for the products mentioned above, the import of the same products and others continues to be permitted at the traditional import tariffs for unprocessed products.

 

•     In December 2007, Russia started to reopen its market to imports of Brazilian beef and pork products from certain states of Brazil and currently has its market open to imports from most states, including the States of Santa Catarina, São Paulo, Paraná, Mato Grosso do Sul, Minas Gerais and Goiás.

 

•     Ukraine also restricted pork imports for the retail market, on which higher taxes are levied, for a period through December 2008. More recently, in March 2009, Ukraine initiated an anti-dumping investigation regarding imports of halves and quarters of poultry, as well as legs and cuts of poultry, in each case originating in the United States and Brazil. We were asked to answer a questionnaire from the Ministry of Economy of Ukraine in connection with the investigation.

 

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•    At the end of 2009 Russia established quotas for 2010 on chicken, pork and beef protein imports. The largest shares of these quotas were allocated to the United States and Europe, with the remainder divided among Brazil, Australia, Canada, New Zealand, Argentina and Uruguay.

 

•    Protectionism in the European market resulted in the imposition of additional import duties on unprocessed products and import quotas for cooked chicken, and processed and seasoned chicken cuts.  The high duties levied  on imports in this market have reduced Brazilian competitiveness.

 

In the short term, we must respond quickly to the imposition of new restrictions, including temporary health-related restrictions, by redirecting products to other markets or changing product specifications to comply with the new restrictions in order to minimize their effect on our net sales from exports. In the long term, these restrictions affect the rate of growth of our business.

 

Effect of Animal Diseases

 

Avian Influenza (H5N1)

 

Global demand for poultry products first decreased in the first half of 2006 due to concerns over the spread of avian influenza. Although there have been no reported cases of this disease in Brazil, in the first half of 2006, the demand for our poultry products in our export markets was significantly lower, resulting in lower net sales of such products in those markets in that period. Although net sales of poultry products in the domestic market increased in the first half of 2006, prices decreased due to the oversupply of products that could not be sold as easily in our export markets.  In the second half of 2006, poultry exports, demand, production and global inventories gradually improved. Poultry exports also increased in 2007 and in 2008 before the onset of the global economic crisis.

 

Concerns about avian influenza had less of an effect on demand in 2009 than overall economic factors and the more highly publicized A(H1N1) virus described below.  However, if significant numbers of new avian influenza cases were to develop in humans, even if they did not occur in any of our markets, then demand for our poultry products both inside and outside Brazil would likely be negatively affected and the extent of the effect on our business cannot be predicted. Even isolated cases of avian influenza in humans could negatively impact our business due to the public sensitivity to the disease.

 

The Brazilian Ministry of Agriculture established a plan for the prevention of outbreaks of avian influenza and Newcastle disease in April 2006, providing for the inspection of Brazilian states’ sanitary systems. In addition to the Brazilian government plan, we have implemented our own regionalization plan to minimize the transportation of raw materials and finished products across state lines and to allow us to isolate production in any state in which an outbreak of an animal disease may occur. We could incur costs in connection with the implementation of the Brazilian government plan and our own regionalization plan.

 

If an avian influenza outbreak were to occur in Brazil, we might find it necessary to redirect a significant portion of our poultry production to cooked products. Even if we were to do so, however, we expect that demand for our products would still be adversely affected by any instance of avian influenza in Brazil.

 

A(H1N1) Influenza (“Swine Flu”)

 

In 2009, A(H1N1) influenza, also called “swine flu,” continued to spread to many countries. A(H1N1) influenza is transmitted from one person to another mainly through coughing, sneezing and contact with nasal secretions from infected individuals. According to the WHO, there is no relation between those infected with A(H1N1) influenza and contact with persons living near swine or the consumption of pork and pork-derived products.

 

More than 17,000 deaths worldwide have been recorded since the outbreak of A(H1N1) influenza in Mexico, and on June 11, 2009, the WHO declared a flu alert level six, signaling a “global pandemic.” Many countries, including Russia and China, prohibited imports of pork from countries reporting a significant number of cases (Mexico, United States and Canada), but, as the WHO and other independent sources stated that A(H1N1) influenza is not transmitted by pork consumption, those countries reopened their markets to producers from Mexico, the United States and Canada. Even so, some states in the importing countries continue to impose restrictions on pork imports from Mexico, the United States and Canada.

 

To date, Brazil has a number of documented cases of A(H1N1) influenza. A significant outbreak of A(H1N1) influenza in Brazil could lead to pressure to destroy our hogs or to restrictions on the export of some of our products to key export markets, even if no link between the influenza cases and pork consumption is shown. Any such destruction of our hogs would result in decreased sales of pork, prevent recovery of costs incurred in raising or purchasing our hogs, and result in additional expense for the disposal of destroyed hogs. Whether or not an outbreak of A(H1N1) influenza occurs in Brazil, further outbreaks of the disease anywhere in the world could have a negative impact on the consumption of pork in key export markets or in Brazil, and a significant outbreak would negatively affect our net sales and overall financial performance. Any further outbreak of A(H1N1) influenza could lead to the imposition of costly preventive controls on pork imports in our export  markets. Accordingly, any spread of A(H1N1) influenza, or increasing concerns about this disease, may have a material and adverse effect on our Company.

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Other Animal Diseases

 

Demand in our export markets may similarly be influenced by other animal diseases. For example, pork imports from most Brazilian states were banned in Russia from 2005 to 2007 due to cases of foot-and-mouth disease affecting cattle in the States of Mato Grosso do Sul and Paraná. Although we do not raise hogs in Mato Grosso do Sul and our Carambeí plant in Paraná accounts for only 12% of our total hog production, these bans affected Brazilian imports into Russia generally and required us to shift pork production for the Russian market to Rio Grande do Sul, the only Brazilian state that was not subject to the ban, until Russia lifted restrictions on imports from an additional eight Brazilian states in December 2007.

 

Effect of Export Market Demand on the Domestic Market

 

Fluctuations in demand for poultry, pork and beef products in our export markets often have an indirect effect on the supply and the selling prices for those products in the domestic market. When concerns about global outbreaks of animal diseases, imposition of trade barriers and other factors lead to a demand decrease in key export markets, we and our principal Brazilian competitors in those markets often attempt to redirect those products to the domestic market. The resulting increases in supply in the domestic market generally lead to a decrease in selling prices, which affects our net sales in the domestic market.

 

Similarly, the abrupt decline in export prices in the fourth quarter of 2008 and in 2009, due to the effect of the global economic crisis on export market demand caused an oversupply of products in the domestic market as Brazilian producers, including our company, redirected products to the Brazilian market, negatively affecting average selling prices.

 

We closely monitor the actions of our major competitors because, among other things, their responses to import restrictions in key markets, Brazilian economic conditions and other factors may significantly influence demand and supply both in the domestic market and our export markets. In the domestic market, for example, a significant majority of the market share in several categories, including specialty meats and frozen processed meats, is attributable to our company and a small number of larger competitors.  See “Item 4. Information on the Company¾B. Business Overview—Competition.”  In addition to monitoring the actions of our domestic competitors, we pay close attention to fluctuations in supply generated by producers in the United States, the European Union and other regions. Temporary increases in supply in those markets, for example, can lead producers in those countries to increase their exports to other key export markets, depressing demand and selling prices for our products.

 

Commodity Prices

 

Many of our raw materials are commodities whose prices constantly fluctuate in response to market forces of supply and demand. We purchase large quantities of soy meal, soybeans and corn, which we use to produce substantially all our own animal feed. For the most part, the commodities we purchase are priced in reais. While input costs are real-denominated, the prices of the commodities we purchase tend to follow international prices for soy meal and soybeans and, to a lesser extent, corn, and are influenced by exchange rate fluctuations. Purchases of corn, soy meal and soybeans represented approximately 22.6% of our cost of sales in 2009, 24.3% in 2008 and 23.9% in 2007. Although we produce most of the hogs we use for our pork products, we purchased approximately 7.48% of our hogs from nearby producers in 2009 and an additional 2.7% on the spot market in 2009.

 

In addition, the selling prices for many of our products, including substantially all our export products, are highly sensitive to the market price of those commodities and fluctuate together with them. In 2009, the average corn price quoted on the Chicago Board of Trade (CBOT) was 28.0% lower than  the average in 2008. Soybean prices also decreased by 16.2% in 2009 compared to 2008. The effect of decreases or increases in prices of raw materials on our gross margin is greater for products that are more similar to commodities in nature relative to more value-added products.

 

Our ability to pass on increases in raw material prices through our selling prices is limited by prevailing prices for the products we sell in our domestic and export markets, especially for those products that are more similar to commodities. For example, in the fourth quarter of 2008, as the global economic crisis increasingly affected demand for products like ours, we were forced to decrease our selling prices even though we had experienced the significant increases in raw material prices described above during the first three quarters of 2008.

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The following graph illustrates the movements in the price of corn in Cascavel in the State of Paraná (a commonly used reference price for corn in Brazil) for the periods indicated, an increase of 2.1% (2009/2008), as reported by Agra Informa Ltda., or “Agra-FNP,” a private Brazilian firm.

 

Wholesale Corn Prices at Cascavel, State of Paraná (R$  per 60Kg sack)

 

  

 

Current Brazilian government estimates of the Brazilian corn harvest in 2009-2010 forecast 51.4 million tons, according to a survey undertaken by the National Supply Company (Companhia Nacional de Abastecimento) or “CONAB,” an agency of the Brazilian Ministry of Agriculture, Husbandry and Supply, in May 2009. This estimate represents a 0.8% increase from the 51.0 million tons harvested in 2008-2009. Of these 51.4 million tons, 32.4 million tons are forecast for the summer crop and 19.0 million tons for the second crop (safrinha), to be harvested up to early August 2010.

 

The following graph illustrates the movements in the price of soybeans in Ponta Grossa in the State of Paraná (a commonly used reference price for soybeans in Brazil) for the periods indicated, a decrease of 17.1% (2009/2008), as reported by Agra FNP.

 

 

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Wholesale Soybean Prices at Ponta Grossa, State of Paraná (R$  per 60Kg sack)

 

According to a survey released by CONAB in February 2010, current Brazilian government estimates of the Brazilian soybean harvest in 2009-2010 forecast 66.7 million tons. This estimate represents a 16.7% increase over the soybean harvest in 2008-2009.

 

The estimated total exports of soybeans in the 2009-10 harvest is 26.4 million tons, which represents a 7.6% decrease over the 2008-09 harvest (28.6 million tons). Inventory volumes for the 2009-10 harvest may be increased  compared to 2008-09. CONAB estimates Brazilian inventories of 4.8 million tons, while in the last season stocks reached 0.7 million tons.

 

Brazilian exports of soybeans from January through December 2009 totaled 28.6 million tons. Revenues from exports in 2009 totaled U.S.$11.4 billion, with an average price of U.S.$400 per ton, compared with an average price of U.S.$447 per ton in 2008.

 

For information about certain expected trends in commodity prices for 2010, see “Item 5. Operating and Financial Review and Prospects—D. Trend Information¾Raw Materials.”

 

Effects of Exchange Rate Variations and Inflation

 

The table below sets forth, for the periods indicated, the fluctuation of the real against the U.S. dollar, the period-end and average daily exchange rates and Brazilian inflation as measured by the National Consumer Price Index (Índice Nacional de Preços ao Consumidor), or “INPC,” IPCA and IGP-M.

 

  2009  2008  2007 
Appreciation (depreciation) of the real against the U.S. dollar  25.5%  (31.9)%  16.3% 
Period-end exchange rate (U.S.$1.00)  R$1.74  R$2.34  R$1.77 
Average (daily) exchange rate (U.S.$1.00) (1)  R$1.99  R$1.84  R$1.95 
SELIC (2)  14.18  13.75  11.25 
Inflation (INPC) (3)  5.2%  6.5%  5.2% 
Inflation (IPCA) (4)  4.3%  5.9%  4.5% 
 
Inflation (IGP-M) (5)  (1.7%)  9.8%  7.6% 
Sources: IBGE, Fundação Getúlio Vargas and the Central Bank.       
 

(1) The average (daily) exchange rate is the sum of the daily exchange rates based on PTAX 800 Option 5, divided by the number of business days in the period.

(2) The SELIC (Sistema Especial de Liquidação e de Custódia) interest rate is the primary Brazilian reference interest rate. 

(3) INPC is published by the IBGE, measuring inflation for families with income between one and eight minimum monthly wages in eleven metropolitan areas of Brazil.

(4) IPCA is published by IBGE, measuring inflation for families with income between one and 40 minimum monthly wages in eleven metropolitan areas of Brazil.

(5) IGP-M gives different weights to consumer prices, wholesale prices and construction prices. The IGP-M is published by the Getúlio Vargas Foundation (Fundação Getúlio Vargas), a private foundation.

 

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Our results of operations and financial condition are significantly affected by movements in the exchange rate of reais to the U.S. dollar, the euro and the pound sterling. We invoice for our export products primarily in U.S. dollars and, in Europe, in euros and pounds sterling, but we report our results of operations in reais. Appreciation of the real against those currencies decreases the amounts we receive in reais and therefore our net sales from exports. For example, in 2009, on a combined basis, our export volumes decreased 6% and our net sales from exports decreased 14% as a result of the significant appreciation of the real against the U.S. dollar during that period.

 

The prices of soy meal and soybeans, which are important ingredients of our animal feedstock, are closely linked to the U.S. dollar. The price of corn, another important ingredient of our feedstock, is also linked to the U.S. dollar, albeit to a lesser degree than the price of soy meal and soybeans. In addition to soy meal, soybeans and corn, we purchase sausage casings, mineral nutrients for feed, packaging and other raw materials, as well as equipment for use in our production facilities, from suppliers located outside Brazil whom we must pay in U.S. dollars or other foreign currencies. When the real depreciates against the U.S. dollar, the cost in reais of our U.S. dollar-linked raw materials and equipment increases, and such increases could materially adversely affect our results of operations. Although the appreciation of the real has a positive effect on our costs because part of our costs are denominated in U.S. dollars, this reduction in U.S. dollar costs because of the appreciation of the real does not immediately affect our results of operations because of the length of our production cycles for poultry and pork.

 

We had total foreign currency-denominated debt obligations in an aggregate amount of R$4,579.7 million at December 31, 2009, representing 52% of our total consolidated indebtedness at that date. Although we manage a portion of our exchange rate risk through foreign currency derivative instruments and future cash flows from exports in U.S. dollars and other foreign currencies, our foreign currency debt obligations are not completely hedged. A significant devaluation of the real in relation to the U.S. dollar or other currencies would increase the amount of reais that we would need in order to meet debt service requirements of our foreign currency-denominated obligations.

 

Historically, our results of operations and financial condition have been affected by rates of inflation in Brazil. Demand for our products in the domestic market is sensitive to inflation in consumer prices, as reflected in variations in the INPC and IPCA inflation indexes, and most of our costs and expenses are incurred in reais. Because long-term contracts with suppliers and customers are not customary in our industry and prices are generally negotiated monthly or quarterly, increases in inflation have a rapid impact on our net sales and costs.

 

The IGP-M index is often used as an inflation reference rate in negotiating prices we pay to our suppliers. In addition, we buy energy to run our production facilities pursuant to long-term contracts that contain periodic inflation adjustments according to the IGP-M index.

 

In terms of personnel costs, Brazilian salaries are adjusted only once a year, based on collective agreements between employers’ syndicates and unions. Generally, unions follow the INPC as a parameter for their negotiations.

 

Effects of Interest Rates

 

Our financial expenses are significantly affected by movements in Brazilian and foreign interest rates. At December 31, 2009, 62% of our total liabilities from debt obligations and derivative instruments of R$8,798.1 million bore interest based on floating interest rates, either because they were denominated in (or swapped into) reais and bore interest based on Brazilian floating interest rates or because they were U.S. dollar-denominated and subject to LIBOR. At that date, our primary interest rate exposure was to the six-month LIBOR rate. The two primary Brazilian interest rates that apply to our indebtedness are the TJLP, which applies to our long-term debt from the BNDES, and the CDI rate, which applies to our currency swaps and some of our other long-term debt.

 

The table below shows the average interest rates to which we were exposed in the years indicated:

 

  Average Interest for the Year Ended December 31, 
  2009  2008  2007 
  (%)  (%)  (%) 
TJLP  6.12  6.25  6.37 
CDI  9.97  12.28  11.91 
Six-month LIBOR  1.11  3.06  5.25 


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Freight Costs

 

The cost of transporting our products throughout our domestic distribution network and to our foreign customers is significant and is affected by fluctuations in the price of oil. In the years ended December 31, 2009 and 2008, freight costs represented approximately 8.0% and 8.9% of our net sales, respectively. For our export goods, we ship many of our goods CFR (cost and freight) or DDP (delivered duty paid), which requires us to pay for freight and insurance costs. Increases in the price of oil tend to increase our freight costs, and fluctuations in exchange rates also significantly affect our international transportation costs.

 

Changes in Share Capital

 

On March 31, 2010, the Company’s shareholders approved a one-for-one share split of the Company’s ordinary shares and a change in the ratio of ordinary shares to ADRs such that one ordinary share corresponds to one ADR.  The combined effect of the share split and the ADR ratio change was that holders of ADRs received four ADRs for each existing ADR.  This share split and ADR ratio change became effective on April 7, 2010 and were designed to reposition the price of the Company’s shares and the ADRs with a focus on an increase in liquidity and the interests of national and international retail investors.  In accordance with Brazilian GAAP, per share data and other information in this Annual Report have not been adjusted to give effect to the related share split, except for per share data as stated in “Item 3. Key Information.”  However, the per share data in accordance with U.S. GAAP that is presented in “Item 3. Key Information—A. Selected Financial Data” and Note 26 to our consolidated financial statements in this Annual Report have been adjusted to reflect the share split.

 

On July 8, 2009, the Company’s shareholders approved the exchange of common shares of HFF for common shares of BRF at an exchange ratio of 0.166247 common shares of BRF for each share of HFF.  On August 18, 2009, an additional separate extraordinary meeting of the common shareholders of Perdigão and Sadia was held to approve the exchange of common and preferred shares of Sadia for common shares of BRF at an exchange ratio of 0.132998 common shares of BRF for each common share or preferred share of Sadia.

 

On February 21, 2008, our board of directors approved the merger of 54% of the shares held by the shareholders of Eleva into Perdigão S.A. at an exchange ratio of 1.74308855 shares of Eleva for one share of Perdigão, for a total amount of 20,256,751 issued shares.

 

Results of Operations

 

The following discussion should be read in conjunction with the consolidated financial statements included elsewhere in this form. The consolidated financial statements are prepared in accordance with Brazilian GAAP, which differ in certain significant respects from U.S. GAAP.

 

The following table sets forth the components of our results of operations as a percentage of net sales.

 

  Year ended December 31, 
  2009  2008  2007 
  (%)  (%)  (%) 
Net sales  100.0  100.0  100.0 
Cost of sales  (77.1)  (75.8)  (71.8) 
Gross profit  22.9  24.2  28.2 
Operating expenses:       
Selling  (19.2)  (16.6)  (19.3) 
General and administrative  (1.3)  (1.2)  (1.2) 
Management compensation  (0.2)  (0.2)  (0.2) 
Operating income before financial income (expense), equity interest and other  2.2  6.2  7.6 
Financial income (expense), net  1.5  (5.5)  (1.6) 
Equity interest in income of associated company  0.0  0.0  0.0 
Other operating expense, net  (1.6)  (2.3)  (0.2) 
Income (loss) before taxes, profit sharing and participation of non-controlling shareholders  2.1  1.6  5.8 
Income and social contribution taxes benefit (expense)  (1.2)  2.2  (0.5) 
Employees’ profit sharing  (0.1)  (0.1)  (0.4) 
Management profit sharing  (0.0)  (0.0)  (0.0) 
Non-controlling shareholders  0.0  (0.0)  (0.0) 
Net income  0.8  0.5  4.8 


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Presentation of Net Sales Information

 

We report net sales after deducting taxes on gross sales and discounts and returns. In 2009, we had total sales deductions of R$2,683.1 million from gross sales of R$18,588.9 million, compared to total sales deductions of R$1,768.3 million from gross sales of R$13,161.3 million in 2008 and total sales deductions of R$1,155.2 million from gross sales of R$7,788.6 million in 2007. Our total sales deductions can be broken down as follows:

 

•     ICMS Taxes. ICMS is a state value-added tax on our gross sales in the domestic market at a rate that varies by state and product sold. Our average ICMS tax rate is 8.8%.

 

•     PIS and COFINS Taxes. The PIS and the COFINS taxes are federal social contribution taxes on our gross sales in the domestic market at the rates of 1.65% for PIS and 7.60% for COFINS.

 

•     Discounts, Returns and Other Deductions. Discounts, returns and other deductions are unconditional discounts granted to customers, product returns and other deductions from gross sales.

 

Most of our deductions from gross sales are attributable to the ICMS, PIS and COFINS taxes.  As a result, our deductions from gross sales in the domestic market, which are subject to these taxes, are significantly greater than our deductions from gross sales in our foreign markets.

 

In 2009, deductions from gross sales to calculate domestic net sales increased 51.7% compared to 2008, an increase higher than the increase in net sales of 39.6%, in part because Sadia’s deductions are proportionately higher than BRF’s historical deductions, as Sadia’s product mix does not include milk, which is subject to lower taxes on sales (PIS and COFINS taxes and ICMS) than other product lines.  In 2008, deductions from gross sales to calculate domestic net sales increased 53.1% compared to 2007, an increase lower than the increase in net sales of 71.8%, primarily due to the incorporation of Eleva from January 1, 2008, which concentrates its production in dairy products that are subject to lower taxes on sales (PIS and COFINS taxes and ICMS) than other product lines.

 

Segment Presentation

 

We operate in two business segments: the domestic market and the foreign market. In each market, we produce and distribute poultry, pork/beef, processed food, milk, dairy products and other products. We report gross and net sales by market. Because we use the same assets to produce products for both our domestic and foreign markets, we do not identify assets by market. Currently, under Brazilian GAAP, there is no requirement to present segments of an enterprise. See Note 26 to our consolidated financial statements.

 

Limits on Comparability of Our Financial Statements

 

Our results of operations for the year ended December 31, 2009 include the effects of the business combination with Sadia since July 8, 2009 and are therefore not fully comparable to our results of operations for the year ended December 31, 2008.

 

Our results of operations for the year ended December 31, 2008 include the effects of the Eleva acquisition (among other acquisitions that occurred in 2008) since January 2, 2008 and are therefore not fully comparable to our results of operations for the year ended December 31, 2007. Because of the merger of Eleva’s operations into our operations, the contribution of Eleva to each line item set forth for the year ended December 31, 2008 is not available.

 

Sadia’s results of operations were fully consolidated as from July 8, 2009, when the common shareholders of Perdigão, Sadia and HFF, a holding company formed by the controlling shareholders of Sadia for the purposes of the acquisition, approved our business combination with Sadia. Consequently, our results of operations for the year ended December 31, 2009 include the results of operations of Sadia only for the period subsequent to the July 8, 2009 acquisition date.

 

In the discussion below, we include certain unaudited combined results of operations data that combines the results of operations of our Company with those of Sadia for the years ended December 31, 2008 and 2009.  The unaudited combined financial data set forth below relating to total net sales, gross profit and net income have been prepared on a basis consistent with the unaudited combined financial data set forth in “Item 5. Operating and Financial Review and Prospects—A. Unaudited Combined Financial Information” and are subject to all the limitations described in that section.  However, the unaudited combined data for net sales of poultry, pork and beef, and processed foods in our domestic and export markets reflect an adjustment to net sales for the year ended December 31, 2008 to eliminate the effect of the implementation of Law No. 11,638 described below.  Therefore, the unaudited combined data for net sales of poultry, pork and beef, and processed foods in our domestic and export markets may not be fully comparable to our other combined data included in this Annual Report.


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For more information on our acquisitions in 2009 and 2008, including the business combination with Sadia, see Note 26.1(g) to our consolidated financial statements.

 

Brazilian GAAP has recently changed pursuant to Law No. 11,638, dated December 28, 2007, and Provisional Measure No. 449/08. These legislative initiatives are aimed at ultimately enabling the convergence of Brazilian GAAP with International Financial Reporting Standards issued by the International Accounting Standards Board. Consequently, our financial statements for the years ended December 31, 2008 and 2009 are not fully comparable to our results of operations for prior periods. See Note 2 to our consolidated financial statements for more information about these changes.

 

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Combined Year Ended December 31, 2009 Compared with Combined Year Ended December 31, 2008

 

Net Sales

 

Our net sales decreased 5.4% on a combined basis to R$20,936.7 million in 2009 from R$22,121.0 million in 2008, primarily due to decreases in our export markets for the reasons described below, partially offset by increased sales of poultry, pork and beef, and processed foods in our domestic market.

 

Domestic net sales increased 3.7% on a combined basis to R$12,161.3 million in 2009 from R$11,724.7 million in 2008, mainly as a result of increased average selling prices for processed foods, pork and beef, and poultry products, as well as slight increases sales in volumes of processed foods and pork and beef. Foreign net sales decreased 15.6% to R$8,775.3 million in 2009 from R$10,396.9 million in 2008, mainly as a result of a 6.1% decrease in sales volumes.

 

Domestic Market

 

Net sales from our domestic market increased 3.7% on a combined basis to R$12,161.3 million in 2009 from R$11,724.7 million in 2008, mainly as a result of the pressure generated by the diversion of commodity-type products from the export market to the domestic market due to the depressed economic situation in many overseas markets. In addition, in the Brazilian market, demand remained concentrated on lower-priced items, partly due to continued robust sales of durable goods, which softened growth in the food sector.

 

Poultry - Domestic net sales from poultry products decreased 1.7% on a combined basis to R$793.5 million in 2009 from R$807.6 in 2008, mainly due to a decrease in sales volumes of 5.7%, which reached 225.0 thousand tons in 2009, partially offset by a 5.3% increase in average selling prices.

 

Pork and beef - Domestic net sales of pork and beef cuts increased 8.1% on a combined basis to R$547.3 million in 2009 from R$506.2 million in 2008, mainly due to a 2.5% increase in average selling prices and a 5.0% increase in sales volumes, primarily because of the business combination with Sadia, which has a product mix more weighted towards beef.

 

Milk - Milk includes long life (UHT), pasteurized and powdered milk. Domestic net sales of milk decreased 2.1% on a combined basis to R$1,444.9 million in 2009 from R$1,475.7 million in 2008, mainly as a result of a 9.3% decrease in sales volume, primarily due to a strategic reduction in sales volume of certain products.  This decrease was partially offset by a 9.7% increase in average selling prices and more effective management of the unprocessed milk business, together with an improvement in results for grocery store products.

 

Processed foods - Processed foods include processed meat, other processed products (such as lasagnas, pizzas and cheese bread) and dairy processed products.  Domestic net sales from processed foods increased 7.0% on a combined basis to R$8,854.1 million in 2009 from R$8,278.2 million in 2008, mainly due to a 4.6% increase in average selling prices and a 1.8% increase in sales volumes, primarily due to our business combination with Sadia, which has a product mix more weighted towards processed foods, including margarines.

 

Other - Other includes soybeans, animal feed and other products. Domestic net sales of these products decreased 20.6% on a combined basis to R$521.5 million in 2009 from R$657.1 million in 2008 mainly as a result of a 15.0% decrease in average selling prices and a 4.2% decrease in sales volumes.

 

The following table provides a breakdown of changes in net sales, sales volumes and average selling prices in the domestic market on a combined basis.

 

  Net Sales Sales Volumes Average Selling Prices 
  2009  2008  Change  2009  2008  Change  2009  2008  Change 
Domestic Market  (in millions of reais)  (%)  (thousand tons)  (%)  (in reais per kg)  (%) 
Poultry  793.5  807.6  (1.7)  225.0  238.5  (5.7)  4.31  4.09  5.3 
Pork /Beef  547.3  506.2  8.1  127.3  121.3  5.0  5.26  5.13  2.5 
Milk (1)  1,444.9  1,475.7  (2.1)  798.7  880.1  (9.3)  2.11  1.92  9.7 
Processed foods (2)  8,854.1  8,278.2  7.0  1,993.6  1,958.1  1.8  5.67  5.42  4.6 
Other  521.5  657.1  (20.6)  367.0  383.1  (4.2)  1.81  2.12  (15.0) 
Total  12,161.3  11,724.7  3.7  3,511.6  3,581.1  (1.9)  4.35  4.11  5.9 
 

(1) Fluid and powder milk.

(2) Includes processed meat, other processed products (lasagnas, pizzas, cheese bread) and dairy processed products.

 

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Foreign Markets

 

Net sales from foreign markets decreased 15.6% on a combined basis to R$8,775.3 million in 2009 from R$10,396.9 million in 2008, mainly due to a 8.5% decrease in average selling prices and a 6.1% decrease in sales volumes.  The principal factors impacting export performance were a significant decline in prices and volumes reflecting the adverse economic circumstances and weak demand in selected markets, the sudden appreciation of the real against the U.S. dollar between March and September of 2009 (which also squeezed margins), pressure from higher production chain costs and expenses due to instability in the markets, together with unusually high inventory, falling prices and irregular increases in the supply of commodity-type products from our competitors.

 

Poultry - Foreign net sales from poultry products decreased 13.8% on a combined basis to R$5,764.8 million in 2009 from R$6,686.6 million in 2008, mainly due to a 6.7% decrease in sales volumes and a 6.8% decrease in average selling prices.  Sales volumes decreased in regions significantly affected by the global economic crisis, such as Europe (6.0%), partially offset by increases in the Middle East (22.7%) and Africa (22.2%).  Average selling prices decreased 16.0% in U.S. dollars.

 

Pork and beef - Foreign net sales of pork and beef products decreased 12.0% on a combined basis to R$1,364.4 million in 2009 from R$1,550.8 million in 2008, mainly due to a 16.4% decrease in average selling prices, partially offset by a 6.9% increase in sales volumes. The decrease in average selling prices was primarily due to general reductions in inventory in the industry in our primary overseas markets (as companies sought working capital that they were unable to obtain from other sources due to the global economic crisis) and lower demand in the European market for poultry and turkey products.

 

Milk - Foreign net sales of milk decreased 88.4% on a combined basis to R$12.4 million in 2009 from R$106.8 million in 2008, principally due to a 83.5% decrease in sales volumes (which was partially due to a decision to reduce exports due to falling prices in the export markets), as well as a 35.3% decrease in average selling prices.

 

Processed foods - Foreign net sales of processed foods decreased 13.3% on a combined basis to R$1,602.8 million in 2009 from R$1,847.9 million in 2008, mainly due to a 10.7% decrease in sales volumes, partially offset by a 3.4% increase in the average selling prices. We recorded a significant reduction in shipped dairy product volumes due to weaker international demand and high inventories in other producing regions, such as New Zealand, combined with the currency translation effect.

In 2009, average prices in FOB – Free on Board U.S. dollars fell by about 16.0%, while the average appreciation in the foreign exchange rate in the same period was approximately 9.0%, resulted in a significant reduction of sales revenue in reais. These factors, together with the decrease in volumes and the increase in our costs and expenses, undermined our performance in this market.

The following table provides a breakdown of changes in net sales, sales volumes and average selling prices in the foreign market.

 

  Net Sales Sales Volumes Average Selling Prices 
  2009  2008  Change  2009  2008  Change  2009  2008  Change 
Foreign Markets  (in millions of reais)  (%)  (thousand tons)  (%)  (in reais per kg)  (%) 
Poultry  5,764.8  6,686.6  (13.8)  1,571.7  1,684.1  (6.7)  3.77  4.05  (6.8) 
Pork /Beef  1,364.4  1,550.8  (12.0)  285.8  267.2  6.9  4.88  5.84  (16.4) 
Milk(1)  12.4  106.8  (88.4)  2.1  12.7  (83.5)  5.44  8.40  (35.3) 
Processed foods(2)  1,602.8  1,847.9  (13.3)  309.4  346.4  (10.7)  1.08  1.05  3.4 
Other  31.0  204.7  (84.9)  9.0  9.4  (4.3)  7.87  23.11  (66.0) 
Total  8,775.3  10,396.9  (15.6)  2,178.0  2,319.8  (6.1)  4.20  4.59  (8.5) 
 

(1) Fluid and powder milk.

(2) Includes processed meat, other processed products (such as lasagnas, pizzas and cheese bread) and dairy processed products. 

 

Cost of Sales

 

Cost of sales decreased 1.8% on a combined basis to R$16,206.7 million in 2009 from R$16,500.5 million in 2008, although net sales decreased 5.4% on a combined basis, which contributed to lower margins. As a percentage of net sales, cost of sales increased to 77.4% in 2009 from 74.6% in 2008.  The increase in annual costs as a percentage of net sales primarily reflects the fixed cost structure of the production chain without the expected compensating growth in volumes and prices. In addition, such increase in costs of sales as a percentage of net sales reflected the following factors:  (1) a 20% cut in production for export in the first quarter, (2) idle capacity along the production chain due to new industrial plants in pre-operational phases, (3) the redirection of production from the Rio Verde, Goiás plant to other industrial units due to an accident that partially affected operations at this industrial complex.

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Gross Profit and Gross Margin

 

Our gross profit decreased 15.8% on a combined basis to R$4,730.0 million in 2009 from R$5,620.5 million in 2008, mainly due to the increase in our cost of sales as a percentage of net sales (primarily due to the fixed cost structure of the production chain without the expected compensating growth in volumes and prices) and the overall decrease in net sales, particularly in the foreign markets. Our gross margin on a combined basis was 22.6% in 2009, compared to 25.4% in 2008, mainly due to increases in cost of sales as a percentage of net sales, as explained above.

 

Operating Expenses

 

Operating expenses increased 1.9% on a combined basis to R$4,579.9 million in 2009 from R$4,491.6 million in 2008. As a percentage of net sales, operating expenses were 21.9% in 2009, compared to 20.3% in 2008, most specifically due to an increase in commercial expenses. Administrative expenses reflect the combined cost structures of Perdigão and Sadia because we are required to keep certain areas of our historical Perdigão operations independent from the operations of Sadia until we receive approval of the business combination from the Brazilian antitrust authorities. The impact of lower market performance was also reflected in higher operating expenses driven by the fixed structure of the production chain and the increases reported in distribution, freight, warehousing costs and investments in marketing campaigns. Operating expenses include other operating expenses, net.

 

Financial Income/Expenses, Net

 

We recorded net financial income of R$587.7 million in 2009, compared to R$4,522.2 million of expenses in 2008 on a combined basis, due primarily to the cost of Sadia’s derivative instruments in 2008 and the volatility of the real-U.S. dollar exchange rate in 2008, which was the opposite of the prevailing situation in 2009.

 

Income Tax and Social Contribution

 

Income tax and social contribution was an expense of R$499.3 million in 2009, compared to a benefit of R$972.9 million in 2008, on a combined basis.  Contributing to these values were the merger of Perdigão Agroindustrial S.A., resulting in tax expense of R$132.0 million in 2009 and the merger of acquired companies, as well as the negative financial result generated by Sadia in 2008.

 

Net Income (Loss)

 

Net income was R$227.6 million in 2009, compared to a net loss of R$2,435.3 million in 2008, on a combined basis, reflecting the financial loss on derivative instruments recorded in Sadia’s financial statements in 2008. If the fiscal loss resulting from the incorporation of Perdigão Agroindustrial were excluded, the net income for 2009 would have been R$360.0 million.

 

Historical – Year Ended December 31, 2009 Compared with Year Ended December 31, 2008

 

Net Sales

Our net sales increased 39.6% to R$15,905.8million in 2009 from R$11,393.0 million in 2008.Our net sales increased in both the domestic and the export markets, primarily as a result of (1) a 51.2% increase in sales volumes of our meat products (poultry, pork and beef), (2) a 47.8% increase in volumes of processed products and (3) a 22.6% increase in sales volumes of other processed products. These increases in our main business segment were primarily due to our business combination with Sadia and, to a lesser degree, organic growth.

In 2009, we generated 29.7% of our net sales from poultry, 8.8% from pork and beef, 9.2% from milk and dairy products and 49.6% from processed foods.

Domestic net sales increased 45.9% to R$9,369.9million in 2009 from R$6,423.8million in 2008, reflecting the additional sales volumes coming from Sadia in the third and fourth quarters of 2009, increases in our selling prices and the continuing shift in our product mix to higher value-added products. Foreign net sales increased 31.5% to R$6,535.8 million in 2009 from R$4,969.2million in 2008, as a result of a 47.7% increase in sales volumes, mainly in pork and beef products, primarily due to the Sadia transaction, and partially offset by a 11.0% decrease in average selling prices due to market instability and the resulting over-supply of commodity-type products.

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Our strategy of increasing our focus on products with higher profit margins contributed to the increase in net sales. Net sales from processed foods increased as a percentage of net sales to 49.6% in 2009 from 44.3% in 2008, mainly due to the growth in meat processed products, such as specialty meats and frozen meats, as well as dairy and other processed products, including pastas and pizzas.

Domestic Market

Net sales from our domestic market increased 45.9% to R$9,369.9 million in 2009 from R$6,423.8 million in 2008, mainly as a result of the additional sales volumes coming from Sadia in the third and fourth quarters of 2009 and favorable results from our meat businesses and other processed food products. The domestic market continued to reflect the pressure generated by the diversion of commodity-type products from the export market to the domestic market due to the depressed economic situation in many overseas markets.  In addition, in the Brazilian market, demand remained concentrated on lower-priced items, partly due to continued robust sales of durable goods, which softened growth in the food sector

Poultry - Domestic net sales from poultry products increased 36.2% to R$565.1 million in 2009 from R$414.9 million in 2008, reflecting Sadia’s consolidation, mainly due to a 27.6% increase in sales volumes (primarily due to the Sadia transaction), which reached 160.6 thousand tons in 2009, and a 6.8% increase in average selling prices.

Pork and beef - Domestic net sales of pork and beef cuts increased 142.5% to R$376.3 million in 2009 from R$155.2 million in 2008, mainly due to a 121.8% increase in sales volumes (primarily due to the Sadia transaction) and a 9.5% increase in average selling prices, including revenue from Sadia.

Milk - Milk includes long life (UHT), pasteurized and powdered milk. Domestic net sales of milk decreased 2.1% to R$1,444.9 million in 2009 from R$1,475.7 million in 2008, mainly as a result of a 9.2% decrease in sales volumes, partially offset by a 7.9% increase in average selling prices, and a more effective management of the unprocessed milk business, together with an improvement in results for grocery store products. 

Processed foods - Processed foods include processed meat, other processed products (such as lasagnas, pizzas and cheese bread) and dairy processed products.  Domestic net sales from processed foods increased 64.0% to R$6,557.0 million in 2009 from R$3,997.5 million in 2008, mainly due to a 49.6% increase in sales volumes as a result of 59.4% growth in sales volumes of meat processed products (in each case primarily due to the Sadia transaction), partially offset by a 15.0% decrease in sales volumes of dairy processed products. Net sales of dairy processed products were unaffected by the Sadia transaction because Sadia does not produce these products. In addition, average selling prices of processed foods increased 9.7% in 2009 compared to 2008.

Other - Other includes soybeans, animal feed and other products. Domestic net sales of these products increased 12.1% to R$426.6 million in 2009 from R$380.5 million in 2008 as a result of a 22.6% increase in sales volumes (due in part to the Sadia transaction), partially offset by an 8.6% decrease in average selling prices.

The following table provides a breakdown of changes in net sales, sales volumes and average selling prices in the domestic market.

  Net Sales Sales Volumes Average Selling Prices 
  2009  2008  Change  2009  2008  Change  2009  2008  Change 
Domestic Market  (in millions of reais)  (%)  (thousand tons)  (%)  (in reais per kg)  (%) 
Poultry  565.1  414.9  36.2  160.6  125.9  27.6  3.52  3.29  6.8 
Pork /Beef  376.3  155.2  142.5  85.6  38.6  121.8  4.40  4.02  9.5 
Milk (1)  1,444.9  1,475.7  (2.1)  798.7  880.1  (9.2)  1.81  1.68  7.9 
Processed foods (2)  6,557.0  3,997.5  64.0  1,502.4  1,004.4  49.6  4.36  3.98  9.7 
Other  426.6  380.5  12.1  268.0  218.6  22.6  1.59  1.74  (8.6) 
Total  9,369.9  6,423.8  45.9  2,815.2  2,267.7  24.2  3.33  2.83  17.5 
 

(1) Fluid and powder milk.

(2) Includes processed meat, other processed products (lasagnas, pizzas, cheese bread) and dairy processed products. 

   

Foreign Markets

Net sales from foreign markets increased 31.5% to R$6,535.8 million in 2009 from R$4,969.2 million in 2008, mainly due to a 47.7% increase in sales volumes driven primarily by the effects of the Sadia transaction, partially offset by an 11.0% decrease in average selling prices. These figures reflect the consolidation of Sadia’s net sales in the third and fourth quarters of 2009.

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The principal factors impacting export performance were a significant decline in prices reflecting the adverse economic circumstances and weak demand in selected markets, the sudden appreciation of the real against the U.S. dollar between March and September of 2009 (which also squeezed margins), pressure from higher production chain costs and expenses due to instability in the markets, together with unusually high inventory, falling prices and irregular increases in the supply of commodity-type products from our competitors.

In 2009, average prices in FOB – Free on Board U.S. dollars fell by about 16%, while the average appreciation in the foreign exchange rate in the same period was approximately 9%, resulted in a significant reduction of net sales in reais. These factors, together with the decrease in volumes and the increase in our costs and expenses, undermined our performance in this market.

In real terms, average selling prices of meats increased approximately 31.5% in 2009 compared to 2008, taking into account the foreign exchange variation of 9% in the period.

Poultry - Foreign net sales from poultry products increased 38.7% to R$4,161.5 million in 2009 from R$3,000.1 million in 2008, mainly due to a 50.6% increase in sales volumes (primarily due to the Sadia transaction). Sales volumes increased mainly in the Middle East (22.7%) and Africa (22.2%) but decreased in regions more affected by the economic crisis, such as Europe (6%). The overall increase in sales volumes was partially offset by a 7.9% decline in average selling prices as a result of general reductions in inventory in the industry in our primary overseas markets (as companies sought working capital that they were unable to obtain from other sources due to the global economic crisis) and lower demand in the European market for poultry and turkey products. Average selling prices in U.S. dollars decreased 16%.

Pork and beef - Foreign net sales of pork and beef products increased 25.4% to R$1,025.0 million in 2009 from R$817.3 million in 2008, mainly due to a 56.7% increase in sales volumes (primarily due to the Sadia transaction), offset by a 20.0% decrease in average selling prices, primarily as a result of global economic conditions. Although foreign sales of beef decreased 10% in 2009 compared to 2008, due to adverse economic conditions in important markets, foreign sales of pork products increased 15%, mainly due to an increase in Russia’s demand.

Milk - Foreign net sales of milk decreased 88.5% to R$12.4 million in 2009 from R$106.8 million in 2008, principally due to a 83.5% decrease in sales volumes (which was partially due to a decision to reduce exports due to falling prices in the export markets), as well as a 30.1% decrease in average selling prices.

Processed foods - Foreign net sales of processed foods increased 27.9% to R$1,337.0 million in 2009 from R$1,045.0 million in 2008, mainly due to a 38.5% increase in sales volumes, partially offset by a 6.6% decrease in average selling prices. We recorded a significant reduction in shipped dairy products volumes due to weaker international demand and high inventories in other producing regions, such as New Zealand, combined with the currency translation effect.

The following table provides a breakdown of changes in net sales, sales volumes and average selling prices in the foreign market.

  Net Sales Sales Volumes Average Selling Prices 
  2009  2008  Change  2009  2008  Change  2009  2008  Change 
Foreign Markets  (in millions of reais)  (%)  (thousand tons)  (%)  (in reais per kg)  (%) 
Poultry  4,161.5  3,000.1  38.7  1,154.8  767.0  50.6  3.60  3.91  (7.9) 
Pork /Beef  1,025.0  817.3  25.4  222.8  142.2  56.7  4.60  5.75  (20.0) 
Milk(1)  12.4  106.8  (88.5)  2.1  12.7  (83.5)  5.88  8.41  (30.1) 
Processed foods(2)  1,337.0  1,045.0  27.9  265.6  191.8  38.5  5.09  5.45  (6.6) 
Total  6,535.8  4,969.2  31.5  1,645.3  1,113.7  47.7  3.97  4.46  (11.0) 
 

(1) Fluid and powder milk.

(2) Includes processed meat, other processed products (such as lasagnas, pizzas and cheese bread) and dairy processed products. 

We reported the following performance in our main overseas markets:

Europe - Net sales increased 49.3% from 2008 to 2009 and sales volumes increased 58.3% in the same period, mainly due to the business combination with Sadia in July 2009 and the consolidation of its results of operations in our consolidated financial statements since July 8, 2009. However, the European economy still reflects the impact of the global economic crisis. Negative margins in this market during 2009 were a result of weak demand for meats, most notably for processed products and turkey meat, and from high inventory driven by local production.

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Middle East - Net sales increased 68.0% from 2008 to 2009 and sales volumes increased 86.7% during the same period. Although this market significantly recovered in 2009 from the global economic and financial crisis, there was a subsequent price and volume volatility due to excessive supplies of grilled chicken.

Far East - Net sales decreased 4.0% from 2008 to 2009 and sales volumes increased 11.4% in the same period. The year 2009 also proved to be an extremely difficult one with various key markets, such as China, Japan and Singapore, which were seriously affected by the global economic and financial crisis. The Japanese economy remained lackluster. China increased local output in order to reduce excessive dependence on the United States. Beef and pork prices decreased significantly, which also affected chicken meat prices.

Eurasia - Net sales decreased 15.7% from 2008 to 2009 and sales volumes increased 10.7% during the same period. This was another market that was hit hard by the adverse economic environment and produced negative margins, particularly in the Russian market, which was severely affected by adverse conditions in the global economy. In addition, the Brazilian quotas for there Russian market were reduced.

Africa, the Americas and Other Countries - Net sales increased 43.5% from 2008 to 2009 and sales volumes increased 44.2% during the same period. Increased business in this market was supported principally by demand from South Africa, Angola and Venezuela.

Cost of Sales

Cost of sales increased 42.1% to R$12,270.6 million in 2009 from R$8,634.1 million in 2008, primarily as a result of the consolidation of Sadia’s costs since July 8, 2009. As a percentage of net sales, cost of sales increased to 77.1% in 2009 from 75.8% in 2008, mainly due to the fixed cost structure of the production chain in a period when net sales in our foreign markets decreased. The cost of sales in 2009 also increased due to (1) the effects of our cuts in meat production of approximately 20% in the first quarter of 2009 due to weak demand in our export markets, including the effects of temporary shutdowns of some facilities, (2) the fixed costs relating to two new industrial plants of Sadia that are still in a pre-operational phase in Lucas do Rio Verde and Vitória de Santo Antäo, and (3) the diversion of production from our Rio Verde plant in the state of Goiás to other units due to a fire that partially interrupted operations at that complex.

Gross Profit and Gross Margin

Our gross profit increased 31.8% to R$3,635.2 million in 2009 from R$2,758.9 million in 2008, mainly due to the Sadia transaction. Our gross margin was 22.9% in 2009, as compared to 24.2% in 2008, mainly due to the increase in our cost of sales as a percentage of net sales for the reasons explained above and the overall decrease in net sales, particularly in the foreign markets.

Operating Expenses

The fixed cost structure of our production chain was also reflected in our operating expenses, which rose by 60.2% to R$3,285.0 million in 2009 from R$2,050.3 million in 2008, outpacing net sales growth. As a percentage of net sales, operating expenses were 20.7% in 2009, as compared to 18.0% in 2008. The main driver of these increases was the 61.5% increase in commercial expenses to R$3,054.3 million in 2009 from R$1,891.1 million in 2008, primarily due to increases in distribution, freight, warehousing costs and investments in marketing campaigns. The effect of the volatility of the real-U.S. dollar exchange rate on our costs denominated in U.S. dollars also contributed to these increases. Administrative expenses reflect the structures of Perdigão and Sadia because we are required to keep certain areas of our historical Perdigão operations independent from the operations of Sadia until we receive approval of the transaction from the Brazilian antitrust authorities.

Financial Income/Expenses, Net

We recorded net financial income of R$241.2 million in 2009 as compared to R$630.3 million in net financial expenses in 2008, primarily due to the appreciation of the real against the U.S. dollar and financial investments resulting from funds raised through the primary offering of our common stock and partially offset by our increased consolidated interest expense in the third quarter of 2009 following our consolidation of Sadia’s indebtedness as described below.

Net debt increased 14.4% in 2009 relative to 2008 due to the consolidation of Sadia’s net debt in our financial statements. In 2009, we raised additional funds through a public offering of our common shares for gross proceeds of R$5.3 billion, of which approximately R$2.2 bil­lion was allocated to Sadia to reduce short-term bank debt.

 

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Other Operating Expenses, Net

Other operating expenses, net decreased 0.8% to R$259.9 million in 2009 from R$261.9 in 2008.  The principal component of other operating costs in 2009 was R$119.7 million in costs of idle capacity related to new plants still at a pre-operational phase.  The principal component of other operating costs in 2008 was the amortization of goodwill. 

Income and Social Contribution Taxes

Income and social contribution taxes were an expense of R$197.2 million in 2009, compared to a benefit of R$255.4 million in 2008, primarily due to the incorporation of Perdigão Agroindustrial S.A. in the first quarter of 2009, when we wrote off a total of R$132.0 million of existing tax loss carry-forwards and the negative base for calculation of the social contribution of this company was recognized by BRF. Positive financial results also contributed to the increase in income and social contribution taxes.

Net Income

Net income increased 121.4% to R$120.4 million in 2009 from R$54.4 million in 2008 for the reasons set forth above. While our operating results reflect the impact of adverse global market conditions, our third quarter net income benefited from financial income due to the impact of the appreciation of the real against the U.S. dollar.

Historical – Year Ended December 31, 2008 compared with Year Ended December 31, 2007

 

Net Sales

 

Our net sales increased 71.8% to R$11,393.0 million in 2008 from R$6,633.4 million in 2007. Our net sales increased in both the domestic and the export markets, primarily as a result of (1) a 45.8% increase in sales volumes of meat products (poultry, pork and beef), including through organic growth and the consolidation of Eleva following its acquisition in 2008, (2) a 739.1% increase in net sales of milk due to the acquisition of Eleva, (3) a 25.9% increase in volumes of processed products mainly due to increases in net sales of specialty and frozen meat products, which increased 14.3%, and of dairy processed products, which increased 66.6%, due in large part to the Eleva acquisition. These results, however, should be considered in the light of diminishing export volumes due to the flooding and damage to port infrastructure in the State of Santa Catarina and an abrupt slide in average selling prices in the international market, in each case in the fourth quarter of 2008.

 

Domestic net sales increased 84.5% to R$6.4 billion in 2008 from R$3.5 billion in 2007, reflecting increases in prices and shifts in mix toward higher value-added products. Exports net sales increased 57.7% to R$5.0 billion in 2008 from R$3.1 billion in 2007, as a result of a 34.8% increase in sales volumes, mainly in processed foods.

 

Our strategy of increasing our focus on products with higher profit margins contributed to the increase in net sales. Net sales from processed foods, however, decreased as a percentage of net sales, to 44.3% from 54.5%, mainly due to the greater exposure to poultry, pork and milk commodity products, particularly due to the consolidation of Eleva and Cotochés after the acquisitions of those companies.

 

Domestic Market

 

Net sales from our domestic market increased 84.5% to R$6,423.8 million in 2008 from R$3,482.4 million in 2007 as a result of favorable performance our meat businesses, dairy products and other processed foods.

 

Poultry - Domestic net sales from poultry products increased 132.6% to R$414.9 million in 2008 from R$178.4 million in 2007, mainly due to a 164.6% increase in sales volumes, which were partially offset by a 12.1% decrease in average selling prices.

 

Pork and beef - Domestic net sales of pork and beef cuts increased 195.1% to R$155.2 million in 2008 from R$52.6 million in 2007, mainly due to an 187.4% increase in sales volumes and a 2.7% increase in average selling prices.

 

Milk - Milk includes long life (UHT), pasteurized and powdered milk. Domestic net sales of milk increased 682.3% to R$1.5 billion in 2008 from R$188.6 million in 2007, mainly as a result of a 590.1% increase in sales volume due to the acquisition of the Eleva and Cotochés businesses in 2008. The absorption of such a large increase in milk production capacity occurred in a particularly difficult economic environment, especially in the UHT milk business, where we made a significant third quarter adjustment in view of growth in supplies of this product in the market set against stagnating demand that contributed to a sharp decline in retail prices. Oversupply and low prices also characterized the powdered milk market due to burgeoning world production. We undertook a review of fluid milk volumes and an adjustment in production costs to reestablish adequate margins for this business, which positively affected our results for the final quarter of the year.


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Processed foods - Domestic net sales from processed foods increased 40.3% to R$4.0 billion in 2008 from R$2.8 billion in 2007, mainly due to a 25.9% increase in sales volumes as a result of 11.3% growth in sales volumes of meat processed products and a 64.5% increase in sales volumes of dairy processed products because of the acquisitions carried out in 2008. In addition, average selling prices of processed foods increased 11.4% in 2008 compared to 2007.

 

Other - Other includes pastas, pizzas, margarines, frozen vegetables, cheese bread and the soybean-based vegetarian line, among others. Domestic net sales from other products increased 78.1% to R$380.5 million in 2008 from R$213.6 million in 2007 as a result of a 18.5% increase in sales volumes due to (1) the inclusion of margarines in our results of operations starting in August 2007 and (2) a 50.3% increase in average selling prices.

 

The following table provides a breakdown of changes in net sales, sales volumes and average selling prices in the domestic market.

 

  Net Sales Sales Volumes  Average Selling Prices 
  2008  2007  Change  2008  2007  Change  2008  2007  Change 
Domestic Market  (in millions of reais) (%)  (thousand tons)  (%)  (in reais per kg)  (%) 
Poultry  414.9  178.4  132.6  125.9  47.6  164.6  3.29  3.75  (12.1) 
Pork /Beef  155.2  52.6  195.1  38.6  13.4  187.4  4.02  3.91  2.7 
Milk (1)  1,475.7  188.6  682.3  880.1  127.5  590.1  1.68  1.48  13.4 
Processed foods (2)  3,997.5  2,849.1  40.3  1,004.4  797.7  25.9  3.98  3.57  11.4 
Other  380.5  213.6  78.1  218.6  184.6  18.5  1.74  1.16  50.3 
Total  6,423.8  3,482.3  84.5  2,267.7  1,170.8  93.7  2.83  2.97  (4.8) 
 _____________

(1) Fluid and powder milk.

(2) Includes processed meat, other processed products (lasagnas, pizzas, cheese bread) and dairy processed products.

 

Export Markets

 

Net sales from export markets increased 57.7% to R$4,969.2 million in 2008 from R$3,151.0 million in 2007, mainly due to a 34.8% increase in sales volumes and a 17.0% increase in average selling prices.

 

Poultry - Export net sales from poultry products increased 61.5% to R$3,000.1 million in 2008 from R$1,858.2 million in 2007, mainly due to a 38.2% increase in sales volumes and a 16.9% growth in average selling prices as a result of an increase in demand in our primary export markets in the first three quarters of the year, following global economic growth of prior years that resulted in Brazilian exports of meat (poultry, pork and beef) in 2008 reaching the highest level in years, before the decrease in average selling prices that occurred in the fourth quarter as a result of the continuing global economic recession.

 

Pork and beef - Export net sales of pork and beef products increased 54.7% to R$817.3 million from R$528.4 million in 2007, mainly due to a 18.1% increase in sales volumes and a 31.0% increase in average selling prices, reflecting solid demand in our primary export markets in the first three quarters of the year, following global economic growth of prior years that resulted in Brazilian exports of meat (poultry, pork and beef) in 2008 reaching the highest level in years, before the decrease in average selling prices that occurred in the fourth quarter as a result of the continuing global economic recession.

 

Processed foods - Export net sales of processed foods increased 36.7% to R$1,045.0 million in 2008 from R$764.4 million in 2007, mainly due to a 27.4% increase in sales volumes and 7.3% increase in average selling prices. Export net sales from dairy products increased to R$127.8 million, mainly due to increases in sales volumes that resulted from the acquisition of Eleva and Cotochés.

 

We increased average selling prices during 2008 in order to partially offset narrower margins caused by significant increases in raw material costs. Our average FOB (Free on Board) U.S. dollar selling prices increased an average of 24.7% compared with 2007.

 

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However, poor economic conditions and other adverse events in the fourth quarter were responsible for undermining our efforts to improve our profit margin, mainly due to (1) an accentuated fall in international average selling prices during the last quarter of 2008 of 15.2% in U.S. dollar-FOB terms compared with the third quarter, a reflection of destocking by importers due to the difficulty in raising working capital; and (2) flooding and damage to port infrastructure in the State of Santa Catarina, with an immediate need to transfer export activities from the ports of Navegantes and Itajaí to those of São Francisco, Paranaguá and Rio Grande, and resulting in reduced shipments in November, the backlog of which had still not been completely cleared by the end of 2008.

 

In real terms, average selling prices of meats increased approximately 15.7% in 2008 as a whole compared to 2007, taking into account a foreign exchange variation of 32% in the period.

 

  Net Sales Sales Volumes Average Selling Prices 
  2008  2007  Change  2008  2007  Change  2008  2007  Change 
Export Markets  (in millions of reais)  (%)  (thousand tons)  (%)  (in reais per kg)  (%) 
Poultry  3,000.1  1,858.2  61.5  767.0  555.2  38.2  3.91  3.35  16.9 
Pork /Beef  817.3  528.4  54.7  142.2  120.4  18.1  5.75  4.39  31.0 
Milk(1)  106.8  —  —  12.7  —  —  8.41  —  — 
Processed foods(2)  1,045.0  764.4  36.7  191.8  150.6  27.4  5.45  5.08  7.3 
Other  —  —  —  —  —  —  —  —  — 
Total  4,969.2  3,151.0  57.7  1,113.7  826.2  34.8  4.46  3.81  17.0 
__________
(1) Fluid and powder milk.
(2) Includes processed meat, other processed products (such as lasagnas, pizzas and cheese bread) and dairy processed products. 

 

We reported the following performance in our main overseas markets:

 

Europe - Net sales increased 18.1% from 2007 to 2008 and sales volumes increased 5.2% in the same period, mainly due to the acquisition of Plusfood in January 2008 and the consolidation of its results of operations in our financial statements as of the first quarter of 2008. However, demand for imported frozen products in the European market declined, as supplies of chilled products increased as a result of increases in local production.

 

Middle East - Net sales increased 79.0% from 2007 to 2008 and sales volumes increased 50.1% during the same period, mainly due to increases in sales volumes to various countries in the region. We believe we were also able to achieve greater market share in this market due to increased production capacity following the acquisition of Eleva and further tailoring of production to customer requirements.

 

Far East - Net sales increased 45.4% from 2007 to 2008 and sales volumes increased 16.8% in the same period, mainly due to increased demand from the Japanese market, which was partially offset by reduced imports of cooked items by China. China reopened for chicken imports from Brazil in the third quarter of 2008, but Chinese authorities did not begin issuing the necessary import licenses to Chinese importers in 2008.

 

Eurasia - Net sales increased 46.8% from 2007 to 2008 and sales volumes increased 4.9% during the same period, mainly due to increased pork and beef exports, especially to the Russian market, which showed increased demand for meats through September 2008 and higher average selling prices ahead of the winter and the holiday season.

 

Africa, the Americas and Other Countries - Net sales increased 227.6% from 2007 to 2008 and sales volumes increased 145.6% during the same period, mainly due to increased sales of whole chicken and other meat products, mainly beef, together with an improvement in product mix. Sales to Angola, Egypt, Mozambique, Uruguay and Venezuela posted the greatest increases.

 

Cost of Sales

 

Cost of sales increased 81.4% to R$8,634.2 million in 2008 from R$4,760.1 million in 2007. As a percentage of net sales, cost of sales increased to 75.8% of net sales in 2008 as opposed to 71.8% in 2007, mainly due to significant increases in the price of our principal raw materials (corn, soybean meal, milk and beef), which more than offset the increases in net sales explained above. In addition, other production costs involving secondary materials, packaging, freight and labor - principally a reflection of collective bargaining agreements - contributed to the increase in cost of sales as a percentage of net sales.

 

Corn and soy bean prices significantly increased in the first half of 2008, translating into higher production costs through the end of the third quarter of 2008. In addition, we faced a sharp currency devaluation in the fourth quarter of 2008. On the other hand, the effects of commodity price increases on our cost of sales has gradually become somewhat less significant as a share of our total costs as we have grown the processed foods part of our business.

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The price of milk, another important raw material included in overall dairy product costs, fell 1.8% during 2008 compared with 2007, and 7.3% between the third and fourth quarters of 2008, partially adjusting prices of acquisition from the farms, which had been above normal levels due to greater demand from producers, especially those in the long-life milk (UHT) business. However, the average price of milk paid to producers increased significantly through September, compressing margins of fluid milk products.

 

Gross Profit and Gross Margin

 

Our gross profit increased 47.3% to R$2,758.9 million in 2008 from R$1,873.3 million in 2007. Our gross margin was 24.2% in 2008, compared to 28.2% in 2007, due to increases in cost of sales as a percentage of net sales explained above.

 

Operating Expenses

 

Operating expenses increased 49.7% to R$2,050.4 million in 2008 from R$1,369.4 million in 2007. As a percentage of net sales, operating expenses were 18.0% in 2008, compared to 20.6% in 2007. This relative decrease of operating expenses as a percentage of net sales occurred primarily due to a relative reduction of commercial expenses, even though operating expenses increased in absolute terms as a result of costs of freight, warehousing and port charges. The effect of these expenses intensified in the last quarter due to the flooding at the ports of Itajaí and Navegantes in the State of Santa Catarina and the damage to port infrastructure. This required us to divert all our exports in the region to three other ports: Rio Grande, Rio Grande do Sul, Paranaguá, Paraná and São Francisco, Santa Catarina, incurring additional costs.

 

Operating Income Before Financial Expenses and Other

 

Our operating income before financial expenses and other increased 40.6% to R$708.5 million in 2008 from R$503.9 million in 2007. Amortization of goodwill relating to acquisitions represented R$153.0 million, or 58.4%, of the total amount of R$261.9 million recorded under other operating expenses.

 

Financial Expenses, Net

 

Our net financial expenses, net increased 498.0% to R$630.3 million in 2008 from R$105.4 million in 2007, primarily as a result of an approximately 32% devaluation of the real against the U.S. dollar (comparing closing rates for 2007 and 2008). As a result of such devaluation of the real against the U.S. dollar, we recognized a non-cash translation effect on our financial expenses of R$416.0 million for 2008. These financial expenses arising from the exchange rate effect are gradually offset as export shipments proceed.

 

Income Tax and Social Contribution

 

Income tax and social contribution was a benefit of R$255.3 million in 2008, compared to a provision of R$32.1 million in 2007, primarily due to an amount amortized in fiscal year 2008 attributable to goodwill from acquisitions, the currency translation effect of devaluation on our financial expenses and deductions of interest on shareholders’ equity.

 

Net Income

 

Net income decreased 83.1% to R$54.4 million in 2008 from R$321.3 million in 2007 for the reasons set forth above.

 

Basis of Preparation and Presentation of the Consolidated Financial Statements and First Adoption of Law No. 11,638/07 and Provisional Executive Act No. 449/08

 

We have prepared our consolidated financial statements in accordance with Brazilian GAAP, which is based on Brazilian Corporation Law and regulations and rules issued by the CVM, accounting standards issued by the Brazilian Institute of Independent Auditors (Instituto dos Auditores Independentes do Brasil), and procedures, provisions and interpretations issued by the Brazilian Accounting Pronouncement Committee (Comitê de Pronunciamentos Contábeis).

 

Beginning on January 1, 2008, the Brazilian Corporation Law was amended by Law No. 11,638, dated December 29, 2007 and by Provisional Executive Act No. 449/08, dated December 3, 2008. The main objective of these amendments is to update the Brazilian Corporation Law in order to enable the convergence of accounting practices adopted in Brazil to the International Financial Accounting Reporting Standards (“IFRS”) issued by the International Accounting Standards Board Law No. 11,638/07 also allows the CVM to issue new standards and procedures, based on IFRS.

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The changes in Brazilian Corporation Law were assessed, measured and recorded by us in our financial statements as of and for the year ended December 31, 2008. Such changes are characterized as changes in accounting practice as provided by CVM Resolution No. 506/06, “Accounting practices, changes in accounting estimates and correction of errors.” In addition, as provided by CVM Resolution No. 565, we recorded the adjustments resulting from change in accounting practice in retained earnings on January 1, 2008. The changes in accounting practices described above resulted in a R$6.5 million increase in total assets, a R$28.7 million decrease in shareholders’ equity and a R$12.2 million increase in net income.

 

The consolidated financial statements as of and for the year ended December 31, 2007 were prepared in accordance with accounting practices adopted in Brazil in force at the time and were not restated in connection with the changes described above.

 

Brazilian GAAP differs in significant respects from U.S. GAAP and IFRS. For more information about the difference between Brazilian GAAP and U.S. GAAP and a reconciliation of our net income and shareholders’ equity from Brazilian GAAP to U.S. GAAP, see Note 26 to our annual consolidated financial statements included in this Annual Report.

 

Critical Accounting Policies and Estimates

 

We have prepared our consolidated financial statements included in this Annual Report on Form 20-F in accordance with Brazilian GAAP, which differs in significant respects from U.S. GAAP. See Note 26 to our consolidated financial statements for an explanation of these differences and a reconciliation of net income and shareholders’ equity to U.S. GAAP.

 

The preparation of these financial statements required management to make estimates and assumptions that affected the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management evaluates its estimates and judgments on an ongoing basis and bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

The following is a description of the critical estimates or judgments that are important to the presentation of our consolidated financial statements.

 

Revenue Recognition and Sales Returns

 

We recognize revenue when we deliver our products to customers, the selling price is fixed and determinable, evidence of arrangements with our customers exists, collectability is reasonably assured and title and risks of ownership have passed to the customer. Our revenue recognition policy therefore requires judgments regarding, among other things, the likelihood of collectability from our customers.

 

During the holiday season, when volumes of some of our products increase, we offer certain large customers the ability to return products they are unable to sell. We monitor these product returns and record a provision for the estimated amount of such future returns, based on historical experience and any notification received of pending returns. While we believe that we make reliable estimates for these matters, fluctuations in demand could cause our estimates and actual amounts to differ and could have a negative effect on our net sales in future periods.

 

Allowances for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses from the inability of our customers to make required payments. Management determines the allowance for doubtful accounts of domestic customers based on the risk analysis, which considers the estimated realization and historical losses on average receivable balances. Management determines the allowance for doubtful accounts of export customers, who are fewer in number, based on an analysis of estimated losses for each customer. Large receivable balances are reviewed monthly to ascertain whether adjustments to the allowance for doubtful accounts are necessary. In estimating losses from doubtful accounts, management takes into account historical bad debts, customer creditworthiness, current economic conditions and changes in customer payment patterns. If the financial condition of our customers were to deteriorate, we could be required to increase our allowances for doubtful accounts, which would be charged to our statements of income.

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Goodwill

 

Under Brazilian GAAP, we used to amortize goodwill on a straight-line basis over the remaining useful lives of the assets acquired based on our expectations of future profitability of those assets. However, since January 2009, Brazilian GAAP does not allow goodwill amortization, and now requires the recoverability of goodwill to be tested at least annually for impairment. In 2009 and 2008, we tested the recoverability of goodwill and, as a result of the evaluations, no impairment loss has been recorded. Under Brazilian GAAP, the amount of goodwill impairment, if any, is measured based on projected discounted future operating cash flows. We identify our reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets. We then determine the fair value of each reporting unit by expected discounted operating cash flows generated by the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized first to goodwill until it is reduced to zero and then proportionally to other long-lived assets.

 

Under U.S. GAAP, goodwill is not amortized and is subject to a yearly impairment test. In performing the yearly impairment test, we identify our reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets. We then determine the fair value of each reporting unit and compare it to the carrying amount of the reporting unit. If the carrying amount of a reporting unit exceeds the fair value of the reporting unit, a second step of the impairment test is performed which involves the determination of the implicit fair value of the reporting unit by performing a hypothetical purchase price allocation. If the implicit value of the goodwill exceeds the book value, impairment is recognized. In order to estimate future cash flows, we must make various assumptions about matters that are highly uncertain, including future production and sales, product prices (which we estimate based on current and historical prices, price trends and related factors), future taxes payable and operating costs.

 

The use of different assumptions for valuation purposes, including estimates of future cash flows and discount rates, may have resulted in different estimates.

 

Accounting for Business Combinations

 

We have made significant acquisitions that included the recording of goodwill and other intangible assets.

 

Under Brazilian GAAP, goodwill is normally attributed to the difference between the book value and the market value of net assets acquired and justified based on expectation of future profitability. Beginning January 1, 2009, the goodwill based on expectation of future profitability is no longer amortized, but is tested for impairment, at least annually.

 

Under U.S. GAAP, goodwill is calculated as the difference between the purchase consideration and the fair value of the net assets acquired.

 

We exercise significant judgment in the process of identifying tangible and intangible assets and liabilities, valuing such assets and liabilities and determining their remaining useful lives. We generally engage third-party valuation firms to assist in valuing the acquired assets and liabilities. The valuation of these assets and liabilities is based on the assumptions and criteria which include in some cases estimates of future cash flow, discounted at the appropriate rates. The use of different assumptions may result in different estimates of value of assets acquired and liabilities assumed.

 

Depreciation, Depletion, Amortization and Impairment

 

We recognize expenses related to the depreciation of our property, plant and equipment, the depletion of our forests and the amortization of software development (i.e., deferred charges). The rates of depreciation, depletion and amortization are based on our estimates of the useful lives of the assets over the periods during which these assets can be expected to provide benefits to us. On December 17, 2008, the CVM issued Resolution No. 565, which required the Company to review and adjust the criteria used to determine the estimated useful economic life and depreciation, depletion and amortization rate, recording the effect as of  December 31, 2009 based on the registered fixed assets as of January 1, 2009 (see note 11 of our consolidated financial statements included in this Annual Report). In addition, we monitor the use of our fixed assets to determine whether any impairment of those assets is necessary. The determination of such impairment involves judgments and estimates as to whether the asset is providing an adequate return in relation to its book value. While we believe that we make reliable estimates for these matters, the use of different assumptions could lead to different conclusions relating to such impairment.

 

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We recorded breeder poultry and hogs as property, plant and equipment. While we raise the breeders, which generally take approximately six months, we allocate the costs of labor, animal feed and medicines associated with the breeders under property, plant and equipment. After that, we depreciate these amounts based on the estimates of offspring to be produced (generally, 15 months for poultry and 30 months for hogs).

 

Contingencies

 

We accrue for losses on tax and other legal contingencies based on an analysis of pending litigation. We record amounts considered sufficient by management to cover probable losses based on the opinion of outside legal counsel and our in-house legal counsel. If any additional information causes the opinion of outside and our in-house legal counsel to change, we must reassess the potential liability related to pending litigation and review our estimates accordingly. Any revision may significantly affect our results of operations and financial position.

 

Derivative Instruments

 

We use derivative instruments, especially swaps, to manage the risks of exchange and interest rate variations. Beginning on January 1, 2008, these instruments have been recorded using the fair value method in accordance with Brazilian GAAP, which uses the same measurement principles as adopted for U.S. GAAP purposes and which we determine based on quotations of similar instruments and estimates of future exchange and interest rates.

 

On December 17, 2008, the CVM issued specific standards addressing accounting of financial derivative instruments through Resolution No. 566, which allows the adoption of hedge accounting. Management adopted the standard on December 31, 2008 for transactions within the scope of the standards.

 

During the periods presented, we have designated certain derivative instruments as hedges for Brazilian GAAP, and, therefore, the accounting adjustments for our derivatives were recorded in equity evaluation adjustments.

 

We do not use derivatives to hedge the risks of changes in commodity prices on a regular basis.

 

Inventory

 

We allocate the costs of parts of slaughtered poultry, hogs and cattle in proportion to the estimated amounts to be recovered from certain by-product parts.

 

Generally, we perform an evaluation of whether any lower of cost or market adjustments are required based on a number of factors, including: (1) pools of related inventory, (2) product continuation or discontinuation, (3) estimated market selling prices and (4) expected distribution channels.

 

Income Tax and Social Contribution

 

We calculate our corporate income tax and the social contribution based on taxable income and tax rates in effect. Results from subsidiaries abroad are subject to taxation in their respective countries, according to local tax rates and regulations. Deferred income tax assets and liabilities arise from tax loss carryforwards and negative bases of social contribution tax, as well as the impact of temporary differences between tax and accounting basis. Deferred income tax and social contribution assets and liabilities are recorded in current or noncurrent assets or liabilities according to their expected realization periods. A valuation allowance is recorded when management estimates that it is more likely than not that the deferred tax assets will not be recovered in the future. While we believe that we make reliable estimates, actual results may be different.

 

Marketable Securities

 

Our classification and recording are made in accordance with the purposes for which they were acquired, as follows:

 

•     Trading securities - if the financial assets were purchased for the purpose of sale or repurchase in the short term, they are initially recorded at fair value and related variations as well as monetary and exchange variation, when applicable, are recorded directly in the statement of  income as financial income or expenses;

 

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•     Held to maturity - if we have the positive intent and ability to hold the financial assets to maturity, they are recorded at their acquisition cost. Interest and monetary variation are recognized in the statement of income, when incurred, as financial income or expenses; and

 

•     Available for sale - includes all financial assets that do not qualify in the other two categories above. They are initially measured at fair value and changes in fair value are recorded to shareholders’ equity, under equity evaluation adjustments while unrealized, net of tax. Interest and monetary variation are recognized in the statement of income, when incurred, as financial income or expenses.

 

While we believe that we make reliable estimates for these matters, actual fair value of these securities may be different than our estimates, which could negatively affect our results of operations.

 

Recently Issued Accounting Pronouncements Under U.S. GAAP

 

In June 2009, the FASB issued the Accounting Standards Codification (ASC). The ASC became the single source of authoritative, nongovernmental generally accepted accounting principles (GAAP) in the United States, other than guidance issued by the SEC. The ASC is effective for interim and annual periods ending after September 15, 2009. The adoption of the ASC did not have a material impact on the Company’s financial statements. However, reference to specific accounting standards have been changed to refer to the appropriate section of the ASC. Subsequent revisions to GAAP by the FASB will be incorporated into the ASC through issuance of Accounting Standards Updates (ASU).

 

 

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements, which will require companies to make new disclosures about recurring or nonrecurring fair value measurements including significant transfers into and out of Level 1 and Level 2 fair value hierarchies and information on purchases, sales, issuance and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. The ASU is effective prospectively for financial statements issued for fiscal years and interim periods beginning after December 15, 2009. The new disclosures about purchases, sales, issuance and settlements on a gross basis in the reconciliation of Level 3 fair value measurements is effective for interim and annual reporting periods beginning after December 15, 2010. The Company expects that the adoption of ASU 2010-06 will not have a material impact on its consolidated financial statements.

 

 

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets an amendment of Statement of Financial Accounting Standards No. 140 (ASU 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfer of Financial Assets), included in ASC Subtopic 860-50, Servicing Assets and Liabilities. This guidance is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance is effective for interim and annual reporting periods beginning after November 15, 2009. The Company continues to evaluate the potential impact of adopting this new guidance on its consolidated financial statements.

 

 

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, Amendments to Financial Accounting Standards Board Interpretation No. 46(R) (ASU 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities), included in ASC Subtopic 810-10, Consolidations — Overall. This guidance is intended to improve financial reporting by enterprises involved with variable interest entities by requiring ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity and addresses concerns regarding the timely and usefulness of information about an enterprise’s involvement in a variable interest entity. This guidance is effective for interim and annual reporting periods beginning after November 15, 2009, with early application prohibited. The Company continues to evaluate the potential impact of adopting this new guidance on its consolidated financial statements.

 

B.  Liquidity and Capital Resources

 

Our main cash requirements are the servicing of our debt, capital expenditures relating to expansion programs, acquisitions and the payment of dividends and interest on shareholders’ equity. Our primary cash sources have been cash flow from operating activities, loans and other financings, offerings of our common stock and sales of marketable securities. We believe that these sources of cash will be sufficient to cover our working capital needs in the ordinary course of our business. Since Sadia became our subsidiary on July 8, 2009, we have used a portion of our cash to provide liquidity to this subsidiary. On September 1, 2009, we announced that we would transfer up to R$3.5 billion to Sadia as an advance on a future capital increase of Sadia (adiantamento para futuro aumento de capital). As of December 31, 2009, we had transferred R$2,260 million to Sadia, including R$950.0 million that we transferred on July 27, 2009 and that Sadia used to repay short-term export credit notes in the amount of R$930.0 million.

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Cash Flows from Operating Activities

 

We had net cash flows from operating activities of R$467.1 million in 2009, compared to R$528.3 million in 2008. Our 2009 operating cash flow of R$467.1 million reflects net income of R$120.4 million, R$590.7 million of depreciation, amortization and depletion, R$59.8 million in loss and disposal of permanent assets, an increase in net deferred income taxes of R$182.3 million and R$207.1 in net changes in operating assets and liabilities, offset by foreign exchange variations and accrued interest of R$691.6 million. These changes are primarily related to the business combination with Sadia during 2009.

 

We had net cash flows from operating activities of R$528.3 million in 2008, compared to R$363.8 million in 2007. The increase in net cash flows from operating activities from 2008 to 2007 was mainly due to a R$176.3 million increase in depreciation, amortization and depletion, a R$131.6 million increase in amortization of goodwill, a R$967.6 million increase in non-cash losses relating to foreign exchange variations and, to a lesser degree, in accrued and unpaid interest, and a R$276.9 million increase in deferred income taxes, which were partially offset by a R$240.6 million increase in inventories and a R$332.7 million increase in payroll and related charges. These changes are primarily related to the acquisitions carried out during 2008.

 

Our working capital, defined as total current assets minus total current liabilities, was R$4,569.6 million at December 31, 2009, compared to R$2,904.2 million at December 31, 2008. The increase in working capital was primarily due to the business combination with Sadia during 2009. Our working capital was R$2,904.3 million at December 31, 2008 compared to R$1,827.0 million at December 31, 2007. The increase in working capital was primarily due to the acquisitions carried out during 2008.

 

Cash Flows Used in Investing Activities

 

We used R$1,223.2 million in cash in investing activities in 2009, compared to R$1,627.6 million used in 2008. In 2009, our cash used in investing activities consisted primarily of capital expenditures in property, plant and equipment (other than acquisitions) of R$693.2 million, net of cash acquired in business acquisitions of R$511.3 million, the acquisition and formation of breeding stock of R$225.9 million.  We recorded investments in marketable securities, net of redemptions of marketable securities, of R$887.8 million in 2009, compared to redemptions of marketable securities, net of investments in marketable securities, of R$96.9 million in 2008.

 

We used R$1,627.6 million in cash in investing activities in 2008, compared to R$831.1 million used in 2007. In 2008, our cash used in investing activities consisted primarily of capital expenditures in property, plant and equipment (other than acquisitions) of R$634.5 million, acquisitions of R$796.2 million in the aggregate and the acquisition and formation of breeding stock of R$208.3 million.

 

Cash Flows Provided by Financing Activities

 

We received R$1,567.6 million in cash in financing activities in 2009, compared to R$1,118.4 million in 2008. In 2009, we received proceeds from loans and financing of R$2,604.6 million, offset by repayments of debt of R$6,210.5 million. In addition, in 2009, we received R$5,290.0 million from the proceeds of our offering of common shares. In 2008, we repaid debt in the amount of R$2,048.8 million, partially offset by proceeds from new loans and financing in the amount of R$3,248.0 million.

 

We received R$1,118.4 million in cash in financing activities in 2008, compared to R$1,265.2 million in 2007. In 2008, we received proceeds from loans and financing of R$3,248.0 million, partially offset by repayments of debt of R$2,048.8 million. In 2007, we repaid debt in the amount of R$1,265.2 million, partially offset by proceeds from new loans and financing in the amount of R$1,705.9 million. In addition, in 2007 we received R$900.0 million from the proceeds of our offering of common shares.

 

Dividends and Interest on Shareholders’ Equity

 

We declared interest on shareholders’ equity in the amount of R$100.0 million in 2009 and paid R$24.8 million relating to the 2008 fiscal year. We declared interest on shareholders’ equity in the amount of R$76.4 million in 2008 and paid R$114.3 million in 2008 (which includes R$62.7 million relating to the 2007 fiscal year).

 

 

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Debt

 

We use the proceeds of our indebtedness primarily for capital expenditures, liquidity and purchases of raw materials. The table below sets forth our debt profile as of the periods indicated.

 

  At December 31, 2009  At December 31, Percentage 
  Short-term  Long-term  2009 2008 change 
  (in millions of reais) (%) 
Local currency  1,913.7  2,304.8  4,218.5  1,228.2  243 
Foreign currency  1,000.0  3,579.6  4,579.6  4,137.9  11 
     Total debt  2,913.7  5,884.4  8,798.1  5,366.1  64 

 

The following table sets forth our indebtedness (according to the type of debt and currency) net of cash, cash equivalents and marketable securities for the periods indicated. We believe this information is useful to investors in light of a strategic decision to increase our cash, cash equivalents and marketable securities to provide flexibility in responding to adverse events in our markets.

 

  At December 31, 2009  At December 31,
  Short-term  Long-term  2009  2008 
  (in millions of reais, except where indicated)
Total debt  2,913.7  5,884.4  8,798.1  5,366.1 
Cash, cash equivalents and marketable securities:         
Local currency  2,393.0  394.0  2,787.0  771.8 
Foreign currency  1,851.0  283.0  2,134.0  1,204.3 
Total  4,244.0  677.0  4,921.0  1,976.1 
Net debt  1,330.7  (5,207.4)  (3,877.1)  (3,390.0) 
Exchange rate exposure (in millions of U.S.$)(1)      (1,092.2)  (581.0) 
 

(1) See Note 20(c) to our financial statements, which includes a table showing the calculation of our exchange rate exposure on the dates presented.

 

 

 

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  At December 31, 
  2009  2008 
  (in millions of reais) 
Debt in foreign currency:     
BNDES – FINEM  255.7  83.3 
Pre-paid exports  1,122.3  1,622.3 
Trade-related facilities  2,613.7  1,871.6 
ACC/ACE  53.4  443.7 
Gains/losses from derivatives  59.5  67.4 
Others  0.3  — 
Bonds  438.3  — 
Receivables  36.4  — 
Working capital  —  49.6 
     Total foreign currency  4,579.6  4,137.9 
 
Debt in local currency:     
Rural credit financing  847.8  220.3 
BNDES – FINEM  1,586.7  538.2 
BNDES – debentures  2.1  6.3 
Tax incentive financing programs  1,113.7  463.3 
Working capital facilities  668.2  — 
Gains/losses from derivatives  —  0.1 
     Total local currency  4,218.5  1,228.2 
 
Gross debt  8,798.1  5,366.1 
Cash and equivalents and marketable securities:     
In foreign currency  2,134.0  1,204.3 
In local currency  2,787.0  771.8 
Total  4,921.0  1,976.1 
Net debt  (3,877.1)   (3,390.0) 

 

The maturity schedule of our indebtedness as of December 31, 2009 is as follows:   
2010  2,913.7 
2011  1,762.7 
2012  2,218.4 
2013  918.7 
2014  187.0 
2015 to 2044  797.6 
Total  R$8,798.1 

 

Our principal debt instruments are described below.

 

BNDES FINEM, Other Secured Debt and Development Bank Credit Lines

 

BNDES Facilities. We have a number of outstanding obligations to BNDES, including loans in the amount of R$1,586.7 million as of December 31, 2009 and debentures in the amount of R$2.1 million as of December 31, 2009. The loans and debentures from BNDES were entered into to finance purchases of machinery and equipment and construction, improvement or expansion of our production facilities. Principal and interest on the loans and debentures are generally payable monthly, with final maturities on various dates from 2010 through 2015. The principal amount of the loans is denominated in reais, the majority of which bears interest at the TJLP rate plus a margin of approximately 2.6% to 6% per year.

 

The remaining amounts of R$255.7 million are linked to the Unidade Monetária BNDES, or “UMBNDES,” basket of currencies, which are the currencies in which BNDES borrows, and bear interest at the UMBNDES rate, which reflects the daily exchange rate fluctuations in the currencies in that basket. The debentures are denominated in reais and bear interest at the TJLP rate plus 6.0%.The loans and debentures are guaranteed by BRF – Brasil Foods S.A. and, in most cases, are secured by equipment and facilities. The principal covenants under these agreements include limitations on indebtedness and liens; mergers and sales of assets; and, in a few cases, financial covenants, including the ratio of shareholders’ equity to total assets, the ratio of current assets to current liabilities and the ratio of total assets to total liabilities.

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FINAME Financing.  The Company obtained certain financing through several banks from the Special Agency for Industrial Financing (Agência Especial de Financiamento Industrial, or “FINAME”) for a total of R$18.9 million as of December 31, 2009, which amount is included under “tax incentives and other” in the table above. The debt is denominated in reais, and the maturity varies from between four to five years. Interest is charged at an average rate of 8.9% per year. We use the funds from these contracts to purchase machinery and equipment. These contracts are secured, usually by the pledge of the financed assets (which cannot be subject to further liens), and are generally supported by guarantees and, in some cases, by promissory notes issued by the debtor equal to the principal amount of the debt. Most of the contracts provide for acceleration in the event of corporate restructuring without prior consent of the creditor.

 

Tax Incentive Financing Programs

 

State Tax Incentive Financing Programs. We also had R$4.4 million outstanding as of December 31, 2009 under credit facilities offered under state tax incentive programs to promote investments in those states, which amount is included under “tax incentives and other” in the table above. Under these programs, we are granted credit proportional to the payment of ICMS tax generated by investments in the construction or expansion of manufacturing facilities in these states. The credit facilities have a 20-year term and fixed or variable interest rates based on the IGP-M plus a margin.

 

 PESA. Sadia has a loan facility obtained through the Special Sanitation Program for Agroindustrial Assets (Programa Especial de Saneamento de Ativos) for an outstanding amount of R$159.6 million as of December 31, 2010 (included in the tax incentives and other), subject to the variation of the IGP-M as of December 31, 2009 plus interest of 9.89% per year, secured by endorsements and pledges of public debt securities.

 

Trade-Related Facilities

 

Pre-Export Facilities. The Company had several pre-export facilities in an aggregate outstanding amount of R$1,122.3 million as of December 31, 2009. The indebtedness under these facilities is generally denominated in U.S. dollars, with maturities on various dates from 2010 to 2013. Lines of credit for pre-payment of export are indexed to the London Interbank Offered Rate ("LIBOR") of six and three months plus a spread with an average all-in interest rate of 2.5% per year as of December 31, 2009. Under each of these facilities, the Company receives a loan from one or more lenders secured by the accounts receivable relating to exports of our products to specific customers. The facilities are generally guaranteed by BRF- Brasil Foods S.A. The principal covenants under these agreements include limitations on liens, mergers and, in certain cases, financial covenants.

 

Trade-Related Facilities. The Company had several trade-related facilities in an aggregate outstanding amount of R$2,613.8 million as of December 31, 2009. The indebtedness under these facilities is denominated in U.S. dollars, and maturities vary from one year to four years. Trade-related facilities bear interest at LIBOR plus a margin, with an average all-in interest rate of 3.26% per year at December 31, 2009, payable quarterly, semiannually and annually. Under each of these facilities, the Company receives a loan the proceeds of which are used to import raw materials and for other working capital needs. The facilities are generally guaranteed by BRF-Brasil Foods S.A. The principal covenants under these agreements include limitations on mergers and sales of assets.

 

BNDES Facilities – Exim. The Company has some credit lines provided by BNDES to finance exports with several commercial banks acting as intermediaries. The amount of debt on December 31, 2009 was R$526.1 million, which was included in "tax and other incentives" and “working capital” in the table above. Such funds are indexed to TJLP plus 4.41% per year and mature on 2012. Settlement occurs in local currency without the risk associated with exchange rate variation.

 

ACCs and ACEs. We obtain short-term pre-export loans known as Advances on Exchange Contracts (Adiantamentos de Contratos de Câmbio), or “ACCs,” and export loans known as Advances on Export Contracts (Adiantamentos de Contratos de Exportação), or “ACEs.” Central Bank regulations permit companies to obtain short-term financing under ACCs due within 360 days from the scheduled shipment date of export goods or short-term financing under ACEs due within 90 days from the actual shipment date of export goods, in each case from Brazilian banks but denominated in U.S. dollars. We had ACCs and ACEs in an aggregate outstanding principal amount of R$53.4 million as of December 31, 2009. Our ACCs and ACEs bore interest at an average rate of 5.3% as of December 31, 2009.


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Export Credit Notes. We also had R$749.7 million outstanding as of December 31, 2009 under export credit notes in reais to finance our exports with several commercial banks in Brazil that offer an average interest rate of 9.26% per year, which amount is included under “working capital” and under “tax incentives and other” in the table above. We generally use the proceeds of these export credit notes for working capital.

 

Working Capital Facilities

 

Industrial Credit Notes. We issued industrial credit notes (Cédulas de Crédito Industrial), receiving credits from official funds (the Fund for Worker Support (Fundo de Amparo ao Trabalhador) and the Constitutional Fund for Financing in the Midwest (Fundo Constitucional de Financiamento de Centro-Oeste)) in the amount of R$37.6 million as of December 31, 2009, which amount is included under “tax incentives and other” in the table above. The notes have maturity dates of up to five years, ending in 2010 and 2014. Interest is usually calculated as the sum of  an average all-in interest rate of 11.4% per year. These titles are secured by pledge of machinery and equipment and real estate mortgages.

 

We expect to obtain financing under additional industrial credit notes (Cédulas de Crédito Industrial) in the amount of R$166.0 million from the Fundo Constitucional de Financiamento do Nordeste (FNE) through Banco do Nordeste do Brasil S.A. These notes will bear interest at 10% per annum, subject to adjustment in accordance with specified laws, and mature on December 23, 2021. BRF will be required to maintain a guarantee in an amount in excess of the principal amount of the notes. The notes will also be secured by mortgages on several of our properties and pledges of equipment and other assets.

 

Rural Credit Financing. We entered into short-term rural credit loans in the amount of R$847.8 million as of December 31, 2009 with several commercial banks under a Brazilian federal government program that offers an interest rate of 6.7% per year as an incentive to invest in rural activities. We generally use the proceeds of these loans for working capital.

 

PROCER – BNDES Facilities. Through the PROCER, BNDES provides working capital credit lines to help Brazilian agribusiness and agricultural companies. We had R$101.7 million outstanding in credit lines as of December 31, 2009, bearing interest at 11.25% per year.

 

Notes and Bonds

 

BFF Notes. In January 2010, BFF International Limited issued senior notes in the aggregate amount of R$750.0 million. The bonds are guaranteed by BRF and Sadia, bear an interest rate of 7.250% per year and mature on January 28, 2020.

 

Sadia Bonds. We had R$438.3 million outstanding as of December 31, 2009 under bonds issued by Sadia in the international capital markets on May 24, 2007. The bonds are guaranteed by BRF, bear an interest rate of 6.875% per year and mature on May 24, 2017.

 

Other

 

Derivatives. We enter into foreign currency exchange derivatives under which we had exposure of R$59.5 million as of December 31, 2009. The counterparties include several Brazilian financial institutions and involve the exchange of taxes and the purchase and sale of currency. Their maturity dates vary from 2010 through 2013. These transactions do not require the provision of guarantees and follow the rules of the BM&F or the CETIP. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for more information on our derivatives.

 

Covenants and Covenant Compliance

 

Some of the instruments governing our indebtedness contain financial covenants, and in particular maximum ratios of net debt to EBITDA (as defined in such agreements). We are required to assess compliance with such covenants on a quarterly or semi-annual basis, depending on the agreement. As recently as April 29, 2009, we were required to obtain a waiver under a US$50 million credit facility from FIN Trade because the ratio of our net debt to EBITDA (as defined in that agreement) did not comply with the levels specified in the agreement. However, at December 31, 2009, we were in compliance with the net debt to EBITDA ratio under this facility and under our other facilities. The most restrictive of our debt facilities contains a maximum ratio Caixa de texto: of net debt to EBITDA of 3.4 to 1.0 for the next determination date on June 30, 2010. As of December 31, 2009, our ratio of net debt to EBITDA, as defined in the facility, was 3.2 to 1.0. EBITDA (as defined in these agreements) may differ among the agreements and may differ from EBITDA as reported by our Company.

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In addition, the instruments governing a substantial portion of our indebtedness contain cross-default or cross-acceleration clauses, such that the occurrence of an event of default under one of those instruments could trigger an event of default under other indebtedness or enable a creditor under another debt instrument to accelerate that indebtedness.

 

Seasonality

 

Processed Food, Poultry, Pork and Beef

 

Domestic market. Our net sales in the domestic market are not subject to large seasonal fluctuations.  However, our fourth quarter is generally slightly stronger than the others due to increased demand for our products during the Christmas season, particularly turkeys, Chester® roosters, ham and pork loins. We market certain products specifically for the holiday season, such as gift packages of our products that some employers distribute to their employees. Our results are also affected by the dry and rainy seasons for corn, soy beans and soy meal, which are our primary raw materials in feed production.

 

In 2009, the first quarter accounted for 23.7% of our total sales in the domestic market, the second quarter accounted for 24.3%, the third quarter accounted for 25.9% and the fourth quarter accounted for 26.1%. In 2008, these quarters accounted for 21.4%, 24.8%, 25.9% and 27.9% of our total sales, respectively.

 

Export markets. Our export sales as a whole are not materially affected by seasonality, partly because seasonal buying patterns vary according to our export markets. However, net sales in specific export markets sometimes vary with the season. In the Middle East, for example, we experience slower net sales during Ramadan and the summer months.

 

In our export markets, in 2009, the first quarter accounted for 25.3% of our export sales, the second quarter accounted for 26.7%, the third quarter accounted for 25.5% and the fourth quarter accounted for 22.5%. In 2008, these periods accounted for 21.9%, 25.0%, 27.7% and 25.4% of our exports, respectively.

 

Milk and Dairy Products

 

In the milk and dairy products market, production varies seasonally between the dry and rainy seasons because most of the milk in Brazil is produced from cows raised in open pastures. Our milk production is higher during the rainy season, which is between November and February in southeastern Brazil and between July and September in southern Brazil. Although most of our production is concentrated in the southern region, our production network helps to mitigate the effects of seasonality.

 

At the end of the fourth quarter and the beginning of the first quarter of the year, there has historically been a general decrease in selling prices and a general increase in inventories of UHT milk and pasteurized milk, due to an increase in domestic production and a decrease in domestic demand. During these months, Eleva has historically increased its inventories and has been able to benefit from higher selling prices during the other months of the year. Gross revenues from dairy products have historically been higher in the second and third quarters of the year, and revenues from pork, poultry and beef have historically been higher in the third quarter and even higher in the fourth quarter of the year.

 

Capital Expenditures

 

See “Item 4 - Information on the Company - A. History and Development of the Company - Capital Expenditures.”

 

C.  Research and Development, Patents and Licenses

 

We have two Technology Centers, located in Videira in the State of Santa Catarina and in São Paulo in the State of São Paulo, which are responsible for research and development, including for systems to increase productivity and reduce costs; adapting international quality control practices to our production facilities; traceability systems to allow monitoring of products and customer orders; and clinical analysis of food to promote food safety. We invested R$17.4 million, R$16.9 million and R$10.7 million in 2009, 2008 and 2007, respectively, in research and development activities.

 

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D.  Trend Information

 

American macroeconomic indicators are showing signals of a slow recovery, but we believe it will take some time until the recovery leads to a significant level of hiring and growth of consumption. In the Euro Zone, France and Germany have also shown positive economic signs, but the economic uncertainty in Portugal, Italy, Greece and Spain may continue to be a challenge to the monetary authorities of Europe.

 

In comparison to developed countries, emerging economies are experiencing  a faster recovery and are expected to be the among main contributors to global economic growth. China, Brazil and India have shown economic growth and have reduced dependence on exports and increased domestic consumption and investments. However, China, Brazil and India impose high import tariffs, which can have a dampening effect on international trade.

 

We are expecting commodity prices to remain stable, as crop projections indicate that the  production of grains and oilseeds will be in demand.  Countries that depend mainly on commodity exports are not expected to grow at the same rate as they did in 2006 through 2008.

 

Although we believe that in 2010, we will continue to see some effects of the decline in our export markets, we also see signs of recovery in some markets, as described below.  We believe that 2010 should provide greater opportunities for growth than in 2009, but we will continue to face challenges as a result of the global economic crisis and other factors we describe in “Item 3.  Key Information —D.  Risk Factors.”

 

The evolution in our export business that we expect for 2010 is based on the improvement in world economic indicators, which should feed through to the increased consumption of our products.  In Brazil, lower unemployment rates, an increase in the minimum wage, favorable outlook for GDP growth, among other positive factors, should contribute positively to domestic demand.

 

Following our business combination with Sadia and related equity offering to raise additional resources, our focus has now turned to the project of merging our operations.  Our objective is to implement the best practices from each organization, resulting in a bigger and better company.  This project will be implemented once a final ruling on the business combination is issued by the Brazilian antitrust authorities. 

 

We are continuing to pursue our strategic goal of long-term growth by managing and minimizing business risks.  Our expected results for 2010 are subject to change, and actual results may differ significantly.   

 

Exports

 

In 2009, Brazil’s volume of poultry exports was 0.3% lower than 2008. This discrepancy can be explained mainly by the decline in sales to Japan and Europe, which together represented 26% of the poultry exports in 2008.

 

In 2010, these economies may recover, but we believe demand will not return to the same levels observed before the financial crisis. Japan’s economy is still dependent on exports to the United States, and we do not expect a sudden recovery in U.S. economic activity that would be capable of driving Japanese industry to its pre-crisis. Unemployment is still high in the United States and many countries in Europe. In Europe, quota systems are an obstacle for Brazil’s chicken and turkey exports and in the middle of an economic recovery, we do not expect a change in this impediment.

 

We believe Middle Eastern and African countries and Hong Kong may boost our poultry exports, particularly of oil prices increase and benefit Middle Eastern and African economies.  In Africa, oil exports are not only boosting the economy, but also the domestic demand.

 

Russia, another significant poultry importer, may increase its imports as liquidity increases in their financial market. Brazilian exports in this region dropped in 2009 because importing companies had no access to working capital. With greater financial stability, those players are expected to return to the meat market. Moreover, Russia’s government banned U.S. poultry, which may benefit Brazilian exporters in 2010.

 

As China also diminished its imports of U.S. poultry, Brazil is able to offer the exports that American companies are no longer fulfilling.

 

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Domestic market

 

Elections, investment in infrastructure, expansion of the credit and real estate markets and high consumer and industry confidence are factors that could lead Brazil’s economy to grow more than 5% in 2010, as is being forecasted by many market participants. Recent numbers show that the Brazilian middle class now represents 50% of the total population.

 

As employment levels rise, people have less time to spend in the kitchen and perspectives are that hyper and supermarkets, as well as foodservice channels, will grow as customers will buy more processed foods or go more often to restaurants to eat. Food inflation is not a danger in the mid-term and therefore, as real income rises, it will be possible to buy more with the same budget.

 

Raw Materials

 

Between January and March 2010, the international price of corn in Chicago averaged US$348/bushel, while in the fourth quarter of 2009 its average price was US$386/bushel. The decline in the price of corn is due to positive projections for the world production of coarse grains, mainly corn. The U.S. Department of Agriculture projects that China’s final stocks of corn will be lower in comparison to the 2008-09 season, but the rise of U.S. production are expected to be enough to supply China’s demand for the grain.

 

Global production of soybeans have been projected to rise approximately 20% from the 2008-09 to the 2009-10 season with increases in all three main soybean producing countries: the United States, Brazil and Argentina.  Soybean prices fell as a response to these production projections, and the trend may be towards a decline in value of soybeans on the international market.

 

The dairy industry did not anticipate the sudden recovery in the international prices of powder milk since July 2009. Higher imports in China and the Middle East (due to lower stock levels and the contraction of production in the United States and Europe) pushed prices up until December 2009, at which point the international prices stabilized.

 

In spite of the price recovery, Brazil’s milk is not competitive in the external market, so the actual value is not expected to lead to exports, and the production of fluid milk is expected to be directed mainly to the domestic market. As many producers did not invest in 2009, we do not expect the production of milk to show a significant rise in 2010. If the domestic demand makes further improvements, prices for fluid milk may increase in the short-term.  However, the average price may remain the same as it was in 2009 because a drought in the southern production states last year negatively affected production, and prices soared as result of this decreased supply.

 

E.  Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements, other than the ones below relating to our subsidiary Sadia, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditure or capital resources that is material to investors.

 

Sadia provides guarantees to loans obtained by certain outgrowers located in the central region of the Brazil as part of a special development program for that region. These loans are used to improve the outgrowers farm installations and are expected to be repaid in ten years. The loans guaranteed by Sadia are in the amount of R$546.9 million as of December 31, 2009. In the event of default, Sadia would be required to assume the outstanding balance. As a result, we have recorded provisions in the amount of R$118.8 million as of December 31, 2009, equal to our assessment of the fair value of the non-contingent portion of these obligations, and an expense in the amount of R$12.0 million on our income statement for the year ended December 31, 2009.

 

Sadia is a guarantor for a loan taken out by Sadia Sustainability Institute (Instituto Sadia de Sustentabilidade) from the BNDES to set up biodigestors on the properties of the rural producers that are taking part in the Sadia’s integration system as part of the Sadia sustainable hog breeding program, which seeks to develop mechanisms for clean development and reduction of emission of carbon gases. The total amount of these guarantees at December 31, 2009 was R$83.0 million. In the event of default, Sadia would be required to assume the outstanding balance. As a result, we have recorded provisions in the amount of R$12.5 million as of December 31, 2009, equal to our assessment of the fair value of the non-contingent portion of these obligations, and revenue in the amount of R$3.2 million on our income statement for the year ended December 31, 2009.

 

The aggregate amount of Sadia’s off-balance sheet guarantees recorded as provisions as of December 31, 2009 is R$131.3 million, and an expense in the amount of R$8.8 million was recorded on our income statement for the year ended December 31, 2009. See note 26.1(i) to our consolidated financial statements. 

 

 

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F.  Tabular Disclosure of Contractual Obligations

 

The following table summarizes significant contractual obligations and commitments at December 31, 2009, that have an impact on our liquidity.

 

  Payments Due by Year
Obligation  Total  2010  2011 through 2013  2014 through 2016  2017 and thereafter 
      (in millions of reais)   
 
Loans and financing (1)  8,798.1  2,913.7  4,899.8  298.7  685.9 
Rental and lease obligations on property and equipment (2)  362.5  155.0  192.5  10.4  4.7 
Commitments for purchases of goods and services (3)  1,797.3  496.8  465.4  208.0  627.1 
Other  12.0  —  5.8  4.7  1.5 
 
Total  10,969.9  3,565.5  5,563.5  521.8  1,319.2 
(1) Includes both short-term debt and long-term debt and expected interest obligations.     
(2) Includes capital and operating leases.

(3) These purchase commitments include future purchase commitments for corn and soy meal and service fees to our integrated outgrowers. Amounts payable under contracts for goods or services that allow termination at any time without penalty have been excluded. With respect to contracts for goods and services that allow termination at any time without penalty after a specified noticed period, only amounts payable during the specified notice period have been included.

 

In addition to the amounts set forth in the table above, we have funding obligations under the defined contribution plans of BRF (which have a small defined benefit component) and the defined benefit and defined contribution plans of Sadia described in Note 24 to our consolidated financial statements, which is incorporated by reference into this item.

The table above sets forth our contractual obligations and commitments in accordance with Brazilian GAAP, which differs from U.S. GAAP. For example, our subsidiary Sadia is party to an agreement to sell, from time to time, its domestic receivables to a Credit Assignment Investment Fund (“FIDC”) administered by Concórdia S.A. Corretora de Valores Mobiliários, Câmbio e Commodities. Based on the structure of the transaction, for U.S. GAAP purposes the agreement has been accounted for as financing by the Company. See Notes 6 and 26.1(t) to our consolidated financial statements.

Our subsidiary Sadia also has the obligations described above under “—E. Off-Balance Sheet Arrangements.”

G.  Safe Harbor

 

See “Part I—Introduction—Forward-Looking Statements.”

 

ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A.  Directors and Senior Management

 

Board of Directors

 

Our overall strategic direction is provided by our board of directors, which is comprised of eleven members who must be shareholders. Our bylaws also provide for eleven alternate directors. During periods of absence or temporary unavailability of a director, the corresponding alternate director substitutes for that absent or unavailable director. At least 20% of the members of our board of directors are required to be independent directors. Our directors and alternate directors are elected at ordinary general meetings for a two-year term.

 

 

The following table sets forth information with respect to our directors and alternate directors.

 

  Director/Alternate
Name  Position Held  Since  Age 
Nildemar Secches  Co-Chairman  April 12, 2007  61 
Wang Wei Chang  Alternate  April 12, 2007  63 
Luiz Fernando Furlan  Co-Chairman  July 8, 2009  63 
Diva Helena Furlan  Alternate  July 8, 2009  60 
Francisco Ferreira Alexandre  Vice Chairman  April 22, 2003  47 
João José Caiafa Torres  Alternate  April 30, 2009  70 
Carlos Alberto Cardoso Moreira  Board Member  April 30, 2009  49 
Wilson Carlos Duarte Delfino  Alternate  April 30, 2009  64 
Décio da Silva (1)  Board Member  April 12, 2007  53 
Gerd Edgar Baumer  Alternate  April 12, 2007  75 
João Vinicius Prianti(1)  Board Member  April 30, 2009  61 
Adib Fadel  Alternate  April 30, 2009  64 
Luis Carlos Fernandes Afonso(1)  Board Member  April 22, 2003  49