20-F 1 brfform20f_2016.htm FORM 20-F brfform20f_2016.htm - Generated by SEC Publisher for SEC Filing

 

 

UNITED STATES
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, 2016
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 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)

R. Hungria, 1400 - 5th Floor
Jd. Europa – 01455-000

São Paulo – SP, Brazil
(Address of principal executive offices)

Pedro de Andrade Faria, Global Chief Executive, Financial and Investor Relations Officer
Tel. (5511) 2322-5005, Fax (5511) 2322-5740
R. Hungria, 1400 - 5th Floor
Jd. Europa - 01455-000

São Paulo – SP, Brazil
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

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

Title of each class

Name of each exchange on

 

Common Shares, no par value*

American Depositary Shares (as evidenced by American Depositary Receipts), each representing one share of common stock

which registered

The New York Stock Exchange

The New York Stock Exchange

____________________

*   Not for trading purposes, but only in connection with the registration of American Depositary Shares representing those common shares.

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

None

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

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, 2016

812,473,246 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨  No ¨

Note:  Not required for registrant.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” and “emerging grwoth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x

Accelerated filer ¨

Non-accelerated filer ¨

Emerging growth company ¨

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. ¨              

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

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

¨ U.S. GAAP

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

¨ Other

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

Item 17 ¨   Item 18 ¨.

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

Yes ¨   No x

 


 

 

TABLE OF CONTENTS

 

Page

PART I INTRODUCTION

1

ITEM 1.       IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

1

ITEM 2.       OFFER STATISTICS AND EXPECTED TIMETABLE

2

ITEM 3.       KEY INFORMATION

2

A.            Selected Financial Data

2

B.            Capitalization and Indebtedness

4

C.            Reasons for the Offer and Use of Proceeds

4

D.            Risk Factors

4

ITEM 4.       INFORMATION ON THE COMPANY

26

A.            History and Development of the Company

26

B.            Business Overview

31

C.            Organizational Structure

51

D.            Property, Plant and Equipment

52

ITEM 4A.    UNRESOLVED STAFF COMMENTS

58

ITEM 5.       OPERATING AND FINANCIAL REVIEW AND PROSPECTS

59

A.            Operating Results

59

B.            Liquidity and Capital Resources

88

C.            Research and Development, Patents and Licenses, etc

95

D.            Trend Information

97

E.            Off-Balance Sheet Arrangements

100

F.             Tabular Disclosure of Contractual Obligations

100

G.            Safe Harbor

101

ITEM 6.       DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

101

A.            Directors and Senior Management

101

B.            Compensation

106

C.            Board Practices

107

D.            Employees

108

E.            Share Ownership

111

ITEM 7.       MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

113

A.            Major Shareholders

113

B.            Related Party Transactions

114

C.            Interests of Experts and Counsel

116

ITEM 8.       FINANCIAL INFORMATION

116

A.            Consolidated Statements and Other Financial Information

116

 

i


 

 

B.            Significant Changes

123

ITEM 9.       THE OFFER AND LISTING

124

A.            Offer and Listing Details

124

B.            Plan of Distribution

125

C.            Markets

125

D.            Selling Shareholders

128

E.            Dilution

128

F.             Expenses of the Issue

128

ITEM 10.     ADDITIONAL INFORMATION

128

A.            Share Capital

128

B.            Memorandum and Articles of Association

128

C.            Material Contracts

151

D.            Exchange Controls

151

E.            Taxation

151

F.             Dividends and Paying Agents

160

G.            Statement by Experts

160

H.            Documents on Display

160

I.             Subsidiary Information

160

ITEM 11.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

160

ITEM 12.     DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

169

A.            Debt Securities

169

B.            Warrants and Rights

169

C.            Other Securities

169

D.            American Depositary Shares

169

PART II

170

ITEM 13.     DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

170

ITEM 14.     MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 

170

ITEM 15.     CONTROLS AND PROCEDURES

170

A.            Disclosure Controls and Procedures

170

B.            Management’s Annual Report on Internal Control Over Financial Reporting

171

C.            Attestation Report of the Registered Public Accounting Firm

172

D.            Changes in Internal Control Over Financial Reporting

172

ITEM 16.     [RESERVED]

172

ITEM 16A.  AUDIT COMMITTEE FINANCIAL EXPERT

172

ITEM 16B.  CODE OF ETHICS

172

ITEM 16C.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

173

 

ii


 

 

PART I
INTRODUCTION

Unless otherwise indicated, all references herein to (1) “BRF” are references to BRF S.A., a corporation organized under the laws of the Federative Republic of Brazil (“Brazil”), and its consolidated subsidiaries, (2) the “Company,” “we,” “us,” “our” or “our company” are references to BRF, and (3) “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 the United States dollar.  Sadia S.A. (“Sadia”), formerly our wholly-owned subsidiary, was incorporated by BRF on December 31, 2012.

Market data and certain industry forecasts used herein were obtained from internal surveys, market research, publicly available information and industry publications. While we believe that market research, publicly available information and industry publications we use are reliable, we have not independently verified market and industry data from third-party sources. Moreover, while we believe our internal surveys are reliable, they have not been verified by any independent source.

We have made rounding adjustments to reach some of the figures included herein.  As a result, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.

Forward-Looking Statements

This Annual Report on Form 20-F contains information that constitute forward-looking statements.  They 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 acquisitions 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, (iv) health risks related to the food industry, (v) the risk of outbreak of animal diseases (vi) more stringent trade barriers in key export markets and increased regulation of food safety and security, (vii) strong international and domestic competition, (viii) interest rate fluctuations, inflation and exchange rate movements of the real in relation to the U.S. dollar and other currencies, (ix) the declaration or payment of dividends, (x) the direction and future operation of the Company, (xi) the implementation of the Company’s financing strategy and capital expenditure plans, (xii) the Company’s financial condition or results of operations and (xiii) other factors identified or discussed under “Item 3. Key Information––D. 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 on Form 20-F, including without limitation the information set forth under the heading “Item 5. Operating and Financial Review and Prospects,” identifies important factors that could cause such differences.  In light of the risks, uncertainties and assumptions associated with forward-looking statements, you should not place undue reliance on any forward-looking statements. Additional risks that we may currently deem immaterial or that are not presently known to us could also cause the forward-looking events discussed in this Annual Report on Form 20-F not to occur.

Our forward-looking statements speak only as of the date of this Annual Report on Form 20-F or as of the date they are made, and except as otherwise required by applicable securities laws, the Company undertakes no obligation to publicly update any forward-looking statement, whether because of new information, future events or otherwise.

ITEM 1.            IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

1


 

ITEM 2.            OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3.            KEY INFORMATION

A.                  Selected Financial Data

We present below certain selected financial data derived from our consolidated financial statements as of and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012, included herein, prepared in accordance with the International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). IFRS differs in certain significant respects from the accounting principles generally accepted in the United States, or “U.S. GAAP.”

In 2015, we sold the assets of our dairy segment, including plants and trademarks, to Lactalis do Brasil – Comércio, Importação e Exportação de Laticínios Ltda. (“Lactalis”). As a result, this segment is reported as discontinued operations, which requires the presentation of prior periods of this segment as discontinued operations. Unless stated otherwise, the results and cash flows that we present in this Annual Report on Form 20-F do not consider the results and cash flows from this discontinued operation (dairy segment).

The summary financial data should be read in conjunction with our consolidated financial statements and the notes thereto contained in this Annual Report on Form 20-F, as well as the information set forth under the heading “Item 5. Operating and Financial Review and Prospects.”

 

 

 

Year Ended December 31,

   

2016

2015

 

2014

 

2013

 

2012

Income Statement Data

 

(in millions of reais, except share, per share and per ADS amounts and as otherwise indicated)

Continuing Operations

 

 

             

Net sales

 

33,732.9

32,196.6

 

29,006.8

 

27,787.5

 

25,974.6

Gross profit

 

7,526.5

10,088.9

 

8,509.4

 

6,909.9

 

5,902.5

Operating income

 

1,815.2

4,228.4

 

3,478.3

 

1,896.4

 

1.359.9

Income from Continuing Operations

 

(367.4)

2,947.7

 

2,135.0

 

1,019.7

 

804.6

   

 

             

Income from Discontinued Operations

 

-

183.1

 

89.8

 

47.2

 

(27.2)

Net profit (loss)

 

(367.4)

3,130.8

 

2,224.8

 

1,066.8

 

777.4

Attributable to:

 

 

             

Controlling shareholders

 

(372.4)

3,111.2

 

2,225.0

 

1,062.4

 

770.0

Non-controlling shareholders

 

5.0

19.6

 

(0.2)

 

4.4

 

7.4

   

 

             

Earnings(loss) per share - basic from continuing operations

 

(0.4581)

3.5009

 

2.4529

 

1.1713

 

0.9254

Earnings (loss) per ADS - basic from continuing operations

 

(0.4581)

3.5009

 

2.4529

 

1.1713

 

0.9254

Earnings (loss) per share - basic

 

(0.4581)

3.7184

 

2.5563

 

1.2204

 

0.9352

Earnings (loss) per ADS - basic

 

(0.4581)

3.7184

 

2.5563

 

1.2204

 

0.9352

Weighted average shares outstanding at the end of the year – basic (millions)

 

801,903

842,000

 

870,412

 

870,535

 

869,534

Earnings (loss) per share - diluted

 

(0.4581)

3.6932

 

2.5551

 

1.2192

 

0.9400

Earnings (loss) per ADS - diluted

 

(0.4581)

3.6932

 

2.5551

 

1.2192

 

0.9400

Weighted average shares outstanding at the end of the year – diluted (millions)

 

801,903

842,402

 

870,824

 

871,442

 

869,703

Dividends per share

 

0.7641

1.1998

 

0.8486

 

0.8315

 

0.3200

Dividends per ADS

 

0.7641

1.1998

 

0.8486

 

0.8315

 

0.3200

Dividends per ADS (in U.S. dollars)

 

0.1933

0.3073

 

0.3195

 

0.3550

 

0.1566

   

3.9521

3.9048

 

2.6562

 

2.3426

 

2.0435

 

2


 

Table of Contents

 

   

At December 31,

   

2016

2015

 

2014

 

2013

 

2012

   

(in millions of reais, except as otherwise indicated)

Balance Sheet Data

 

 

             

Cash and cash equivalents

 

6,356.9

5,362.9

 

6,006.9

 

3,127.7

 

1,930.7

Trade accounts receivable, net

 

3,085.1

3,876.3

 

3,046.9

 

3,338.4

 

3,131.2

Inventories

 

4,791.6

4,032.9

 

2,941.4

 

3,111.6

 

3,018.6

Total current assets

 

18,893.7

19,180.1

 

17,488.3

 

13,242.5

 

11,590.0

Property, plant and equipment, net

 

11,746.2

10,915.8

 

10,059.3

 

10,821.6

 

10,670.7

Intangible assets

 

6,672.6

5,010.9

 

4,328.6

 

4,757.9

 

4,751.7

Total non-current assets

 

24,051.2

21,207.9

 

18,615.4

 

19,132.1

 

19,175.5

Total assets

 

42,944.9

40,388.0

 

36,103.7

 

32,374.6

 

30,765.5

Short-term debt

 

3,245.0

2,628.2

 

2,738.9

 

2,696.6

 

2,440.8

Trade accounts payable

 

5,839.8

4,745.0

 

3,522.2

 

3,674.7

 

3,381.3

Total current liabilities

 

12,640.4

11,621.2

 

9,569.1

 

8,436.0

 

7,481.6

Long-term debt

 

15,717.4

12,551.1

 

8,850.4

 

7,484.6

 

7,077.6

Total non-current liabilities

 

18,085.1

14,931.0

 

10,844.7

 

9,242.4

 

8,694.7

Shareholders’ equity

 

 

             

Capital

 

12,460.5

12,460.5

 

12,460.5

 

12,460.5

 

12,460.5

Total shareholders' equity

 

12,219.4

13,836.0

 

15,689.9

 

14,696.2

 

14,589.2

Total liabilities and shareholders’ equity

 

42,944.9

40,388.0

 

36,103.7

 

32,374.6

 

30,765.5

   

 

             

 

 

2016

2015

2014

2013

2012

Operating Data

 

 

 

 

 

Poultry slaughtered (million heads per year) 

1,715.3

1,724.4

1,663.6

1,795.9

1,792.4

Pork/beef slaughtered (thousand heads per year)

9,614.1

9,510.5

9,620.6

9,744.1

10,874.1

Total production of meat and other processed products (thousand tons per year)

4,251.6

4,358.2

4,307.1

4,595.4(1)(2)

4,809.0

Employees (at year end)

102,463

96,279

108,829

110,138

113,992

 

(1)     Meat volumes for the third quarter of 2013 were adjusted from 985.5 to 985.2 due to a correction in the Argentina’s production volumes.

(2)     Other processed volumes for the third quarter of 2013 were adjusted from 131.5 to 130.9 due to a correction in the Argentina’s production volumes.

 

 

Exchange Rates

The Brazilian foreign exchange system allows the purchase and sale of foreign currency and the international transfer of reais by any person or legal entity, regardless of the amount, subject to certain regulatory procedures.

In the past, the Central Bank has intervened occasionally to control unstable movements in foreign exchange rates.  We cannot predict whether the Central Bank or the Brazilian government will continue to permit the real to float freely or will intervene in the exchange rate market through the return of a currency band system or otherwise.  The real may depreciate or appreciate against the U.S. dollar and/or the euro substantially.  Furthermore, Brazilian law provides that, whenever there is a serious imbalance in Brazil’s balance of payments or there are serious reasons to foresee a serious imbalance, temporary restrictions may be imposed on remittances of foreign capital abroad.  We cannot assure you that such measures will not be taken by the Brazilian government in the future.  See “Item 3. Key Information—D. Risk Factors—Risks Relating to Brazil—Exchange rate movements may adversely affect our financial condition and results of operations.”

3


 

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 daily exchange rates during the periods 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

Year

High

Low

Average

Period End

2012

2.1121

1.7024

1.9550

2.0435

2013

2.4457

1.9528

2.1605

2.3426

2014

2.7403

2.1974

2.3547

2.6562

2015

4.1949

2.5754

3.3387

3.9048

2016

4.1558

3.1193

3.4833

3.2591

         

 

 

Reais per U.S. Dollar

Month

High

Low

October 2016

3.2359

3.1193

November 2016

3.4446

3.2024

December 2016

3.4650

3.2591

January 2017

3.2729

3.1270

February 2017

3.1479

3.0510

March 2017

3.1735

3.0765

 

Source: Central Bank.

                The exchange rate on March 31, 2017 was R$3.1684 per US$1.00.

 

B.                  Capitalization and Indebtedness

Not applicable.

C.                  Reasons for the Offer and Use of Proceeds

Not applicable.

D.                  Risk Factors

Risks Relating to Our Business and Industry

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, public perception of product safety for both the industry as a whole and also our products specifically, but not exclusively, as a result of disease outbreaks or the fear of such outbreaks, the potential cost and disruption of a product recall and possible impacts on our image and brandsAmong such risks are those related to raising animals, including disease and adverse weather conditions.   

4


 

Meat is subject to contamination during processing and distribution. In particular, processed meat may become exposed to various disease-producing pathogens, including listeria monocytogenes, salmonella and generic E. coli. These pathogens can also be introduced to our products during production or as a result of improper handling by third-party food processors, franchisees, distributors, foodservice providers or consumers. Spoilage, especially spoilage due to failure of temperature-control storage and transportation systems, is also a risk. We maintain systems designed to monitor food safety risks throughout all stages of production and distribution, but these systems could fail to function properly and product contamination could still occur. Failures in our systems to ensure food safety could result in harmful publicity that could cause damage to our  brands, reputation and image and negatively impact sales, which could have a material adverse impact on our business, results of operations, financial condition and prospects.

 

Even if our own products are not affected by contamination, our industry may face adverse publicity in certain of its markets if the products of other producers become contaminated, which could result in negative public perception about the safety of our products and  reduced consumer demand for our products in the affected category.  Significant lawsuits, widespread product recalls, and other negative events faced by us or our competitors could result in a widespread loss of consumer confidence in the safety and quality of our products. Our sales are ultimately dependent on consumer preferences, and any actual or perceived health risks associated with our products could cause customers to lose confidence in the safety and quality of our products and 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 their meat, which require us to maintain certain standards of animal health and control disease.  We could be required to destroy animals or suspend the sale or export of some of our products to customers in Brazil and abroad, in the event of an outbreak of disease affecting animals, such as the following: (1) in the case of hogs and certain other animals, foot-and-mouth disease and A(H5N1) influenza (discussed below); and (2) in the case of poultry, avian influenza and Newcastle disease. In addition, if the Porcine Reproductive and Respiratory Syndrome and Porcine Epidemic Diarrhea, which have broken out in Europe and the United States, were to outbreak in Brazil, we could be required to destroy hogs, however currently there is no legislation supporting this action. 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 and loss of inventory. An outbreak of foot-and-mouth disease could have an effect on livestock we own, the availability of livestock for purchase. Also, the global effects of avian influenza would impact consumer perception of certain protein products and our ability to access certain markets, which would adversely affect our results of operations and financial condition. 

Outbreaks, or fears of outbreaks, of any 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 diseases in Brazil may result in foreign governmental action to close export markets to some or all of our products, which may result in the destruction of some or all of these animals. Our poultry business in Brazilian and export markets could also be negatively affected by avian influenza.

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

5


 

Between 2003 and the first week of 2017, there have been 856 human cases of avian influenza and 452 related deaths, according to the World Health Organization (“WHO”). The cases reported were caused by the H5N1 virus. In 2013, direct human-to-human transmission of the H7N9 virus was proven. Various countries in Asia, the Middle East and Africa reported human cases in the last five years and various European countries reported avian flu cases in poultry. In 2014, there were reports of human cases of avian influenza in Egypt, Indonesia, Cambodia, China and Vietnam. In the Americas, there were reports of human cases of avian influenza in both Canada and the United States. In early 2015, new cases of H5N1 and H5N2 reported in the United States resulted in restrictions on US exports. In 2016, new outbreaks occurred in bird populations across Northern Europe, including France, the Netherlands, Switzerland, Finland, and Germany. Middle Eastern and African countries also had outbreaks during 2016.

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 in the poultry industry, prevent recovery of costs incurred in raising or purchasing 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. In early 2017, Chile, a neighboring country, confirmed the occurrence of avian influenza.

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 results of operation and financial condition. 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.

We may also be subject from time to time to additional outbreaks of animal-related diseases, such as Porcine Epidemic Diarrhea and foot-and-mouth disease affecting cattle. See “Item 5: Operating and Financial Review and Prospects—A. Operating Results—Effect of Animal Diseases—Other Animal Diseases” for further information.

Climate change may negatively affect our business and results of operations.

 

We consider the potential effects of climate change when evaluating and managing our operations and supply chain, recognizing the vulnerability of natural resources and agricultural inputs that are essential for our activities. The main risks we have identified relate to the alterations in temperature (average and extreme), changes in rainfall (average and extreme, such as drought, flooding and storms) and lack of water , which could affect agricultural productivity, the quality and availability of pasture areas, animal wellbeing and the availability of energy. These changes could have a direct impact on our costs, raising the price of agricultural commodities as a result of long periods of drought or excessive rainfall, increasing operating costs to ensure animal wellbeing, increasing the risk of rationing and raising the price of electrical energy through water shortages and the need for other energy sources to supply the demand for electricity. We also consider potential regulatory changes and monitor trends in changes to licensing legislation for greenhouse gas emissions at the domestic and international levels.

 

Our operations are largely dependent on electricity, and energy-related expenses are one of our highest fixed costs. Energy costs have historically fluctuated significantly over time, and increases in energy costs could result in reduced profits. A significant interruption in power supply or outright loss of power at any of our production facilities or distribution centers could result in a temporary disruption in production and delivery of products to customers and additional costs.

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A significant portion of Brazil’s installed electric generation capacity is currently dependent upon hydroelectric generation facilities. Hydroelectric production is vulnerable to a variety of factors, including water supply. If the amount of water available to energy producers becomes increasingly scarce due to drought or diversion for other uses, as has occurred in recent years, our energy expenses may increase. For example, following the 2015 drought conditions in the Southeast of Brazil, the availability of power generation from hydroelectric sources was reduced.

 

Although Brazil holds nearly a fifth of the world’s water reserves, the World Bank warned in August 2016 that water crises, such as the ones recently experienced in São Paulo, Rio de Janeiro and Minas Gerais, could become commonplace in Brazil over the next four decades. The severe drought in Brazil in 2014 to 2015 was the region’s worst in 80 years, affecting farm and factory output while driving up the price of corn. Although we use a methodology developed by us to evaluate water-related risks in our areas of operation, this methodology may fail to accurately assess the water supply or anticipate water-related risks. This could result in us or our key suppliers encountering water shortages. In addition, the increased industrial use of water by water-intensive business may also adversely affect the continuing availability and quality of water in Brazil. Whether unexpected or expected, the shortage or lack of water could materially adversely affect our business and results of operations.

 

Among the initiatives we have taken to reduce our exposure to climate change and to maintain our competitiveness in terms of costs is the monitoring of stocks in grains purchases and the constant monitoring of the weather in agricultural regions to guide buying decisions, as well as anticipating price movements in the commodity markets. We also undertake efficiency projects to develop more efficient processes that consume less energy. Other initiatives include technological innovations in the animal-raising installations to improve the environment and acclimatization and safeguard the animal’s wellbeing. We may fail to continue to implement programs to mitigate effects of climate change, which may affect our business and results of operations in the future.

 

Any shortage or lack of water could materially adversely affect our business and results of operations.

 

A study conducted by the Food and Agriculture Organization indicates that, in the next two decades, the demand for water will increase 50% on a global scale. In connection with that, it is estimated that by 2025, 1.8 billion people will live in places with absolute shortage of water and two thirds of the global population will live in water-stressed places. By 2050, the demand for water will jump 55%, according to the Food and Agriculture Organization, on a global scale, including some of our key markets, such as North Africa and the Middle East. Water is an essential raw material for our businesses, being present from the production of grains and inputs, the agricultural chain through our production processes. As a result, the shortage or lack of water represents a critical risk for our business. On the other hand, we are aware that the industrial use of water may adversely affect its availability.

 

In order to mitigate these risks, in 2015, we began developing a methodology to evaluate water-related risks in the locations where we have operations in order to understand the specific impacts of our company and others in those regions and, consequently, reduce our water consumption and exposure to water supply risks in each location. It is an initiative regarding water-related risks through which we can assess internal and external aspects impacting water supply and quality and generate a score for each unit. The objective is to carry out internal and external actions to reduce consumption and comply with applicable rules in order to minimize our impact on the environment and the community. We analyzed the micro and macro watersheds composing the region, as well as the industrial activities and characteristics of the use of water resources, in order to understand the local demand growth, anticipating risks. In 2016, we conducted a vulnerability assessment in all productive units in Brazil. As the methodology is composed of internal and external aspects, we applied a complete assessment for the internal aspects, in which the data was available in its entirety. For the external aspects, which involve information of river basins,  information was difficult to obtain, which led us to review indicators in order to have data for all units. The assessment for external aspects will be fully applied in 2017.

 

The shortage or lack of water could materially adversely affect our business and results of operations.

 

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We have a governance structure and compliance processes designed to sustain our positive image and reputation in the marketplace, but they may fail to ensure compliance with relevant anti-corruption, anti-bribery, anti-money laundering and other international trade laws and regulations.

We have a framework of antifraud initiatives - including anti-bribery and anti-corruption - that supports all business segments and their commercial standards worldwide. However, we may not be able to mitigate all fraud risk entirely. Any negative reflection on our image or our brand from these or other activities could have a negative impact on our results of operations, as well as our ability to achieve our growth strategy.

We are subject to anticorruption, anti-bribery, anti-money laundering and other international trade laws and regulations. We are required to comply with the laws and regulations of Brazil and various jurisdictions where we conduct operations. In particular, we are subject to the Brazilian Anti-Corruption Law nº 12,846, the U.S. Foreign Corrupt Practices Act of 1977 ( “FCPA”), the United Kingdom Bribery Act of 2010, as well as economic sanction programs, including those administered by the United Nations, the European Union and the United States, including the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”). The FCPA prohibits providing anything of value to foreign officials for the purposes of obtaining or retaining business or securing any improper business advantage. As part of our business, we may deal with entities and employees that are considered foreign officials for purposes of the FCPA. In addition, economic sanctions programs restrict our dealings with certain sanctioned countries, individuals and entities.

 

Although we have internal policies and procedures designed to ensure compliance with applicable anti-fraud, anti-bribery and anti-corruption laws and sanctions regulations, potential violations of anti-corruption laws have been identified on occasion as part of our compliance and internal control processes. In addition, we were recently notified of allegations involving potential misconduct by some of our employees in the context of the “Weak Flesh Operation.” For more details, see “Item 8. Financial Information – B. Significant Changes.”

 

When allegations of non-compliance with applicable anti-fraud, anti-bribery and anti-corruption laws and sanctions regulations arise, we attempt to act promptly to learn relevant facts, conduct appropriate due diligence, and take any appropriate remedial action to address the risk.  Given the size of our operations and the complexity of the production chain, there can be no assurance our internal policies and procedures will be sufficient to prevent or detect all inappropriate or unlawful practices, fraud or violations of law or our internal policies and procedures by our employees, directors, officers, partners, or any third-party agents and service providers or that such persons will not take actions in violation of our policies and procedures (or otherwise in violation of the relevant anti-corruption laws and sanctions regulations) for which we or they may be ultimately held responsible. Violations of anti-bribery and anti-corruption laws and sanctions regulations could have a material adverse effect on our business, reputation, brand, selling prices, results of operations and financial condition, including as a result of the closure of international markets. We may be subject to one or more enforcement actions, investigations and proceedings by authorities for alleged infringements of these laws. These proceedings may result in penalties, fines, sanctions or other forms of liability. Potential bad developments in the “Weak Flesh Operation” may also negatively affect the market price of our common shares and ADRs.

 

Our failure to continually innovate and successfully launch new products, as well as maintain our brand image, could adversely impact our operating results.

Our financial success depends on our ability to anticipate changes in consumer preferences and dietary habits and our ability to successfully develop and launch new products and product variations that are desirable to consumers. We devote significant resources to new product development and product extensions; however, we may not be successful in developing innovative new products or our new products may not be commercially successful. For example, trends towards prioritizing health and wellness present a challenge for developing and marketing successful new lines of products to address these consumer preferences. To the extent that we are not able to effectively gauge the direction of our key markets and successfully identify, develop, manufacture and market new or improved products in these changing markets, in a timely or cost-effective manner, our products, brands,  our financial results and our competitive position may suffer, which could have a material adverse effect on our business, results of operations, financial condition and prospects.

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We also seek to maintain and extend the image of our brands through marketing, including advertising, consumer promotions and trade spending. Due to inherent risks in the marketplace associated with advertising, promotions and new product introductions, including uncertainties about trade and consumer acceptance, our marketing investments may not prove successful in maintaining or increasing our market share. Continuing global focus on health and wellness, including weight management, increasing media attention to the role of food marketing and bad press about our quality controls and products, including in connection with the “Weak Flesh Operation,” could adversely affect our brand image or lead to stricter regulations and greater scrutiny of food marketing practices.

Our success in maintaining, extending and expanding our brand image also depends on our ability to adapt to a rapidly changing media environment, including increasing reliance on social media and online dissemination of advertising campaigns. The growing use of social and digital media increases the speed and extent that information or misinformation and opinions can be shared.

Negative posts or comments about us, our brands or our products on social or digital media could seriously damage our reputation and brand image. If we do not maintain or improve our brand image, then our product sales, financial condition and results of operations could be materially and adversely affected.

Recent and future acquisitions or joint ventures may divert management resources or prove to be disruptive to our company.

We regularly review and pursue opportunities for strategic growth through acquisitions, joint ventures and other initiatives. We have completed several acquisitions in recent years, such as Golden Foods Siam (“GFS”) in Thailand, Campo Austral and Calchaqui in Argentina, Universal Meats in the United Kingdom, Al Khan Foodstuff LLC (“AFK”) in Oman, and Qatar National Import and Export Co.’s (“QNIE”) frozen distribution business in Qatar. We have also entered into an agreement with FFM Berhad providing for cooperation in FFM Further Processing SDN BHD and an agreement to acquire Banvit in Turkey, (the completion of this transaction is subject to the satisfaction of the conditions precedent set forth in the definitive documents, including anti-trust approvals). For more details on these and other transactions, see “Item 4. Information on the Company—A. History and Development of the Company—Other Acquisitions and Investments in 2016.” Acquisitions, new businesses and joint ventures, especially involving sizeable enterprises, may present financial, managerial, operational and compliance risks and uncertainties, including:

  • challenges in realizing the anticipated benefits of the transaction; 
     
  • diversion of management attention from existing businesses; 
     
  • difficulty with integrating personnel, especially to different managerial practices;
     
  • disruptions when integrating financial, technological and other systems; 
     

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  • difficulty identifying suitable candidate businesses or consummating a transaction on terms that are favorable to us; 
     
  • challenges in retaining an acquired company’s customers and key employees; 
     
  • increased compensation expenses for newly-hired employees;
     
  • exposure to unforeseen liabilities or problems of the acquired companies or joint ventures;
     
  • warranty claims and claims for damages which may be limited in content, timeframe and amount;
     
  • challenges arising from a lack of familiarity with new markets with differing commercial and social norms and customs ,which may adversely impact our strategic goals or require us to adapt our marketing and sales model for specific countries;
     
  • compliance with foreign legal and regulatory systems; and
     
  • difficulties in transferring capital to new jurisdictions.

Acquisitions outside of Brazil may present additional difficulties and new political and countries risks, such as compliance with foreign legal and regulatory systems, difficulties to transfer capital, integration of personnel to different managerial practices and would increase our exposure to risks associated with international operations.

We may be unable to realize synergies and efficiency gains from our recent acquisitions in the timeframe we anticipate or at all, because of integration or other challenges. In addition, we may be unable to identify, negotiate or finance future acquisitions or other strategic initiatives particularly as part of our international growth strategy, successfully or at favorable terms, or to effectively integrate these acquisitions or joint venture businesses with our current businesses. Any future joint ventures or acquisitions of businesses, technologies, services or products might require us to obtain additional equity or debt financing, which may not be available on favorable terms, or at all. Future acquisitions and joint ventures may also result in unforeseen operating difficulties and expenditures, as well as strain on our organizational culture.

Political and economic risks in regions and countries where we have exposure could limit the profitability of our operations and our ability to execute our strategy in these regions.

Since we have expanded our operations around the world, we are subject to a variety of situations that may adversely affect our financial results. In the regions where we have production and distribution activities, we are subject, among others, to the following risks:

  • governmental inertia;
     
  • geopolitical risk (including terrorism);
     
  • imposition of exchange or price controls;
     
  • imposition of restrictions on exports of our products or imports of raw materials necessary for our production;
     
  • fluctuation of local currencies against the real;

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  • nationalization of our property;
     
  • increase in export tax and income tax rates for our products; and
     
  • unilateral (governmental) institutional and contractual changes, including controls on investments and limitations on new projects.

As a result of these factors, our results of operations and financial condition in the regions where we have production and distribution activities may be adversely affected, and we may experience in the future significant variability in our revenue on both an annual and a quarterly basis from those operations. The impact of these changes on our ability to deliver on our planned projects and execute our strategy cannot be ascertained with any degree of certainty, and these changes may, therefore, have an adverse effect on our operations and financial results.

Deterioration of general economic and political conditions could negatively impact our business.

Our business may be adversely affected by changes in Brazilian and global economic and political conditions, which may result in increased volatility in our markets and contribute to net losses. Since the end of 2015, the price of oil has declined significantly and has led to lower economic growth in relevant oil-dependent regions, such as several countries in the Middle East, Russia, Venezuela and Angola. Thus, per capita meat consumption in these areas could be affected as well. In addition, concerns about the Chinese economy and its inability to grow at rates as high as the ones we had in prior years could affect the prices and consumption of all commodities, including chicken and hogs. Because of the global nature of our business, we remain subject to the risk of economic volatility worldwide, and economic and political disruptions around the world can have a material adverse effect on our business and results of operations.

Furthermore, on June 23, 2016, the United Kingdom held an in-or-out referendum on the United Kingdom’s membership within the European Union, the result of which favored the exit of the United Kingdom from the European Union, or “Brexit.” A process of negotiation will determine the future terms of the United Kingdom’s relationship with the European Union. The potential impact of Brexit on our market share, sales, profitability and results of operations is unclear. Depending on the terms of Brexit, economic conditions in the United Kingdom, the European Union and global markets may be adversely affected by reduced growth and volatility. The uncertainty before, during and after the period of negotiation could also have a negative economic impact and increase volatility in the markets, particularly in the Eurozone. The volatility and negative economic impact that may result not only from Brexit, but also from the European elections in 2017 could adversely affect our business.

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 and other raw materials, as well as the selling prices of our poultry and pork. These prices are determined by supply and demand, which may fluctuate significantly, and other factors over which we have little or no control. These other factors include, among others, fluctuations in local and global poultry and hog  production levels, environmental and conservation regulations, economic conditions, weather, animal and crop diseases, cost of international freight and exchange rate and interest rate fluctuations. 

Our industry, both in Brazil and abroad, is generally 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 entirely.

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Natural disasters, pandemics or extreme weather, including floods, excessive cold or heat, hurricanes or other storms, as well as any interruption we can observe in our plants that may require the temporary re-allocation of plant functions to other facilities could impair the health or growth of livestock or interfere with our operations due to power outages, damage to our production and processing facilities or disruption in transportation channels or information systems, among other issues.

Our international sales are subject to a broad range of risks associated with international operations.

International sales account for a significant portion of our net sales in line with our global strategy, representing 46.8% in 2014, 50.2 % in 2015 and 52.3% in 2016. Our major international markets include the Middle East (particularly Saudi Arabia), Asia (particularly Japan, Hong Kong, Singapore and China), Europe, Eurasia (particularly Russia) Africa and Americas (particularly Argentina), 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 the economic, political and social conditions in our main export markets.

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

  • exchange rate and interest rate fluctuations;
     
  • commodities price volatility;
     
  • deterioration in international economic conditions;
     
  • political risks, such as turmoil, government policies, difficulties to transfer capital  and political instability;
     
  • decreases in demand, particularly from large markets such as China; 
     
  • 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; 
     
  • strikes, not only of our employees, but also of port employees, truck drivers, customs agents, sanitary inspection agents and other government agents at the Brazilian ports from which we export our products;
     
  • sabotage affecting our products; and
     
  • bad press related to the Brazilian meat processing industry, including in connection with the “Weak Flesh Operation.”

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.

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Any of these risks could adversely affect our business and results of operations.  In addition, flooding and similar events affecting the infrastructure necessary for the export of our products could adversely affect our revenues and results of operations.

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.  Trade barriers can consist of both tariffs and non-tariff barriers.  In our industry, non-tariff barriers are a particular concern, especially sanitary and technical restrictions.

Some countries, such as Russia and South Africa, have a history of erecting trade barriers to imports of food products.  In Europe, another of our key markets, the European Union has adopted a quota system for certain chicken products and prohibitive tariffs for certain products that do not have quotas in order to mitigate the effects of Brazil’s lower production costs on local producers over European producers. 

Many developed countries use direct and indirect subsidies to enhance the competitiveness of their producers in other markets. In addition, local producers in some markets may exert political pressure on their governments to prevent foreign producers from exporting to their market, particularly during unfavorable economic conditions. 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 market and from Brazilian and foreign producers in our international markets.  The Brazilian market for whole poultry, poultry and pork cuts is highly fragmented.  Small producers can also be important competitors, 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 most of our frozen (in natura) meat products in the export markets and is a barrier to expanding our sales of those products in the domestic market.  With respect to exports, we compete with other large, vertically integrated Brazilian producers that have the ability to produce quality products at low cost, as well as with foreign producers.

In addition, the potential growth of the Brazilian market for processed food, poultry, pork and beef and Brazil’s low production costs are attractive to international competitors.  Although the main barrier to these companies has been the need to build a comprehensive distribution network and a network of outgrowers, international competitors with significant resources could undertake to build these networks or acquire and expand existing networks.

The Brazilian poultry and pork cuts markets, 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.

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

Our manufacturing facilities and products are subject to Brazilian federal, state and local, as well as foreign, governmental inspections and extensive regulation in the food safety area, including governmental food processing controls. We already incur significant costs in connection with the compliance with applicable rules, and changes in government regulations relating to food safety or animal welfare could require us to make additional investments or incur additional 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, recall certain products, destroy all or part of a shipment or incur costs because of delays in delivering products to our customers. Any tightening of food safety or animal welfare regulations could result in increased costs and could have a material adverse effect on our business and results of operations, financial condition and prospects. In addition, Brazil has no specific regulation regarding animal welfare; however, we adopt worldwide practices to serve our clients.

Our performance depends on favorable labor relations with our employees and our compliance with labor laws. Any deterioration of those relations or increase in labor costs could adversely affect our business.

As of December 31, 2016, we had approximately 102,000 employees worldwide. All of our production employees, in Brazil and in countries where there is a labor union force, are represented by labor unions. Upon the expiration of existing collective bargaining agreements or other collective labor agreements, we may not reach new agreements without union action and any such agreements may not be on terms satisfactory to us, which could result in us paying higher wages or benefits to union workers. If we are unable to negotiate acceptable union agreements, we may become subject to work stoppages or strikes.

Labor costs are among our most significant expenditures. In 2016, they represented 14.2% of our cost of sales, representing a decrease of 1.2 percentage points compared to 2015. In the event of an employee contractual structure review, additional operational expenses could be incurred. Additionally, during our normal business operation, we outsource some of our labor force, therefore being subject to the contingencies that may arise from this relationship. These contingencies may involve claims directly against us as if we were the direct employer of those outsourced workers or claims seeking our subsidiary liability. In the event that a significant amount of these contingencies materialize in an unfavorable outcome against us, we may be held liable for amounts higher than our provisions, which may have a material adverse effect on our business, financial and operational condition and results of operations. In addition, if the outsourced activities are deemed by the authorities to be core activities, outsourcing may be considered illegal and the outsourced workers may be considered our employees, which would result in a significant increase in our costs and could subject us to administrative and judicial procedures by the relevant authorities and fines. We are also subject to increases in our labor costs due to Brazilian inflation and increases in health insurance. Material increases in our labor costs could have a material adverse effect on our business, results of operations and financial condition and prospects.

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 interference with protected areas (conservation units, archeological areas and permanent preservation areas), handling and disposal of waste, discharges of pollutants into the air, water and soil, atmospheric emissions, noise and clean-up of contamination, all of which affect our business. Water management is especially crucial, posing many challenges to our operations. In Brazil, water use regulations impact farming operations, industrial production and hydroelectric power. Any failure to comply with any of 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 civil liability for remediation or compensation for environmental damage without any caps. We cannot operate a plant if the required environmental permit is not valid or updated. Civil penalties may include summons, fines, temporary or permanent bans, the suspension of subsidies by public bodies and the temporary or permanent shutdown of commercial activities. Criminal penalties include fines, temporary interdiction of rights and prison (for individual offenders) and liquidation, temporary interdiction of rights, fines and community services (for legal entities).

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Furthermore, pursuant to Brazilian environmental legislation, the corporate entity of a company will be disregarded (such that the owners of the company will be liable for its debts) if necessary to guarantee the payment of costs related to the recovery of environmental damages, whenever the legal entity is deemed by a court to be an obstacle to reimbursement of damages caused to the quality of the environment.

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 and operational 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 timely renewed or have their request of renewal dismissed by the competent environmental authority, we may incur fines and other administrative penalties, such as 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 in the renewal process, and we cannot guarantee that environmental agencies will approve our renewal requests within the required legal period. Brazilian Complementary Law No. 140/2011 establishes that renewal of environmental licenses must be requested at least 120 days in advance of its expiration, so that the license may be automatically extended until a final decision from the environmental authority is reached. In the interim, we are permitted to continue operations under the respective license, during the renewal process. In addition, if since the issuance of a license under renewal there have been regulatory changes in the environmental standards that the plant is required to meet, the environmental agency may condition the renewal upon expensive facility upgrades, which might result in delays or disruptions, or, in the worst case scenario, result in a denial of the license.

 

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, or “TAC”). Under IFRS, we classify the risk of adverse results in legal proceedings as “remote,” “possible” or “probable.” We disclose the aggregate amounts of these proceedings that we have judged possible or probable, to the extent the amounts are known or reasonably estimable, and we record provisions only for losses that we consider probable. See “Item 8. Financial Information—Legal Proceedings” and Note 27 of our consolidated financial statements.

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We are not required to disclose or record provisions for proceedings in which our management judges the risk of loss to be possible or remote. However, the amounts involved in some of these proceedings are substantial, and eventual losses on them could be significantly high. Even for the amounts recorded as provisions for probable losses, a judgment against us would have an impact on our cash flow if we were required to pay those amounts and the eventual losses could be higher than the provisions we have recorded.  Unfavorable decisions in our legal proceedings may, therefore, reduce our liquidity and have a material adverse impact on our business, results of operations, financial condition and prospects.

With regard to tax contingencies, we are currently defendants in a number of cases, which include, for example, disputes about the offset of tax credits and the use of tax incentives in several states that have not yet reached a final ruling at Brazilian courts. In addition, we may face risks arising from potential impairment of input state VAT that we accumulate on exportations. We have a case involving Tax on the Circulation of Merchandise and Services (Imposto Sobre a Circulação de Mercadorias e Serviços), or “ICMS,” on sales of staple foods (cesta básica) on which the Supreme Court of Brazil has ruled against us. The case is currently pending judgement of a last appeal and, if the final decision is upheld against some or all of BRF’s operations, it could have a significant impact on our liquidity and financial results. See “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings—Tax Proceedings.”

As of December 31, 2016, we had R$122.4 million in provisions for civil contingencies, R$281.7  million in provisions for tax contingencies and R$479.6 million in provisions for labor contingencies. See Note 27 to our consolidated financial statements. 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.

We are currently being investigated in the “Weak Flesh Operation,” which may result in penalties, fines, sanctions or other forms of liability.

In addition, our ability to compete effectively depends in part on our rights to trademarks, logos and other intellectual property rights we own or license. We have not sought to register or protect every one of our trademarks in every country in which they are or may be used, which means that third parties may be able to limit or challenge our trademark rights there. Furthermore, because of the differences in foreign intellectual property or proprietary rights laws, we may not receive the same level of legal protection in every country in which we operate. Litigation may be necessary to enforce our intellectual property rights, and if we do not prevail, we could suffer a material adverse impact on our business, goodwill, financial position, results of operations and cash flows. Further, third parties may allege that our intellectual property and/or business activities infringe their own intellectual property or proprietary rights, and any litigation in this regard would be costly, regardless of the merits. If we are unsuccessful in defending any such third party claims, or to settle such claims, we could be required to pay damages and/or enter into license agreements, which might not be available under favorable terms. We may also be forced to rebrand or redesign our products to avoid the infringement, which could result in significant costs in certain markets. If we are found to infringe any third party’s intellectual property, we could suffer a material adverse impact on our reputation, business, financial position, results of operations and cash flows.

 

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

Certain kinds of losses cannot be insured against via third-party insurance, and our insurance policies are subject to liability limits and exclusions. For example, ammonia leakage, natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce and the global economy, and thus could have a material adverse effect on us. Additionally, we are exposed to certain product quality risks, such as criminal contamination, bird flu and salmonella that can impact our operations and which are not covered under insurance. If an event that cannot be insured occurs, or the damages are higher than our policy limits, we may incur significant costs. In addition, we could be required to pay indemnification to parties affected by such an event. In addition, even where we incur losses that are ultimately covered by insurance, we may incur additional expenses to mitigate the loss, such as shifting production to different facilities. These costs may not be fully covered by our insurance.

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From time to time, our installations may be affected by fires as was the case with our Toledo unit in 2014 and other units in 2016, such as Chapecó/SC and Paranaguá/PR, besides electrical damages or explosion in substations, or widespread truck driver strikes. Although our business interruption insurance covers certain losses in connection with disruptions to our operations, all of our direct and indirect costs and intangible costs may not be covered by our insurance. Any similar event at these or other facilities in the future could have a material adverse impact on our business, results of operations, financial condition and prospects

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 our results. In addition, the loss of key professionals may adversely affect our ability to implement our strategy, as well as the expenses associated to these losses can impact our results.

Breaches, disruptions, or failures of our information technology systems could disrupt our operations and negatively impact our business.

 

Information technology is an important part of our business operations and we increasingly rely on information technology systems to manage business data and increase efficiencies in our production and distribution facilities and inventory management processes. We also use information technology to process financial information and results of operations for internal reporting purposes and to comply with regulatory, legal and tax requirements. In addition, we depend on information technology for digital marketing and electronic communications between our facilities, personnel, customers and suppliers. Like other companies, our information technology systems may be vulnerable to a variety of interruptions, including during the process of upgrading or replacing software, databases or components thereof, natural disasters, terrorist attacks, telecommunications failures, computer viruses, cyber-attacks, hackers, unauthorized access attempts and other security issues. Integrating newly-acquired companies into the system can be uniquely problematic. We have implemented technology security initiatives and disaster recovery plans to mitigate our exposure to these risks, but these measures may not be adequate. A significant failure of our systems, including failures that prevent our systems from functioning as intended, could cause transaction errors, processing inefficiencies, loss of customers and sales, have negative consequences on our employees and our business partners and have a negative impact on our operations or business reputation.

In addition, if we are unable to prevent security breaches, we may suffer financial and reputational damage or penalties because of the unauthorized disclosure of confidential information belonging to us or to our partners, customers, consumers or suppliers. Also, the disclosure of non-public sensitive information through external media channels could lead to the loss of intellectual property or damage our reputation and brand image.

 

Risks Relating to Our Indebtedness

We have substantial indebtedness, and our leverage could negatively affect our ability to refinance our indebtedness and grow our business.

At December 31, 2016, our total consolidated debt (comprised of short-term and long-term debt) was R$18,962.4 million (US$5,818.3 million).

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Our substantial indebtedness could have major 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; 
     
  • increasing our expenditures due to depreciations of the Brazilian real, which can lead to an increased amount of capital needed to service indebtedness that are denominated in U.S. dollars; 
     
  • 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 
     
  • 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.

As of December 31, 2016, we had R$2,674.4 million of debt that matures in 2018, R$3,188.7 million of debt that matures in 2019, R$1,412.7 million of debt that matures in 2020, R$8,441.6 million of debt that matures in in 2021 and thereafter.

A substantial portion of our outstanding debt is denominated in foreign currencies, primarily U.S. dollars. As of December 31, 2016, we had R$10,318.7 million of foreign currency debt, including R$1,257.1 million 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. Foreign currency hedge agreements may not be effective in covering these currency-related risks.

Any future uncertainty in the stock and credit markets could 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 pressures on credit return as a result of disruptions in the global stock and credit markets, 
     
  • 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

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  • 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 restrictions on us.

The instruments governing our consolidated indebtedness impose significant 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;
     
  • 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 the imposition of covenants that are more restrictive, the requirements for additional 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, results of operations and the market prices of our common shares or the ADRs.

The Brazilian economy has historically been characterized by interventions by the Brazilian government and unstable economic cycles. The Brazilian government has often changed monetary, price controls, taxation, credit, tariff and other policies to influence the course of Brazil’s economy. Our business, results of operations, financial condition and prospects as well as the market prices of our common shares or the American Depositary Receipts (“ADRs”) may be adversely affected by, among others, the following factors:

  • exchange rate fluctuations;
     
  • expansion or contraction of the Brazilian economy, as measured by rates of growth in gross domestic product (GDP);
     
  • high inflation rates;

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  • changes in fiscal or monetary policies;
     
  • commodities price volatility;
     
  • increase in interest rates;
     
  • exchange controls and restrictions on remittances abroad;
     
  • volatility and liquidity of domestic capital and credit markets;
     
  • natural disasters and changes in climate or weather patterns; 
     
  • energy or water shortages or rationalization, particularly in light of water shortages in parts of Brazil;
     
  • changes in environmental regulation; 
     
  • social and political instability, particularly in light of recent protests against the government; 
     
  • strikes, not only of our employees, but also of port employees, truck drivers, other transport facilities, customs agents, sanitary inspection agents and other government agents; and
     
  • other economic, political, diplomatic and social developments in or affecting Brazil, including with respect to alleged unethical or illegal conduct of certain figures in the Brazilian government and legislators, which are currently under investigation.

The Brazilian economy has recently experienced a slowdown. In recent years, GDP growth rates were 1.8%, 2.7% and 0.1% in 2012, 2013 and 2014, respectively, but GDP decreased 3.8% and 3.6% in 2015 and 2016, respectively.  Inflation and interest rates decreased, but remained in historically high levels, while unemployment had a significant increase. For 2017, there is an expectation of a slight improvement of the economic indicators (especially, interest rates and inflation), but the economy will probably continue to grow at a very slow pace.

 

Our results of operations and financial condition may be adversely affected by the economic conditions in Brazil and, in addition, protests, strikes and corruption scandals have led to a decrease in confidence and a political crisis.

 

After the legal and administrative process for the impeachment, Brazil’s Senate removed president Dilma Rousseff from office on August 31, 2016 for infringing budgetary laws. Michel Temer, the former vice president, who has been de facto president Brazil since Ms. Rousseff’s suspension in May, was sworn in by the Senate to serve out the remainder of the presidential term until 2018. However, the resolution of the political and economic crisis in Brazil still depends on the outcome of the “Lava Jato” investigation and approval of reforms that are expected to be promoted by the new president. We cannot predict which policies Mr. Temer may adopt or change during his mandate or the effect that any such policies might have on our business and on the Brazilian economy. Any such new policies or changes to current policies may have a material adverse impact on our business, results of operations, financial condition and prospects.

The political crisis could worsen the economic conditions in Brazil, which may increase production and supply chain costs and adversely affect our results of operations and financial condition. Uncertainty as to whether the Brazilian government will implement changes in policies or regulations affecting these or other factors in the future may contribute to economic uncertainty in Brazil and to heightened volatility in our production operations.

 

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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 ADRs.

Brazil experienced high inflation rates in the past. According to the National Amplified Consumer Price

Index (Índice Nacional de Preços ao Consumidor Amplo, or “IPCA”), published by the Brazilian Institute of

Geography and Statistics (Instituto Brasileiro de Geografia e Estatística, or the “IBGE”), Brazilian consumer price inflation rates were 5.8% in 2012, 5.9% in 2013, 6.4% in 2014, 10.7% in 2015 and 6.29% in 2016. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Principal Factors Affecting Our Results of Operations—Brazilian and Global Economic Conditions” and “—Effects of Exchange Rate Variations and Inflation.”

 

Although the market is currently forecasting that the inflation level will return to the Central Bank’s target in 2017, it is impossible to dismiss the possibility of higher inflation, taking into account the historic behavior of the country’s economy and the recurring political instability. Periods of higher inflation slow the growth rate of the Brazilian economy, which may lead to lower growth in consumption of food products. Inflation also is likely to continue to put pressure on industry costs of production and expenses, which will force companies to search for innovative solutions in order to remain competitive. We may not be able to pass this cost onto our customers and, as a result, it may reduce our profit margins and net profit. 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 profit. In addition, inflation and its effect on domestic interest rates can 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 prices of our common shares and the ADRs.

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

The interest rate is one of the instruments used by the Central Bank to keep inflation under control or to stimulate the economy. If interest rates decrease, the population has greater access to credit and consumes more. This increase in demand can push prices if the industry is not prepared to meet higher consumption. On the other hand, if interest rates go up, the monetary authority inhibits consumption and investment once they get more expensive. Another consequence is the greater return paid by government securities, directly impacting other investments that become less attractive. Investment in public debt absorbs money that would fund the productive sector.

At December 31, 2016, 28.7% of our total liabilities with respect to indebtedness and derivative instruments corresponding to the amount of R$19,491.9 million were 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), 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 the London Interbank Offered Rate, or “LIBOR.” Any increase in the CDI, TJLP or LIBOR rates may have an adverse impact on our financial expenses and our results of operations.

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

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 2012, 2013, 2014 and 2015, the real depreciated 8.9%, 14.6%, 13.4% and 47.0%, respectively, against the U.S. dollar, while, in 2016, the real appreciated 16.5%.

Appreciation of the Brazilian real against the U.S. dollar may lead to a dampening of export-driven growth. Our production costs are denominated in reais, but our international sales are mostly denominated in U.S. dollars. 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 appreciation could reduce the competitiveness of our exports and adversely affect our net sales and our cash flows from exports. On the other hand, a depreciation of Brazilian real against the U.S. dollar may lead to higher exports and revenues, but costs may be higher.

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Costs are also directly impacted by the exchange rate. Any depreciation 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 have established policies and procedures to manage our sensitivity to such risks, such as the Financial Risk Management Policy. This policy, however, may not cover 100% of our revenue and cost exposure to exchange rates.

We had total foreign currency-denominated debt obligations in an aggregate amount of R$10,318.7 million at December 31, 2016, representing 54.4% 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.

Changes in tax laws or changes in their interpretation 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 tax rates and, on occasion, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. In the past, 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”) and Contribution for Social Security Funding (Contribuição para o Financiamento da Seguridade Social, or “COFINS”) taxes, the ICMS and some other taxes, such as increases in payroll taxes. These proposals may not be approved and passed into law. Others, such as the Lei do Bem incentive program and the deduction of interest on shareholders’ equity, may be revoked. 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. Moreover, for as long as the Provisional Measure No. 774/17 related to social contributions is in effect or if it is passed into law, our overall tax burden will be increased, which could negatively affect our overall financial performance. For more information, see “Item 8. Financial Information – B. Significant Changes – Social Contributions.”

Risks Relating to Our Common Shares and ADRs

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

Holders of ADRs may exercise voting rights with respect to our common shares represented by ADSs and evidenced by ARSs only in accordance with the deposit agreement governing the ADRs. Holders of ADRs face practical limitations in exercising their voting rights because of the additional steps involved in our communications with ADRs 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 ADRs 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 ADRs must instruct the ADR depositary on a timely basis. This voting process necessarily takes longer for holders of ADRs than for holders of our common shares. If the ADR depositary fails to receive timely voting instructions for all or part of the ADRs, the depositary will assume that the holders of those ADRs are instructing it to give a discretionary proxy to a person designated by us to vote their ADRs, to the extent permitted by the New York Stock Exchange rules.

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

Non-Brazilian holders of ADRs 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 ADRs 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 ADRs surrenders its ADRs 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 ADRs 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 ADRs 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 ADRs 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 ADRs.

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Holders of ADRs 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 evidenced by their ADRs.

Holders of ADRs 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 the ADSs evidenced by their ADRs) 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 rights, 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 33.3% or more of our share capital to disclose such information immediately through a filing with the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários) or “CVM” and,  within 30 days from the date of such acquisition or event, commence a public tender offer with respect to all of our shares for a price per share that may not be less than the greater of: (i) 140% of the average trading price on the stock exchange trading the greatest volume of shares of the capital stock of the Company during the last 120 trading sessions prior to the date on which the public offer became obligatory; and (ii) 140% of the average trading price on the stock exchange trading the greatest volume of shares of the capital stock of the Company during the last 30 trading days prior to the date on which the public offer became obligatory.

 

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

Historically, any capital gain realized on a sale or other disposition of ADRs between non-Brazilian holders outside Brazil was not subject to Brazilian income tax. However, a December 2003 Brazilian law (Law No. 10,833, of December 29, 2003) 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 and evidenced by ADRs, 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 ADRs, 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. 4,373, as amended, of the Brazilian National Monetary Council (Conselho Monetário Nacional), or “CMN”), is generally viewed as being subject to taxation in Brazil. Pursuant to Article 26 of 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 the case of a non-Brazilian holder, the withholding tax rate applicable upon the capital 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).

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For additional discussion of the tax consequences of a disposition of our common shares, see “Item 10. Additional Information––E. Taxation.”

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

The Brazilian securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States.  The Novo Mercado of BM&FBovespa (the “BM&FBOVESPA” or the “São Paulo Stock Exchange”) had a total traded volume of  R$694.8 billion, or US$201.2 billion, and an average daily trading volume of R$1.9 billion, or US$576.4 million for the year in 2016. The New York Stock Exchange had a market traded volume of US$10.2 trillion (U.S. domestic listed companies) and an average daily trading volume of  US$44.0 billion for the year in 2016. The Brazilian securities markets are also characterized by considerable share concentration.

The ten largest companies in terms of market capitalization represented approximately 43% of the aggregate market capitalization of the São Paulo Stock Exchange as of December 31, 2016. In addition, the ten most widely traded stocks in terms of trading volume accounted for approximately 46% of all shares traded on the São Paulo Stock Exchange in 2016. These market characteristics may substantially limit the ability of holders of the ADRs to sell common shares underlying ADSs evidenced by ADRs 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 price of our common shares and ADRs.

The market for securities issued by Brazilian companies is influenced, to varying degrees, by economic and market conditions in other emerging markets. 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 markets have at times resulted in significant outflows of funds from, and declines in, the amount of foreign currency invested in Brazil. In addition, economic and 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, as well as the market for securities issued by Brazlian companies, is also affected, to a varying degree, 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 ADRs 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 2016, and we do not expect to be a PFIC for 2017 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 ADRs 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 ADRs, which is subject to change.  See “Item 10. Additional Information––E. Taxation––U.S. Federal Income Tax Considerations––Passive Foreign Investment Company.”

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ITEM 4.            INFORMATION ON THE COMPANY

A.                  History and Development of the Company

BRF 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 as Perdigão 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.

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.;
     
  • SISTEL – Fundação Telebrás de Seguridade Social, 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 Econômico 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 de Seguridade Social, or “VALIA,” the pension fund of employees of Vale S.A.; 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.

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For recent information about our major shareholders, see “Item 7.  Major Shareholders and Related Party Transactions––A. Major Shareholders.

Our principal executive offices are located at Rua Hungria, 1400 - 5th Floor, Jd. Europa, 01455-000, São Paulo, SP, Brazil, and our telephone number at this address is +55-11-2322-5000/5355/5048. Our internet address is www.brf-br.com/ir.  From time to time, we may use our website as a channel of distribution of material company information. Financial and other material information regarding us is routinely posted on and accessible at www.brf-br.com/ir. The information on our website is not incorporated by reference into this Annual Report on Form 20-F.

Business Combination with Sadia

Agreement with Sadia

On May 19, 2009, we signed a merger agreement with Sadia for a business combination of the two companies. Holders of common shares and preferred shares of Sadia received common shares of BRF, and holders of American Depositary Shares (“ADS”) representing preferred shares of Sadia, received ADRs evidencing ADSs representing common shares of BRF.

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 S.A. (“Perdigão”), Sadia, and HFF Participações S.A. (“HFF”), a holding company formed by the controlling shareholders of Sadia for purposes of the acquisition. In connection with the business combination, we changed our name from Perdigão S.A. to BRF – Brasil Foods S.A.  The business combination became fully effective on September 22, 2009, and Sadia became our wholly owned subsidiary.

On December 31, 2012, we incorporated Sadia S.A., then a wholly-owned subsidiary, into BRF, and Sadia ceased to exist as a separate legal entity.

Antitrust Approvals

The business combination was reviewed by antitrust authorities both in Brazil and in Europe.  Approval by the European antitrust authorities was received on June 29, 2009, followed by the Administrative Council for Economic Defense (Conselho Administrativo de Defesa Econômica, or “CADE”) on July 13, 2011, conditioned upon compliance with the terms of a Performance Commitment Agreement (Termo de Compromisso de Desempenho, or “TCD”) that we entered into with the CADE on July 18, 2011.  Under the TCD, we agreed to a number of measures, including, among others, the suspension of use of certain brands for a range from three to five years and the divestment of certain trademarks, plants, and distribution centers in the domestic market. In March 2012, we entered into an agreement with Marfrig Alimentos S.A., or “Marfrig,” pursuant to which we agreed to transfer certain assets in compliance with our agreement with the CADE. The last suspension of use of brands imposed by CADE in connection with the business combination with Sadia expires July 3, 2017. After such date, BRF will only be prohibited from having exclusivity on sales, publicity or merchandising in points of sale in Brazil. The TCD does not restrict our ability to act freely in the Brazilian food service market or outside the Brazilian market.

Agreement with Marfrig

In July 2011, we received Brazilian antitrust approval for our business combination with Sadia from CADE, but that approval was subject to a number of conditions set forth in a TCD, including, among others, the suspension of use of certain brands for a range from three to five years and the divestment of certain trademarks, plants, and distribution centers in the domestic market. On March 20, 2012, we entered into an agreement with Marfrig pursuant to which we have agreed to transfer certain assets in compliance with the TCD.  In exchange, we acquired the right to receive from Marfrig an amount corresponding to R$350.0 million to be paid as follows:

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  • R$25.0 million paid on June 11, 2012;
     
  • R$25.0 million, adjusted by the General Market Price Index (Índice Geral de Preços do Mercado, or “IGP-M”), paid on July 1, 2012;
     
  • R$250.0 million to be paid by Marfrig to BRF in 72 monthly and successive installments, which are due from August 1, 2012, being the first installment in the amount of R$4.4 million and other remaining installments in the amount of R$4.8 million, subject to the fixed rate of 12.1% per year.

As disclosed in the quarterly information for the nine month period ended September 30, 2012, BRF and Marfrig renegotiated the payment terms of the amount correspondent to R$50.0 million which previous settlement was expected to occur on October 1, 2012. As a consequence, this amount has been received as from January 2, 2013 in 67 monthly and successive installments in the amount of R$964 thousand.

All the installments were properly paid by Marfrig.

The Asset Exchange agreements between Marfrig and BRF also included as part of the payment for this transaction the acquisition of the total shareholding stake in Quickfood S.A. (equivalent to 90.05% of its capital stock), a publicly held Argentine food corporation.  For more details on these agreements, see “Item 4. Information on the Company—A. History and Development of the Company—Business Combination with Sadia.”  

Agreement with Lactalis

On September 3, 2014, BRF entered into a binding memorandum of understanding with Lactalis, a company controlled by Parmalat S.p.A., an Italian publicly held company pertaining to the Groupe Lactalis S.A., or “Groupe Lactalis,” for the sale of its dairy division, including:  (i) manufacturing facilities located in the cities of Bom Conselho (PE), Carambeí (PR), Ravena (MG), Concórdia (SC), Teutônia (RS), Itumbiara (GO), Terenos (MS), Ijuí (RS), Três de Maio I (RS), Três de Maio II (RS) and Santa Rosa (RS), and (ii) related assets and trademarks (Batavo, Elegê, Cotochés, Santa Rosa and DoBon) dedicated to such segment. The transaction closed on July 1, 2015 for a total consideration of US$697.8 million.

Establishment of OneFoods

On June 30, 2016, we approved the establishment of our subsidiary One Foods Holding Ltd. (“OneFoods”), formerly known as Sadia Halal, dedicated to the production, distribution and sale of halal products.  Such restructuring process will contemplate the transfer of several assets related to the production and distribution of halal products, including: (i) grain storage facilities, feed mills, agreements with outgrowers (outsourced farmers), hatcheries and eight slaughtering and processing plants in Brazil; (ii) one processing plant in United Arab Emirates; (iii) the equity participation in FFM Further Processing SDN BHD and (iv) the equity participation held by us in certain distribution companies based in Saudi Arabia, Qatar, United Arab Emirates, Sultanate of Oman and Kuwait.These assets were transferred to SHB Comércio e Indústria de Alimentos S.A. (“SHB”), a controlling shareholder of OneFoods, or directly to OneFoods. We will also transfer or license to OneFoods some brands that we use in some halal markets. We are analyzing strategic alternatives for the expansion of our halal business in our current markets as well as in those not currently served by us, as well as alternatives for the capitalization of OneFoods. OneFoods, based in Dubai, United Arab Emirates, started operations on January 2, 2017.

 

Other Acquisitions and Investments in 2016

Campo Austral – Argentina

 

On December 1, 2015, BRF signed a binding offer with Pampa Agribusiness Fund L.P. and Pampa Agribusiness Follow-on Fund L.P. relating to the acquisition of all the shares issued by Eclipse Holding Cooperatief UA, a Dutch company that controls Campo Austral, a group of companies with fully integrated business operations in the hog segment in Argentina, including the cold cuts market, for the total consideration of US$68.2 million. This transaction was completed on April 15, 2016.

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Calchaquí – Argentina

 

On March 22, 2016, BRF, through its subsidiaries BRF GmbH and BRF Holland B.V., entered into a share purchase agreement for the acquisition of all the shares issued by Alimentos Calchaquí Productos 7 S.A., for the total consideration of US$104.7 million. This transaction was completed on May 10, 2016.

 

Al Khan Foodstuff – Oman

 

On April 25, 2016, BRF, through its subsidiary BRF GmbH, entered into a share purchase agreement with the shareholders of Al Khan Foodstuff LLC, or “AKF.” After completion of the transaction on June 20, 2016, BRF GmbH held all of AKF’s economic interest. The valuation of AKF within the context of the transaction (enterprise value for 100% of AKF) was of US$32.6 million.

 

FFM Further Processing – Malaysia

 

On September 9, 2016, BRF, through its subsidiary BRF Foods GmbH, entered into an agreement with FFM Berhad, providing for the cooperation of both parties in FFM Further Processing SDN BHD, a food processing company based in Malaysia, along with an investment by BRF Foods GmbH in FFP in the amount of approximately US$16.0 million. After completion of the transaction on October 4, 2016, BRF Foods GmbH held 70% of the shares of FFP, and FFM Berhad held the remaining 30%.

 

Banvit - Turkey

 

On January 9, 2017, we entered into a share purchase agreement with the controlling shareholders of Banvit Bandirma Vitaminli Yem Sanayii A.Ş. (“Banvit”) for the acquisition of all the Banvit shares held by them, which represent 79.5% of the Banvit shares. Banvit is the largest poultry producer in Turkey, with fully integrated operations and the highest brand awareness in the sector in Turkey.

 

Additionally, we and Qatar Investment Authority (“QIA”), the sovereign wealth fund of the State of Qatar, have entered into definitive agreements related to the incorporation of a new company, which will acquire the Banvit shares referred to above, and the relationship between this new company and Banvit. The rights arising from these agreements will be assigned to OneFoods, which will hold 60% of this new company and QIA will hold the remaining 40%.

 

Pursuant to the terms of the share purchase agreement described above and subject to the financial performance of Banvit for 2016, the enterprise value for 100% of Banvit is approximately US$470.0 million. Based on the net debt position of Banvit as of September 30, 2016, the equity value of Banvit would therefore be approximately US$340.0 million.

 

Following the consummation of this transaction, the new company will launch a mandatory tender offer to acquire the remaining 20.5% of the Banvit shares from the minority shareholders on the same terms and conditions offered to the Banvit controlling shareholders.

 

The completion of this transaction is subject to the satisfaction of the conditions precedent set forth in the definitive documents, including anti-trust approvals.

 

Weak Flesh Operation

We are currently being investigated in the context of the “Weak Flesh Operation.” For more information, see “Item 8. Financial Information – B. Significant Changes – Weak Flesh Operation.”

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Capital Expenditures

The table below sets forth our capital expenditures for the periods indicated:

 

As of December 31,

 

2016

2015

2014

 

(in millions of reais)

Expansion and enhancement of production facilities

686.2

495.0

292.8

UAE Facility

7.7

51.8

236.9

Other expansion investments

678.5

443.1

55.9

Productivity investments

348.4

435.1

267.8

Automation

115.0

257.6

124.9

Other productivity investments

233.4

177.6

142.9

Other capital expenditures

481.6

554.8

387.5

Subtotal capital expenditures

1,516.2

1,485.0

948.1

Biological Assets

784.2

598.9

517.5

Acquisitions and other investments

3,084.1

376.9

514.4

Leasing

82.0

21.3

67.8

Total capital expenditures

5,466.5

2,482.0

2,047.8

 

The main capital expenditures in 2014, 2015 and 2016 are described below:

                Acquisitions. For the main acquisitions in 2016, see “—Other Acquisitions and Investments in 2016”.

 

Logistics Management: BRF invested R$53.4 million in 2016 in the Vitória de Santo Antão distribution center in order to better serve all the states in the northeastern region of Brazil and some states in the north of the country.

Tatui (SP-Brazil): In 2014, BRF continued the development of a production line for sliced cold cut products to be sold in an exclusive single package. This new line was installed in the Tatui Industrial Complex, located in the state of São Paulo (Brazil). This new product aims at strengthening the presence of the Sadia brand in the cold cuts category, offering a differentiated pre-sliced product, with clear identification of the brand and food security assurance. BRF is a leader in the cold cuts category and wants to expand the portfolio of products that reach the consumer needs, such as single fresh slices. The sliced cold cuts line Soltissimo offers thin and single slices that do not stick together, with “easy-open” and storage packaging and fresh products.

Automation: In 2016, BRF invested nearly R$115.0 million for the automation of company processes. The goal has been to improve efficiency by increasing productivity and reducing production costs. In 2016, investments on automating the chicken leg deboning processes continued, which not only drastically reduced costs, but also improved ergonomics in the factory and increased product quality. In 2015 and 2014, BRF invested R$375.8 million for the automation of company processes. The goal has been to improve efficiency by increasing productivity and reducing production costs. In 2015, the focus of automation investments was on deboning processes and poultry packaging.

Internationalization Project: BRF is working on a broad long-term internationalization project. In 2016, we increased our investments in Argentina, including in the San Jorge burger factory and in Rio Cuarto in the amount of R$17.9 million and R$101.5 million, respectively. In 2014, the company opened a processed products facility in the UAE, with production capacity of 70 thousand tons/year, which  represented a total investment of around US$160.0 million.

Demand: Despite the decrease in demand growth in the Brazilian market, which is closely related to the poor performance of the Brazilian economy, demand should resume its growth in the following years. Therefore, BRF invested in projects to keep up with demand growth, such as the investments made in the Toledo, Uberlândia and Lucas do Rio Verde plants, in the aggregate amount of R$90.6 million in 2016.

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Operational footprint: In 2015, the company had a strong focus on improving its operational complex, investing on growth and optimization of production between plants in order to minimize the cost to produce and deliver each product. The optimization takes into account aspects of production cost, logistics, tax, quality and production specialization. At this point, the review also takes this opportunity to improve the mix of the Company's products, maximizing investments in higher value-added products, in line with the strategy of BRF. The revaluation of footprint also provides greater flexibility and agility in the production process.

 

In 2017, in addition to existing projects, BRF is focused on increasing production – specially of pork meat, developing new products and improving efficiency. In accordance with BRF’s commitment to a more efficient use of its employed capital, we will also analyze divestiture opportunities (such as inactive real estate assets) should they allow us to increase our focus on the core business and generate higher returns for shareholders.

 

B.                  Business Overview

BRF S.A. is one of the largest producers of fresh and frozen protein foods in the world, with a portfolio of over five thousand stock keeping units (“SKUs”).  Our processed products include marinated and frozen chicken, Chester® rooster and turkey meat, specialty meats, frozen processed foods, frozen prepared entrees, portioned products and sliced products. We also sell margarine, sweet specialties, sandwiches, mayonnaise, and animal feed. We are the holder of brands such as Sadia, Perdigão, Qualy, Perdix, Paty, Bocatti, Vienissima, Dánica, Confidence, Speedy Polo and Hilal. In December 2016, BRF was responsible for 16.3% of the world trade in poultry.

Our portfolio strategy is focused on creating new, convenient, practical and healthy products for our consumers based on their needs. We seek to achieve that goal through strong innovation to provide us with increasing value-added items that will differentiate us from our competitors and strengthen our brands.

With 35 plants in Brazil, BRF has among its main assets a widespread distribution network that enables its products to reach Brazilian consumers through 551,050 monthly deliveries and 47 distribution centers, 20 of which are in the domestic market and 27 of which are in our export markets.

In the international market, BRF has a leading brand, Sadia, in various categories in Middle Eastern countries. We maintain 27 sales offices outside of Brazil serving customers of more than 150 countries on five continents. We have nine industrial units in Argentina, five in Thailand, two in Europe (BRF UK and BRF Holland), one in Abu Dhabi and one in Malaysia.

We are able to reach substantially all of the Brazilian population through a nationwide network of 20 distribution centers. 

In Brazil, we operate 35 meat processing plants, three margarine processing plants, three pasta processing plants, one dessert processing plant and three soybean crushing plants, all of them near our raw material suppliers or the main consumer centers. We have an advanced logistic system in our domestic market, with 20 distribution centers, being eight owned by us and 12 leased by third parties, all of which serve supermarkets, retail stores, wholesale stores, restaurants and other clients.

In our international markets, we operate 12 meat processing plants in Argentina,  Netherlands, United Kingdom, Thailand, the United Arab Emirates and Malaysia one margarine and oil processing plant Argentina, one sauce and mayonnaise processing plant Argentina, and one frozen vegetables processing plant Argentina. We have 27 distribution centers located overseas, as well as commercial offices in the United Kingdom, France, Spain, Italy, Austria, Hungary, Netherlands, Russia, Singapore, South Korea, China, Japan, Saudi Arabia, the United Arab Emirates, Qatar, Oman, Kuwait, South Africa, Argentina, Uruguay, Chile, Turkey and Malaysia.

 

Our domestic distribution network uses 20 distribution centers in several Brazilian states.  Refrigerated trucks transport our products from our processing plants to the distribution centers and from the distribution centers to our customers. We have 30 transit points, previously referred to as 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 eight of our distribution centers and lease the remaining 12 centers, which are listed below under “—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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BRF has been a public company since 1980. Our shares have been listed on the BM&FBovespa as BRFS3 since 2006, and we are also traded on the New York Stock Exchange (NYSE - ADR level III). Since 2005, BRF has been part of BM&FBovespa’s Corporate Sustainability Index (ISE) portfolio in acknowledgement of its strong commitment to sustainable development. This commitment has been reinforced and internationally recognized since 2012, upon our entrance into the portfolio of Emerging Markets of Dow Jones Sustainability Index.

 

Competitive Strengths

We believe our major competitive strengths are as follows:

  • Leadership in the Brazilian Food Market with Strong Brands and a Global Presence.  We are one of the largest producers of fresh and frozen protein foods in the world with a size and scale that allows us to compete in Brazil as well as in our export markets. We are one of the largest food companies in the world in terms of market capitalization. We believe our leading position allows us to take advantage of market opportunities by expanding our business, increasing our offer of added value products and improving our initiatives in export markets.  In 2016, we slaughtered approximately 1.72 billion chickens and other poultry and 9.61 million hogs and cattle. In the same year, we sold approximately 5.0 million tons of poultry, hogs, beef and processed products. Our own and licensed brands are highly recognized in a number of countries, such as Brazil, Argentina, Saudi Arabia, Angola, to name a few, and we are expanding the presence with local brands in key markets. Our Sadia and Perdigão brands were included among the “Most Valuable Brand in Brazil” in 2016 and 2015, respectively, by Millward Brown Vermeer. Our sustainable practices have also brought BRF great recognition over the years. We are one of the leading companies in terms of transparency published by the Carbon Disclosure Project, or “CDP.” We are the only company in the food sector to have been included in BM&FBOVESPA’s Corporate Sustainability Index, or “ISE,” for the last 12 years. We became part of the Emerging Markets portfolio of the Dow Jones Sustainability Index five years ago and are also among the companies listed on the United Nations Global Compact 100 Index since 2013. 
     
  • Extensive Distribution Network in Brazil and the Export Markets.  We believe we are one of the few companies with an established distribution network that can deliver frozen and chilled products in practically any region of Brazil. Moreover, we export products to approximately 150 countries and are developing our own distribution network in Europe, where we sell directly to food processing companies and local distributors. We operate in the Middle East through equity interests we have acquired in distribution companies such as Al Khan Foodstuff LLC, or “AKF,” the leader in the distribution of frozen and chilled food in the Sultanate of Oman, the retail frozen foods distribution business of Alyasra Food Company W.L.L, or “Alyasra,” the leader in the distribution of frozen, chilled and dried food in Kuwait, and Federal Foods Limited, or “Federal Foods,” the leader in the distribution of food in the United Arab Emirates. Besides this, we also operate through Al Wafi in Saudi Arabia. In Argentina, we are working to optimize the number and increase the loyalty of our distributors. Our established distribution capabilities and logistical experience allow us to expand our national and international business, leading to higher sales volume and a greater coverage of our line of products. Moreover, in Europe, we partnered with Invicta Food Group Limited, or “Invicta,” and acquired Universal Meats (UK) Ltd, or “Universal Meats,” to strengthen our distribution of processed food in the United Kingdom, Ireland and Scandinavia.
     
  • Low Cost Producers in a Growing Global Market.  We believe we have a competitive advantage over producers in some of our export markets due to our lower production costs and gains of efficiency in animal production in Brazil. We have also achieved a scale of production and quality that allows us to compete effectively with the main producers in Brazil and other countries. We set up a series of programs aimed at maintaining and improving our cost effectiveness, including programs to optimize our supply chain by integrating demand, production, inventory management and customer service. Our Shared Service Center (CSC - Centro de Serviços Compartilhados) centralizes our administrative and corporate activities, and our BRF Value Generation system (GV BRF - Geração de Valor BRF”) provides our managers with a more efficient use of fixed and working capital, while our Zero-Base Budget (OBZ - Orçamento Base Zero) is directed at enhancing the efficiency of cost management.

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Table of Contents

  • Strategic and Diversified Geographic Allocation.  Our slaughterhouses are strategically located in different regions of Brazil (South, Southeast and Midwest). This allows us to offset the risks from any restrictions on exports that may occur in particular regions of the country due to sanitary concerns. The geographical diversity of our distribution centers in 14 Brazilian states also allows us to reduce the cost of transport due to their proximity to the grain-producing regions and the country´s main export ports. We opened our first processed food plant in the Middle East in Abu Dhabi, in the United Arab Emirates in 2014. This is the largest BRF factory globally. In Argentina, in 2016, we integrated Campo Austral, through the acquisition of its controller, Eclipse Holding Cooperatief UA, and Alimentos Calchaquí Productos 7 S.A., or “Calchaquí,” both with own production capabilities and local brands to strengthen our position in the cold cuts market. Additionally, in 2016, we increased our presence in Asia by acquiring Golden Foods Siam, or “GFS,” one of the leading poultry producers in Thailand, with fully integrated operations and exporting to more than 15 markets globally, we concluded a cooperation agreement with FFM Berhad in Malaysia, we signed an agreement for the acquisition of Banvit in Turkey (the completion of this transaction is subject to the satisfaction of the conditions precedent set forth in the definitive documents, including anti-trust approvals), and more recently, in January 2017, our subsidiary, OneFoods, focused 100% in the Halal market, started to operate. Those are great steps forward as part of our international expansion and aim to provide the best options to clients through local operations, which allow rapid and efficient access to strategic markets and increase the flexibility of the adaptation of products to local wishes. This approach is always carried out according to the specific requirements of each country and follows rigorous controls in all the productive processes.
     
  • Emphasis on Quality, Safety and Diversified Portfolio of the Product.  We are committed to food safety and quality in all of our operations to meet the specifications of our clients, prevent contamination and reduce the risks of epidemics of animal illnesses. We monitor the treatment of our poultry and hogs raised in all the stages of their lives and throughout the entire production process. In 2013, we launched a campaign in Brazil to publicize the Sadia Total Guarantee Program (Programa de Garantia Total Sadia) that ensures our chickens have no hormones or preservatives and are individually inspected. Moreover, we were the first Brazilian company approved by the European Food Safety and Inspection System, which qualified us to sell processed poultry products to European consumers. This means that our clients include some of the most demanding clients in the world and that we meet their quality controls and external audits. We have a diversified variety of products that give us the flexibility to direct our production according to the market demand and the seasonality of our products. To support this continuous innovation of our product portfolio, we have been continuously investing in our Technology Center in Jundiaí, in upstate São Paulo.
     
  • Committed Management Team.  Our management endeavors to accentuate best practices in our operations and corporate governance standards, as demonstrated by the listing of our common shares on the Novo Mercado segment of the São Paulo stock exchange. Companies listed on this stock market must pledge to adopt the highest standards of corporate governance. We have improved our organizational structure and have redesigned it under the following five vice presidents: (i) VP of Finance and Management; (ii) VP of People; (iii) VP of Marketing and Innovation; (iv) VP of Operations and Supply Chain; and (v) VP of Corporate Integrity.

Business Strategy

We intend to become the most inspiring and relevant global food company. In order to achieve this, we reviewed our long-term plan in our yearly strategic planning process. We set four main targets for our company in the next years:

  • Have a global brand portfolio. We are expanding our brand portfolio throughout the world. Sadia, for example, has different brand stages across our markets. In Brazil and Middle East countries, it has impressive penetration and preference levels, while in Russia, Angola and in some Asian countries, it is becoming increasingly stronger. Qualy is our most relevant brand for spreads, with an innovative approach to our consumers in Brazil.  Paty and Danica are renowned brands for burgers and condiments, respectively, in Argentina. Those are just some initiatives and, for each of our brands, we look to bring the most value to our consumers.

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Table of Contents

  • Focus in six key global categories. Strengthening our portfolio and its quality must be a continuous effort, therefore, we elected our most important categories, considering strategic and value importance. Our global focus is in value added poultry and pork cuts, cold cuts, cooked and coated, ready-to-eat meals, on-the-go and food service portfolio.
     
  • Capture global opportunities. Internationally, we made important steps to solidify BRF as a global company. In Middle East and Africa, we continued to improve our local production (Abu-Dhabi plant), consolidated distribution and increased processed food portfolio participation. In Asia, we invested in branded portfolio and footprint expansion, such as our recent acquisition in Thailand and Malaysia. In Eastern Europe, we focused on retailing presence and, in the U.K., our food service channel became even more relevant. In Argentina, we expanded our position in the cold-cuts market by acquiring two more companies. Recently, we announced a joint venture with Banvit to enter Turkey, an important poultry market. Banvit is the largest poultry producer in Turkey, with fully integrated operations and the highest brand awareness in the sector in Turkey. The completion of this transaction is subject to the satisfaction of the conditions precedent set forth in the definitive documents, including anti-trust approvals.
     
  • Transformational changes. In the second semester of 2016, we announced our intention to focus on the halal market. In this context, BRF analyzed strategic alternatives for its new subsidiary, OneFoods, enabling its expansion in current markets as well as in those not currently served by BRF. In the beginning of 2017, OneFoods became operational.

Products

We are a food company that focuses on the production and sale of poultry, pork and processed foods.

Poultry

We produce frozen whole and cut poultry. In 2016, we slaughtered approximately 1.72 billion heads of poultry, 0.5% decrease compared to 1.72 billion in 2015. We sold 2,006 thousand tons of frozen chicken and other poultry products in 2016, compared to 1,944 thousand tons in 2015. Most of our poultry sales are to our export markets.

Pork and Beef

In 2016, we slaughtered approximately 9.61 million hogs and cattle, compared to 9.51 million in 2015. We raise hogs but do not raise cattle at our facilities.  Although most of hogs that we slaughter are used for processed products in the domestic market, we also produce frozen pork and beef cuts, such as loins and ribs, and whole carcasses. We are developing our international customer base for pork and beef cuts.  In 2016, we sold 350 thousand tons of pork and beef cuts, compared to 273 thousand tons of pork and beef cuts in 2015.

Aligned with our strategic plan (BRF 17), in 2014, we transferred our beef operations to Minerva, in exchange for an equity participation in that company.

Processed Food Products

We produce processed foods, such as marinated and frozen chicken, Chester® rooster and turkey meat, specialty meats, frozen processed foods, frozen prepared entrees, 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 2,017 thousand tons of processed foods in 2016, compared to 2,116 thousand tons in 2015.  Most of our sales of processed foods are to our domestic market. We believe that there are opportunities to market value-added products like these to targeted regions and other market segments in Brazil as well as to expand our sales in the export market.

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Our processed food products strategy relies on accurate brand equity management, varied product portfolio with strategic pricing, and innovation and service excellence, which allows our products to reach thousands of Brazilian and international homes each day.

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, pork and beef products, including hamburgers, steaks, breaded meat products, kibes (a type of Middle Eastern beef patty popular in Brazil) and meatballs.

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 we 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.

Halal Products

We offer poultry products for Muslim markets in accordance with the Halal method of animal slaughter.

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.

  • Pastas and Pizzas. We produce several varieties of lasagna, pizza and other ready-to-eat meals. We produce the meat used in these products and buy other raw materials in the domestic market.
     
  • Vegetables. We sell a variety of frozen vegetables, such as broccoli, peas and French fries. These products are produced by third parties that deliver them to us packaged. We purchase most of these products in the domestic market, but we import French fries and peas.
     
  • Pies and Pastries. We produce a variety of pies and pastries, such as chicken and heart-of-palm 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 sell margarine under Qualy, Deline and Claybom brands. We maintain our leadership with Qualy brand and in 2014 we introduced the first aerated margarine in Brazil. The aerated texture is a result of unique manufacturing process. We purchase the soybean oil from an agricultural cooperative supplier. We also entered into a strategic agreement with Unilever for the management of the margarine brands Becel and Becel ProActiv in Brazil.

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Mayonnaise

We began sales of mayonnaise in 2012 under the Dánica brand name as part of our strategy to diversify our product lines and to take advantage of our production capacity in Argentina.

Other

We produce animal feed mainly to feed poultry and hogs raised by us, although we also sell a small portion to our integrated outgrowers or to unaffiliated customers. In 2016, we produced 10,506 thousand tons of feed and premix, compared to 10,437 thousand tons in 2015. We also produce a limited range of soy-based products, including soy meal and refined soy flour.

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

Poultry

Brazil is the second largest producer and the leading exporter of poultry in the world for 2016, followed by the U.S., EU-27 and Thailand, based on estimates calculated by the United States Department of Agriculture, or the “USDA.” Brazil’s production, consumption and export volumes for poultry have increased significantly over the past several years. This development can be explained by the increase of Brazilian companies’ production dedicated to exports, as well as by the competitiveness of Brazilian poultry. Sanitary issues in the main producing countries, such as avian influenza cases in the United States in recent years, have changed the global poultry trade dynamics by reducing competition from major exporting countries, specially with China banning poultry meat from the USA (including breeders).

According to the USDA, global poultry trade increased 5.26% in 2016 (mainly due to Brazil which exported 7.0% more, gaining 1.66% of market share, as a result of a weaker domestic market leading to an increase in attractiveness of exports). According to the Brazilian Association of Animal Protein (ABPA – Associação Brasileira de Proteína Animal), exports of poultry parts increased 4.2%, representing 59.1% of the total poultry exported volumes. Whole chicken, which represents 31.3% of the total, decreased 2.2%. The main destinations were Saudi Arabia, China and the European Union (with China for the first time in the top three), which decreased total imports from Brazil by 5.4%, increased by 57.8% and decreased by 2.0%, respectively.

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

Primary Broiler Producers

2016

2015

2014

 

(in thousands of tons – “ready to cook” equivalent)

U.S. 

18,283

17,971

17,306

Brazil

13,605

13,146

12,692

China

12,700

13,400

13,000

European Union (28 countries)

11,070

10,810

10,450

India

4,200

3,900

3,725

Russia

3,750

3,600

3,260

Mexico

3,270

3,175

3,025

Argentina

2,100

2,080

2,050

Turkey

1,900

1,909

1,894

Thailand

1,780

1,700

1,570

Others

14,980

15,265

15,973

Total

89,548

88,694

86,555

 

Primary Broiler Exporters

2016

2015

2014

 

(in thousands of tons – “ready to cook” equivalent)

Brazil

4,110

3,841

3,558

U.S. 

2,978

2,867

3,310

European Union (28 countries)

1,250

1,177

1,133

Thailand

670

622

546

China

395

401

430

Others

1,390

1,346

1,500

Total

10,793

10,254

10,477

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Primary Broiler Consumers

2016

2015

2014

(in thousands of tons – “ready to cook” equivalent)

China

12,715

13,267

12,830

U.S. 

15,379

15,094

14,043

Brazil

9,497

9,309

9,137

European Union (28 countries)

10,570

10,361

10,029

India

4,194

3,892

3,716

Mexico

4,087

3,960

3,738

Russia

3,835

3,804

3,660

Japan

2,366

2,321

2,228

Argentina

1,955

1,894

1,773

South Africa

1,795

1,690

1,572

Others

21,245

21,364

22,219

Total

87,638

86,956

84,945

Source: USDA, February 2017.

Pork

Brazil is the fourth largest producer and exporter and fifth largest consumer of pork in the world, according to tonnage data compiled by the USDA. Brazil’s production and consumption of pork has increased since 2009.  The USDA expects a decrease in global production and consumption of pork in 2016 of 1.97% and 1.73%, respectively. According to ABIPECS, pork exports reached 724 thousand tons in 2016.  Brazilian pork breeding and slaughtering companies continue to increase their efficiency of production. Research developments have also helped to reduce fat, cholesterol and calories in pork produced in Brazil. These enhancements allow for better productivity of prime cuts, more meat per carcass and more nutritious and healthier meat. Improved genetic potential of breeders also contributed to the production increase.

According to the Brazilian Animal Protein Association (Associação Brasileira de Proteína Animal), or “ABPA,” until December 2016, Russia was Brazil’s major destination of pork followed by Hong Kong and China, representing 33.8%, 22.7% and 12.1%  respectively of total Brazilian pork exports. Russian, Hong Kong and Chinese imports from Brazil increased 0.60%, 32.7% and 1,581.9%, respectively, from January to December of 2016. China’s big increase in Brazilian imports, taking second place from Angola in terms of growth rate, made it more relevant.

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

 

World Pork Panorama

Main Pork Producers

2016

2015

2014

(in thousands of tons – weight in equivalent carcass)

China

51,850

54,870

56,710

European Union (28 countries)

23,350

23,290

22,540

U.S. 

11,307

11,121

10,368

Brazil

3,710

3,519

3,400

Russia

2,770

2,615

2,510

Vietnam

2,528

2,475

2,425

Others

12,695

12,486

12,613

Total

108,207

110,376

110,566

 

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Main Pork Exporters

2016

2015

2014

(in thousands of tons – weight in equivalent carcass)

U.S. 

2,356

2,272

2,309

European Union (28 countries)

3,300

2,389

2,164

Canada

1,350

1,239

1,280

Brazil

900

627

556

China

180

231

276

Chile

175

178

163

Others

277

288

214

Total

8,538

7,224

6,962

 

 

Main Pork Consumers

2016

2015

2014

(in thousands of tons – weight in equivalent carcass)

China

54,070

57,668

57,195

European Union (28 countries)

20,062

20,913

20,390

U.S. 

9,452

9,341

8,545

Russia

3,160

3,016

3,024

Brazil

2,811

2,893

2,845

Japan

2,590

2,568

2,543

Others

15,903

13,506

15,354

Total

108,001

109,905

109,896

Source: USDA, February 2017.

Beef

Brazil is the second largest producer and consumer of beef in the world and the first largest exporter (from third last year), according to tonnage data compiled by the USDA. From 2016 to 2017, the USDA estimates an increase in global beef production and consumption of approximately 0.77%, 0.97% and 3.39%, respectively and a decrease in exports of 1.03%

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

 

World Beef Panorama

Main Beef Producers

2016

2015

2014

 

(in thousands of tons – weight in equivalent carcass)

U.S. 

11,389

10,817

11,075

Brazil

9,284

9,425

9,723

European Union (28 countries)

7,850

7,691

7,443

China

6,900

6,700

6,890

India

4,250

4,100

4,100

Argentina

2,600

2,720

2,700

Australia

2,075

2,547

2,595

Mexico

1,880

1,850

1,827

Pakistan

1,750

1,710

1,675

Russia

1,340

1,355

1,375

Others

11,168

11,107

11,690

Total

60,486

60,022

61,093

 

 

World Beef Panorama

Main Beef Consumers

2016

2015

2014

(in thousands of tons – weight in equivalent carcass)

U.S. 

11,664

11,276

11,241

Brazil

7,499

7,781

7,896

European Union (28 countries)

7,890

7,751

7,514

China

7,673

7,399

7,277

Argentina

2,390

2,534

2,503

Russia

1,915

1,966

2,294

Others

19,697

19,457

20,299

Total

58,728

58,164

59,024

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World Beef Panorama

Main Beef Exporters

2016

2015

2014

(in thousands of tons – weight in equivalent carcass)

Brazil

1,850

1,705

1,850

India

1,850

1,806

2,082

Australia

1,385

1,854

1,851

U.S. 

1,120

1,028

1,167

New Zealand

580

639

579

Others

2,654

2,505

2,463

Total

9,439

9,537

9,992

 

Source: USDA, February 2017.

 

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 and pork 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, and Aviagen. We send these chicks 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.  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 1.76 billion day-old chicks, including chickens, Chester® roosters, turkeys, partridge and quail in 2016.  We hatch these eggs in our 31 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, the feed-to-meat conversion ratio and the quantity of meat produced 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 8,804 integrated poultry outgrowers. Many of these outgrowers also produce and sell corn that we use to produce animal feed.

At December 31, 2016, we had a fully automated slaughtering capacity of 35.7 million heads of poultry per week.

 

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Pork

We produce the majority of the pork we use in our products. We also purchase some pork on the spot market.

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 produced by our company or from producers such as Agroceres and DanBred or we 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 3,999 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, 2016, we had a pork slaughtering capacity of 197,188 heads per week.

Beef

We had a beef slaughtering capacity of 14,400 heads per week until October 1, 2014 when BRF and Minerva signed an Investment Agreement pursuant to which BRF allocated its beef slaughtering plants in Várzea Grande and Mirassol, as well as the BRF employees involved in these activities, to a closed capital company that was incorporated within Minerva, in return for an equity in Minerva. This deal closed on October 1, 2014.

BRF currently has a beef slaughtering capacity of 3,106 heads per week in a factory in Argentina.

Processed Foods

We sell a variety of processed foods, some of which contain poultry, pork and beef meat that we produce. BRF has a total production capacity of 197 thousand tons/month across 17 production units in Brazil (Chapecó, Marau, Capinzal, Toledo, Várzea Grande, Videira, Lucas do Rio Verde, Rio Verde, Uberlândia, Concórdia, Tatuí, Vitória de Santo Antão, Herval d’Oeste, Lajeado, Ponta Grossa, Paranaguá and Rio de Janeiro) processing meat products (such as mortadella, franks, sausage, hamburger and breaded) and non-meat products (such as lasagna, ready meals and pizzas) for both the domestic and international markets. In Tatuí, in the State of São Paulo, we produce ready-to-eat sandwiches, lasagnas, pizzas, cheese breads and other pasta and bakery items. In Ponta Grossa, in the State of Paraná, we produce pizzas, pastas, desserts (Miss Daisy) and other processed 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. 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.

BRF also has nine plants in Argentina for processing products such as hamburgers, franks, hams, vegetables and margarines. Their capacities are on average 15 thousand tons/month.  

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In November 2014, BRF inaugurated its first plant in Middle East, with a total capacity of 70 thousand tons/year, aiming to supply the local Market, Europe and Asia. This plant produces franks, breaded, hamburger, mortadella and marinated chicken breast.

We sell a variety of frozen vegetables, such as broccoli, cauliflower, peas, French beans, French fries and cassava fries. These products are produced for us by third parties that deliver them to us packaged. We purchase most of these products in the Brazilian market, but we import French fries from Belgium and peas from 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.

The raw material for margarine is crude soybean oil, which is subjected to refining and bleaching processes. We produce margarines in our plant in Paranaguá, State of Paraná, Uberlândia, State of Minas Gerais and Vitória de Santo Antão, under the Qualy, Deline and Claybon brands and in the State of Pernambuco under the brands Qualy and Deline. We sell these products as part of our strategy to diversify our product lines and to take advantage of our distribution network for refrigerated products.

We also sell halal food, which is the food allowed for Muslim consumption. The halal poultry needs to undergo through a specific religious/technical procedure of slaughter and processing, assuring that it was produced according to the Islamic law and that it had no contact with prohibited food or ingredient. Both BRF and OneFoods are assisted by Muslim entities that are responsible for slaughtering and certifying all our halal products.

 

Feed

We produce most of the feed consumed at the farms operated by our integrated poultry and hog outgrowers. 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 hog producers at market rates.

We own 31 feed production plants. The basic raw materials used in animal feed production are corn and soy meal mixed with preservatives and micronutrients.  In 2015 and 2016, we also purchased corn from rural producers and small merchants, through cooperatives and from trading companies such as Coamo, Bunge, Cargill, ADM and others. The corn is grown primarily in the states of Paraná, Santa Catarina, Rio Grande do Sul, Goiás, Mato Grosso, Mato Grosso do Sul and  Minas Gerais. We buy soy meal from major producers such as Bunge, Cargill, ADM, Dreyfus and Amaggi, primarily pursuant to long-term contracts. The prices of corn, soybeans and soy meal fluctuate significantly. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Principal Factors Affecting our Results of Operations—Commodity 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.

Suppliers

One of our strategies is to build more efficient relationships with our suppliers, using selection criteria to assess the suppliers in different dimensions, including the quality of the product, the product performance and reliability in terms of delivery.

In the third quarter of 2015, we started a process to enhance partnerships with some strategic suppliers through agreements that value partnership and innovation. This initiative was developed in 2016 and by now we have entered into almost 20 contracts.

The efficient evaluation in selecting suppliers is regarded as one of our critical responsibilities, aimed at maintaining a network of accomplished suppliers and meeting our growing challenges to ensure our market competitiveness. The assessment process often involves the simultaneous consideration of various important attributes of the supplier´s performance, including price, delivery time, quality and post-sales support, along with its social and environmental policies and performance.

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Our Code of Conduct, which is posted on our website and agreed in advance by our suppliers, governs and regulates our relationship and focuses on ethical behavior and social and environmental responsibility, as the supplier’s performance is one of the determining factors of our success.

Our process follows established guidelines, supported by systems, that lay down rules and instructions to be followed by all members of procurement team, such as the Approval Chain of Command and the Service Level Agreement (SLA).

Tracking and auditing are continually monitored through internal and external audits to ensure that our processes are constantly improving.

 

Brazilian Market

Brazil is the fifth largest country in the world, both in terms of land mass and population. In August 2016, Brazil had an estimated population of 206.08 million people, according to figures from the IBGE. Brazil’s GDP amounted to R$5.77 trillion in 2014, R$6.0 trillion in 2015 and R$6.26 trillion in 2016, in current value. GDP decreased in accumulated terms in 2016 by 3.59%

Inflation measured by the National Amplified Consumer Price Index (known as the IPCA - Índice Nacional de Preços ao Consumidor Amplo), published by the IBGE, came to 6.41% in 2014, 10.67% in 2015 and 6.29% in 2016, following a trend of relatively high rates. The end-of-period exchange rate, as measured by the Brazilian Central Bank, was R$2.65/US$1.00 in 2014, R$3.90/US$1.00 in 2015 and R$3.26/US$1.00 in 2016 with the real apreciating by 16% in 2016.

Brazil is also one of the largest meat consumers in the world, with per capita consumption in 2016 of 96.11 kilograms, including beef, chicken and pork products, according to the USDA. Demand for poultry and pork products in the domestic market is directly affected by the country’s economic conditions. The overall trend to a deterioration in economic conditions and the lower purchasing power of Brazilians in 2016 have supported the decrease in demand for processed products, as well as traditional fresh food and frozen poultry and pork products.

Brazil’s domestic market is highly competitive, particularly for fresh food and frozen poultry and pork products. There are many large producers, most notably BRF, but also Cooperativa Central Aurora Alimentos (“Aurora”) and Seara Alimentos S.A. (“Seara”) (which was acquired from Marfrig by JBS S.A. (“JBS”) in 2013). The main producers in the fresh food market face strong competition from a large number of small players which operate in the informal economy and sometimes offer low quality products at lower prices than those of the large producers. BRF endeavors to develop quality products, focusing on innovative solutions that meet clients’ needs and capture value for the strong brands it owns, such as Sadia and Perdigão.

The processed food sector is more concentrated than the fresh food sector in terms of the number of players. Consumption of processed products is influenced by a number of factors, including the rise in consumer income and marketing efforts directed at meeting consumer demand for more value-added products. We believe that processed foods also represent an opportunity for growth in the coming years.

We estimate the following market information:

  • the Brazilian industrialized food market had revenues of approximately R$13,757 million in 2016 compared with R$13,260 million in 2015;
     
  • the Brazilian frozen food market had revenues of approximately R$3,293 million in 2016 compared with R$3,385 million in 2015;

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  • the Brazilian margarine market had revenues of R$2,969 million in 2016 compared with R$2,729 million in 2015; and
     
  • the Brazilian frozen pizza with filling market had revenues of R$531 million until October 2016 compared with R$613 million in 2015.

These estimates are calculated by us based on data from A.C. Nielsen, which is reported to them by us and by some of our competitors.  These figures do not include BRF data by region or category of products that are not covered by the A.C. Nielsen figures.

International Markets

Brazil is a leading player in global export markets due to its natural advantages (land, water, climate), competitive inputs costs and increasing efficiencies in animal production. Like other large Brazilian producers, we have capitalized on these advantages to develop the scope and scale of our business.

Global demand for Brazilian poultry, pork and beef products is significantly affected by trade barriers, both (i) tariff barriers, with high rates that ultimately protect certain domestic markets (e.g., the extra-quota tariffs for chicken imports in the EU and the high import tax for poultry in South Africa), or (ii) non-tariff barriers, mainly import quotas, such as those imposed by Russia and Europe, sanitary barriers (sanitary requirements, disease-related bans, and regulations) which in the case of meat industry is the type of trade barrier that mostly affects exports, and technical/religious barriers (i.e. customs, technical standards, licensing requirements, and religious considerations).

With regard to sanitary requirements, most countries demand specific sanitary agreements so that Brazilian producers can export to them. Outbreaks of animal disease may also result in bans on imports, such as when many countries temporarily suspended the imports of bovine meat in 2013 after reports of a possible case of BSE in the State of Paraná in Brazil.

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, Africa, Mexico and the United States. Human cases were reported in various countries. For example, from 2014 to 2016 (December), there have been confirmed 207 human cases of avian influenza (H5N1) and 67 deaths, according to the WHO. Several countries have also reported cases of avian influenza in birds. During 2016, cases of various types of virus (H5 and H7) were reported in several countries, like China, Hong Kong, Japan, Korea and Europe. Avian influenza has not been detected in Brazil. Should this occur, global demand for poultry products would likely decline for a period whose length cannot be predicted.

In December 2015, the WTO established a panel requested by the Brazilian government in order to investigate technical and sanitary barriers imposed by Indonesia in the imports of poultry meat.

With regards to religious barriers, while the Middle East is an active region for Brazilian poultry exporters, it generally does not import pork meat and products because of a Muslim prohibition of its consumption.

In addition to trade barriers, the economic conditions of a particular market (national or international) may interfere in the demand for all kinds of poultry, swine and bovine meat, as well as for further processed products. 

Sales

We sell our products both in the domestic and export markets around the world. Net sales to the Brazilian market, including most of our processed foods, accounted for 43.9% of our net sales in 2016 and 47.4% in 2015. Net sales to international markets, including most of our frozen whole and cut chickens and other poultry and frozen pork cuts and beef cuts, accounted for 52.3% and 50.2% of our net sales in 2016 and 2015, respectively.  None of our customers (or groups of affiliated customers) accounted for more than 5% of our total net sales in 2016. 

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

 

 

2016

2015

2014

Brazilian Market

 

 

 

Poultry

7.1%

7.0%

7.0%

Pork/Beef

2.1%

2.3%

3.6%

Processed food products

34.4%

37.9%

39.2%

Other Sales

0.3%

0.2%

0.4%

Total Brazilian market

43.9%

47.4%

50.2%

 

International Markets

 

 

 

Poultry

32.1%

32.8%

29.5%

Pork/Beef

5.0%

5.2%

6.4%

Processed food products

14.4%

12.1%

10.8%

Other Sales

0.8%

0.1%

0.2%

Total International markets

52.3%

50.2%

46.9%

 

 

 

 

 

Other Segments

 

 

 

Poultry

0.0%

0.1%

-

Pork/Beef

1.3%

0.0%

-

Processed food products

0.0%

0.1%

-

Other Sales

2.5%

2.2%

2.9%

Total Other Segments

3.8%

2.4%

2.9%

Total

100%

100%

100%

 

Seasonality

See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources.”

Overall Comparison of the Company’s Net Sales for the Years Ended December 31, 2016 and 2015

Brazil

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, food services and other institutional buyers. The table below sets forth our Brazilian net sales to supermarkets, retail stores, wholesalers and food services buyers as a percentage of total domestic net sales for the periods indicated.

 

    

 

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Our domestic distribution network uses 20 distribution centers in several Brazilian states.  Refrigerated trucks transport our products from our processing plants to the distribution centers and from the distribution centers to our customers. We have 30 transit points, previously referred as 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 eight of our distribution centers and lease the remaining 12 centers, which are listed below under “—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.

International

We export our products to the Middle East, Africa, Asia, Europe and Latin America (LATAM). The graphs below set forth a breakdown of our export net sales by region. 

Competition

Brazil

Brazil’s domestic market is highly competitive, particularly for fresh food and frozen poultry and pork products. BRF endeavors to develop quality products, focusing on innovative solutions that meet clients’ needs and capture value for the strong brands it owns, such as Sadia and Perdigão.

The graph below shows the most recently available percentage of our market share in 2016 for the selected categories:

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Source: A.C. Nielsen Bimonthly Retail – Margarines and Ready Made Dishes (Oct/Nov survey); Filled and Chilled (Nov/Dec survey)

 

Because A.C. Nielsen gathers data from those in the industry who report to it voluntarily in the areas of the country and categories covered by it, the overall market sizes on which these percentages were based are smaller than our own internal estimates of the market sizes that we describe above under “—Brazilian Market.” 

JBS is our main competitor in the domestic market. In the processed meat segment, we compete against JBS. In the specialty meat market, we compete against Aurora and JBS, while the remainder of the market is represented by several small players. In the frozen product market (which includes hamburgers, steaks, breaded meat  meatballs and pasta), we are the leader in terms of market share, followed by JBS, Aurora and Pif Paf Alimentos S.A. (“Pif Paf”) and other smaller players. In the margarine market, we also maintained the majority of the market share, followed by Bunge Alimentos S.A, JBS (under the brand Doriana) , Unilever Brasil Alimentos Ltda. (“Unilever”) and Vigor Alimentos S.A., an affiliate of JBS S.A.

In the Brazilian market for whole poultry, 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 factor in our selling a majority of our whole chickens, 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. The market for processed food products is still growing in Brazil and we believe that the medium and long-term prospects for this segment are positive based on the trend over the preceding years. Simultaneously, BRF is focusing on initiatives aimed at innovation, such as launching new products with a focus on healthiness, a rationalization of our processed meat portfolio in the domestic market and an improvement in the positioning of the brands in our portfolio.

International

We face significant competition in our international markets, both from Brazilian producers and from producers in other countries. An increasingly relevant example are the cooperatives, which have tax advantages and certain mobility to reassign their production to foreign markets at times when exports become more attractive than the domestic market. Another example is JBS, one of our direct competitors in the international market that has many of the same competitive advantages that we have over producers in other countries, including natural resources and competitive inputs costs.

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Our chicken and pork cuts, in particular, are highly competitive in price and sensitive to substitution by other products. Customers sometimes seek to diversify their sources of supply in different countries, even though we have the lowest cost of production.

Protectionist measures among Brazil's trading partners are also an important competitive factor. Brazilian exports of poultry and swine are increasingly affected by actions taken by other countries to protect local producers.

Our net sales in the international market reached R$17.6 billion in 2016, an increase of 9.1% over 2015. We believe we export significantly more than our main Brazilian competitors, as BRF has approximately 32.4% and 70.2% of the export market share in poultry and turkey, respectively.

In our international markets, our competition is based on quality, cost, sale prices and service to our customers.

Distribution of Products

Brazilian Market 

As of December 31, 2016, we operated 20 distribution centers and 30 transit points. In 2016, we gained productivity based on new technologies in our Brazilian distribution and an improvement in the service level with reduction of lead time in deliveries.

International Markets

We export our products mainly through the ports of Itajai, Navegantes and Itapoá in the state of Santa Catarina. We also export our products through Rio Grande in the state of Rio Grande do Sul, Paranaguá in the state of Paraná and Santos in the state of São Paulo. We store our products in refrigerated storages that are owned and operated mainly by third parties located at ports in the states of Paraná, Santa Catarina and Rio Grande. We previously owned two refrigerated storages in Paranaguá, but they ceased their export operations in 2014. It is not efficient to export using our own structure due to the low volumes in comparison with the fixed costs of structure and employees. In 2016, we packed more than 66% of our export containers at plants, referred to as loading “fresh frozen products.” We contract with exclusive third-party carriers to transport our products from our production facilities to the ports, and we ship our products to export markets through independent shipping companies.

All the ports that we use to load our cargo are private terminals from third parties. In the past, we have occasionally experienced disruptions at the ports concerning logistics challenges, including flooding, strong currents, small drafts, strong winds/waves and winter fog. 

Our sales and distribution efforts abroad are coordinated through sales offices in the United Kingdom, France, Spain, Italy, Austria, Hungary, Netherlands, Russia, Singapore, South Korea, China, Japan, Saudi Arabia, the United Arab Emirates, Qatar, Oman, Kuwait, South Africa, Argentina, Uruguay, Chile, Turkey and Malaysia. We coordinate our marketing efforts and provide sales support to customers in our main international markets through these offices. Our distribution arrangements in our international markets vary according to the market.

 

Europe. In Europe, we have revamped our sales and distribution network by selecting and tightening partnerships with food processors, food service operators and local distributors. A joint-venture with Invicta Foods Limited (“Invicta Foods”), a regional leader in the food service segment, was successfully launched in April 2015, to strengthen our position in the food service market and enhance our global sourcing activity. The acquisition of the Universal Foods in June 2016 allowed us to consolidate our position in the food service channel in the frozen and chilled segments. We are distributing our products in practically all EU markets, including Switzerland, improving our delivery time within approximately two days of receiving an order. Our operations are geographically divided into three major markets. We are also expanding our B2C presence in a few focused markets. After the acquisition and now full integration of Plusfood in 2008, retail, food services and a few processing clients are buying goods mainly produced in our two European processing units, which allows us to offer items closer to local preferences developed in the most efficient and rapid form. In Russia and other regions of Eurasia, we sell primarily to selected distributors, which place our products to processors, food service operators and some retailers. Political developments have precluded almost all of our sales in Ukraine, historically the second most important market for our pork exports. On the other hand, we have refurbished our sales to other markets in Central Asia and reentered in the three markets in the Caucasus region.

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Asia. China, together with Hong Kong, is our largest market in Asia where we supply a significant volume and diverse portfolio including chicken wings and paws. In Japan, our local level of service, quality standards and product range have made us a preferred supplier of chicken products in the market. Singapore and Hong Kong, while smaller markets, represent reference markets in Asia for us to get closer to local consumers. Through the joint-venture SATS BRF Food in Singapore and an exclusive partnership in Hong Kong, we reach our customers with distribution and factories built to suit specific local needs and are growing our retail share of Sadia branded frozen meat. In Thailand, the integration process of BRF Thailand (from the acquisition of GFS in the end of 2015) is progressing well, providing a fully-integrated supply footprint in Asia and bringing to us a complementary set of capabilities in cooked items. In September 2016, we formed a business venture with FFM Berhad in Malaysia through the acquisition of a majority stake in its processing facility in Selangor. This in turn serves as a strategic entry point for BRF’s halal company OneFoods to extend its reach into halal markets in Asia.

 

Middle East. In Saudi Arabia and other countries of the Middle East, we sell to large distributors and small stores (traditional trade), some of which have been our customers for decades. In these markets, we primarily sell frozen chicken in three categories: whole, cuts and processed products. We believe we are one of the preferred suppliers of these products in this region due to our quality standards and our long-standing customer relationships. In fact, our biggest brand, Sadia is recognized as the #1 preferred food brand in the Middle East and enjoys the highest Top of Mind brand within the frozen meat category, according to a study made by Ipsos Research, a third-party consulting firm. In 2012, we took an important step in increasing our presence in the region: we acquired 49% of the capital stock of Federal Foods, a leading food company in the United Arab Emirates that caters to a full spectrum of retail, food service and wholesale clients and is responsible for the distribution of Sadia products in the region. This transaction was concluded in the beginning of 2013. Then, in 2014, we acquired the remaining economic rights owned by this company.  During the year of 2014 we also announced two other strategic acquisitions of distributors following our strategy to advance in the value chain in this region: (1) we acquired 40% of the capital stock of AKF a company leader in the distribution of frozen food in Oman, covering a broad sector of retail, food service and wholesale clients and (2) we acquired 75% of the of the retail frozen foods distribution business of Alyasra Food Company, a leader in food distribution in Kuwait. This transaction was concluded in 2015. We finished the construction of our processed food plant in Kizad, Abu Dhabi, an industrial area, which started operating in November 2014. By October 2015, the Kizad factory released all the planned products seven months ahead of schedule. In December 2015, we acquired the frozen business of QNIE to take full control of BRF operations in the Qatari market, and this transaction was concluded in 2016. These transactions consolidates our leadership position in the retail channel with over 42% market share in the GCC (Gulf Cooperation Council) across our brands. In the first weeks of 2017, we announced the beginning of OneFoods operations. We also entred into an agreement to acquire Banvit (the completion of this transaction is subject to the satisfaction of the conditions precedent set forth in the definitive documents, including anti-trust approvals).

Africa. 2016 was a year where a great deal of energy was placed on the repositioning of strategy and focus, with all efforts towards setting the stage for success in the short and long term. A focal point for the region was unlocking a number of in-market opportunities that fell under the attractive and affordable processed category, mostly driven by Food Processed Products (“FPP”) segments such as franks, bologna and margarine. The current trading model of BRF in Africa remains with direct sales to distributors with the widest possible distribution, all supported by a well-developed relationship. Underpinning this model are Sadia and Perdix, which continue to be the focus brands for the region. Going forward, careful consideration in identifying key selected future growth markets has been a point of focus, with the next phase of developments emphasizing more control of the interaction between the brand and the consumer. We intend to strengthen this control by uncovering consumer insights to strengthen its value proposition and possible distribution opportunities.

Americas and Other Countries. We sell our products to several countries in Latin America, including Paraguay, Uruguay and Chile, where we sell primarily to trading companies that resell the products to distributors. We also sell chicken cuts, including breasts and wings, to processing companies in Canada. In Argentina, where we have local production, we distribute the products directly to big retailers and supermarkets and through other distributors to the small retailers.

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Sadia is an established brand and holds important market shares in Chile, Uruguay and Paraguay where we maintain local offices. We reach supermarket channels through direct distribution and traditional channels through the strong partnerships with exclusive distributors. In addition to Sadia in Argentina, we have expanded on brands, such as Patty, Vienissima and Danica, which are leaders or vice leaders in all categories in which we compete.  Our brands are recognized as innovative, of high quality and pioneering. In 2016, we acquired the brands Calchaqui and Bocatti, both cold cut brands. Bocatti is a premium brand in Argentina and is well known for the quality of its products, and Campo Austral is a company with a strong agribusiness that will help us with its cost management. These are two important acquisitions that occurred in 2016, increasingly consolidating our position in the region.

Intellectual Property

Our principal intellectual property consists of our domestic and international brands. We sell our products mainly under the “Sadia,” “Qualy,” “Hot Pocket”,” “Perdigão”, “Nuggets”, “Chester” and other brands in the Brazilian market and mainly under the “Perdix,” “Perdigão”, “Sadia”, “Confidence”, “Fazenda,” “Paty”, “Qualy”, “Borella,” “Sahtein,” “Hilal,” “Danica”, “Sulina”, “Deline” and other brands in our international markets, as described below under “—Marketing.”. We plan to enter into certain agreements with OneFoods for its exclusive right to use the “Sadia” word and design marks and the “Perdix,” “Halal” and “Lequetreque” design marks in approximately 50 countries in Africa and Asia upon the payment of royalties, subject to certain quality standards and branding guidelines.

We also own several brands for specific products or product lines. In the Brazilian market, these brands include, but are not limited to, “Chester,”, “Claybom,” Hot Pocket”, “Salamitos” “Perdigão Ouro,” and “Nabrasa”. Among our trademarks are: “Halal” (in the Middle East, aside from Saudi Arabia), “Unef” (in the Middle East), “Sulina” and “Fazenda” (in Europe) and “Alnoor” (in several Middle Eastern countries). We plan to enter into an assignment agreement with OneFoods to assign the “Confidence,” “Halal” and “UNEF” brands worldwide to Onefoods. The “Sadia” trademark is registered in more than 90 countries. In the Middle East, Sadia is registered in countries such as Saudi Arabia, the United Arab Emirates, Egypt, Bahrain, Yemen, Iran, Iraq, Israel, Lebanon and Oman, as well as in the Caucasus, Asian countries and in Latin America. 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. In addition, a healthy pre-prepared line of poultry products under the trademark “Sadia,” signed by the celebrity chef Jamie Oliver, was launched in 2016. A licensing agreement executed with Jamie Oliver allows us to merchandise such products using his name.

Under our agreement with CADE in connection with the approval of our business combination with Sadia S.A. in 2011, we agreed to suspend the use of the trademarks “Perdigão” and “Batavo” with respect to several product lines in the Brazilian market for periods ranging from three to five years. The “Batavo” trademark was included on the sale of our dairy business Lactalis, a company controlled by Parmalat S.p.A., which closed on July 1, 2015. On July 3, 2015, the restriction on using the “Perdigão” trademark in relation to “ham and sausages” products was terminated. On July 3, 2016, the restriction on using “Perdigão” trademark in relation to “salamis” products was terminated. As a result, we are now authorized to use such trademark in these products. By July 3, 2017, the remaining restrictions that are still applicable to other lines of products will be terminated. The only restriction that will continue to apply to BRF is the prohibition to agree on exclusivity clauses with retailers, which will terminate by July 13, 2021. See “Item 4. Information on the Company-  A History and Development of the Company - Business Combination with Sadia.”

BRF maintains an active marketing program using both electronic and print media. In addition, we have patents registered in Brazil and more than 10 other countries. BRF has applied to have the Sadia, Perdigão and Qualy trademarks recognized as “well known trademarks” by the Brazilian National Institute for Industrial Property (Instituto Nacional de Propriedade Industrial – INPI), which already granted us that recognition for Sadia in June 2011. BRF has also applied for its new corporate trademark “BRF” (and accompanying design) to be registered in over 150 countries in North and South America, Europe, Asia, Africa and the Middle East.

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Lastly, we own several internet domain names in Brazil, registered with the competent authority, such as “perdigao.com.br,” “claybom.com.br”, “qualy.com.br”, “sadia.com.br,” ,” brf-foodservices.com.br” and “brf-global.com”.

 

Marketing

Our marketing efforts are based on (1) adding value to existing categories and diversifying our product lines; (2) increasing convenience on our in natura and processed products; (3) ensuring that our brands are recognized and associated with high quality products; and (4) strengthening our reputation for quality by emphasizing high quality service to our customers. Furthermore, we intend to consolidate our brands, while continuing to tailor our appeal to specific export markets and domestic market segments.

In the Brazilian market, we sell our products primarily under the Sadia, Perdigão and Qualy brands. Apart from these major brands, we also sell our products under Sadia master brands: Deline, Hot Pocket, Soltíssimo, Miss Daisy, Nuggets, Frango Fácil, Jamie Oliver and under Perdigão master brands: Chester, Ouro, Na Brasa, Meu Menu and Mini Chicken.

Chester® is a well-known brand for festive products and one of the most popular brands for premium poultry products in Brazil. In 2007, we acquired from Unilever a margarine brand called Claybom, along with other brands, and entered into a joint venture with Unilever to use the margarine brand Becel.

In our international markets, our main brands are Sadia and Perdix. We also operate under tactical brands as Confidence, Hilal, and Speedy Pollo. In Argentina, we sell our products primarily under Paty and Danica brands. The opening of the Abu Dhabi plant in Middle East and its current expansion establish an important milestone in our globalization.

Our recent acquisitions are expanding our brand portfolio internationally. In Argentina, we also have Vienissima, GoodMark, Delícia, Manty, Campo Austral, Bocatti and Calchaqui. In Malaysia, our  main brand is Marina. In addition, we shall soon incorporate more brands in Turkey.

 

Regulation

The Brazilian Ministry of Agriculture, Livestock and Food Supply (Ministério da Agricultura, Pecuária e Abastecimento, or “MAPA”) regulates our activities through the Department of Agriculture Defense (Secretaria de Defesa Agropecuária) and the Department of Inspection of Animal Products (Departamento de Inspeção de Produtos Animais), which is responsible for regulation and inspection activities related to health, technical (including labeling) and quality criteria related to the making of animal food products in all industrial units focused on national and international markets.

The inspection activity is performed by placing teams of the Federal Inspection Service (Serviço de Inspeção Federal, or “SIF”) of MAPA in the industrial units. Their scope of work includes all stages of the production process (including receipt of raw materials, production, labeling and storage) and they can appoint noncompliance with applicable rules, with penalties ranging from a warning to permanent suspension of business activities.

 

C.                  Organizational 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.

 

 

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Entities

 

Country

Main a activity

 

Interest in Equity as
of December 31, 2016

             

BRF GmbH

 

Austria

 

Holding

 

100.00%

Al-Wafi Food Products Factory LLC

 

United Arab Emirates

 

Industrialization and commercialization of products

 

49.00%

BRF Al Yasra Food K.S.C.C. ("BRF AFC")

 

Kuwait

 

Import, commercialization and distribution of products

 

75.00%

BRF Foods GmbH

 

Austria

 

Industralization, import and commercialization of products

 

100.00%

BRF Global GmbH

 

Austria

 

Holding and trading

 

100.00%

Qualy 5201 B.V.

 

The Netherlands

 

Import, commercialization of products and holding

 

100.00%

BRF Holland B.V.

 

The Netherlands

 

Import and commercialization of products

 

100.00%

BRF Invicta Ltd.

 

England

 

Import, commercialization and distribution of products

 

62.00%

Invicta Food Products Ltd.

 

England

 

Import and commercialization of products

 

100.00%

Invicta Food Group Ltd.

 

England

 

Import, commercialization and distribution of products

 

100.00%

Federal Foods LLC

 

United Arab Emirates

 

Import, commercialization and distribution of products

 

49.00%

Federal Foods Qatar

 

Qatar

 

Import, commercialization and distribution of products

 

49.00%

Golden Poultry Siam Limited

 

Thailand

 

Holding

 

48.16%

BRF Feed Thailand Limited

 

Thailand

 

Import, Industrialization, commercialization and distribution of products

 

100.00%

Golden Foods Siam Europe Limited

 

England

 

Import, commercialization and distribution of products

 

100.00%

Quickfood S.A.

 

Argentina

 

Industrialization and commercialization of products

 

91.21%

Sadia Alimentos S.A.

 

Argentina

 

Holding

 

43.10%

Avex S.A.

 

Argentina

 

Industrialization and commercialization of products

 

33.98%

 

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

   

For a complete list of all of our direct and indirect wholly-owned subsidiaries, see Note 1.1 to our consolidated financial statements.

 

D.                  Property, Plant and Equipment

Production

Our activities are organized into six regions: Brazil, Middle East and North Africa (MENA), Africa, Europe, Asia and Latin America (LATAM).

In Brazil, we operate 35 meat processing plants, three margarine processing plants, three pasta processing plants, one dessert processing plant and three soybean crushing plants, all of them near our raw material suppliers or the main consumer centers. We have an advanced logistic system in our domestic market, with 20 distribution centers (eight owned by us and 12 by third parties), which serve supermarkets, retail stores, wholesale stores, restaurants and other clients.

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In our international markets, we operate 12 meat processing plants in Argentina, Netherlands, United Kingdom, Thailand, the United Arab Emirates and Malaysia; one margarine and oil processing plant in Argentina; one sauce and mayonnaise processing plant in Argentina; and one frozen vegetables processing plant in Argentina. We have 27 distribution centers located overseas, as well as commercial offices in the United Kingdom, France, Spain, Italy, Austria, Hungary, Netherlands, Russia, Singapore, South Korea, China, Japan, Saudi Arabia, the United Arab Emirates, Qatar, Oman, Kuwait, South Africa, Argentina, Uruguay, Chile, Turkey and Malaysia.

 

The table below sets forth our production facilities in Brazil.

Production Plant

State of Location

Activities

Meat Products:

 

 

Bugio Agropecuária*

Santa Catarina

Pork slaughtering

Buriti Alegre**

Goiás

Poultry slaughtering

Campos Novos

Santa Catarina

Pork slaughtering

Capinzal

Santa Catarina

Poultry slaughtering and industrialized products processing

Carambeí**

Paraná

Poultry slaughtering

Chapecó

Santa Catarina

Poultry slaughtering (including turkey), industrialized products processing, animal feed and hatcheries

Concórdia

Santa Catarina

Pork and poultry slaughtering, industrialized products processing, animal feed and hatcheries

Dois Vizinhos**

Paraná

Poultry slaughtering, animal feed and hatcheries

Dourados

Mato Grosso do Sul

Poultry slaughtering, animal feed and hatcheries

Duque de Caxias

Rio de Janeiro

Industrialized products processing

Francisco Beltrão**

Paraná

Poultry (including Turkey) slaughtering

Garibaldi**

Rio Grande Sul

Poultry slaughtering

Herval D'Oeste

Santa Catarina

Pork slaughtering and industrialized products

Jataí**

Goiás

Poultry slaughtering

Lajeado

Rio Grande do Sul

Pork, poultry slaughtering and industrialized products

Lucas de Rio Verde

Mato Grosso

Pork and poultry slaughtering, industrialized products processing

Marau

Rio Grande Sul

Pork and poultry slaughtering, industrialized products, animal feed and hatcheries

Mineiros***

Goiás

Poultry and special poultry (turkey and Chester®) slaughtering and processing

Nova Marilândia*

Mato Grosso

Poultry slaughtering

Nova Mutum**

Mato Grosso

Poultry slaughtering

Paranaguá

Paraná

Industrialized products processing

Ponta Grossa

Paraná

Industrialized products processing

Rio Verde

Goiás

Pork and poultry slaughtering, industrialized products processing

Sagrinco*

Santa Catarina

Pork slaughtering

Serafina Corrêa

Rio Grande Sul

Poultry slaughtering

Tatuí

São Paulo

Industrialized products processing

Toledo

Paraná

Pork and poultry slaughtering, industrialized products processing

Uberlândia**

Minas Gerais

Poultry (including turkey) and pork slaughtering, industrialized products processing and hatcheries

Várzea Grande

Mato Grosso

Poultry slaughtering and industrialized products processing

Videira

Santa Catarina

Poultry slaughtering and industrialized products

Vitória de Santo Antão

Pernambuco

Industrialized products processing

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Production Plant

State of Location

Activities

Soybean and Margarine Products:

 

 

Paranaguá

Paraná

Margarine processing

Uberlândia

Minas Gerais

Margarine processing

Vitoria de Santo Antão

Pernambuco

Margarine processing

Dois Vizinhos**

Paraná

Soybean crushing

Videira

Santa Catarina

Soybean crushing

Toledo

Paraná

Soybean crushing

 

*      Production facilities owned and operated by third-party producers who produce according to our specifications.

**    Operates in accordance with the Halal requirements.

***  The activities of the Mineiros plant were suspended by the MAPA on March 17, 2017 in connection with the “Weak Flesh Operation.” The plant resumed operations on April 11, 2017. For more details, see “Item 8. Financial Information – B. Significant Changes – Weak Flesh Operation.”

 

Part of our real estate assets are subject to liens incurred to ensure our obligations to financing agreements, payment of taxes and lawsuits, as described in Note 18 to our consolidated financial statements.

Distribution Centers

We operate 20 distribution centers throughout Brazil, as set forth in the table below.

Location

State

Owned or Leased

Aparecida de Goiânia

Goiás

Leased

Belém

Pará

Leased

Cuiabá

Mato Grosso

Leased

Duque de Caxias

Rio de Janeiro

Leased


 

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Location

State

Owned or Leased

Embu

São Paulo

Leased

Exportação Ponta Grossa

Paraná

Owned

Fortaleza

Ceará

Owned

Itajaí

Santa Catarina

Leased

Jundiaí

São Paulo

Owned

Manaus

Amazonas

Leased

Marau

Rio Grande do Sul

Owned

Nova Santa Rita

Rio Grande do Sul

Leased

Ribeirão das Neves

Minas Gerais

Leased

Rio Verde

Goiás

Owned

Salvador

Bahia

Leased

São José dos Pinhais

Paraná

Leased

Uberlândia

Minas Gerais

Owned

Viana

Espírito Santo

Leased

Videira

Santa Catarina

Owned

Vitória de Santo Antão

Pernambuco

Owned

 

We operate 30 transit points in Brazil in the locations set forth in the table below.

Transit Points

State of Location

Owned or Leased

Apucarana

Paraná

Leased

Aracajú

Sergipe

Leased

Araçatuba

São Paulo

Leased

Bauru

São Paulo

Owned

Brasília

Distrito Federal

Leased

Campo Grande

Mato Grosso do Sul

Owned

Campo dos Goytacazes

Rio de Janeiro

Leased

Criciúma

Santa Catarina

Leased

Foz do Iguaçu

Paraná

Leased

Governador Valadares

Minas Gerais

Leased

Guarulhos

São Paulo

Owned

Itabuna

Bahia

Leased

Juazeiro do Norte

Ceará

Leased

Limeira

São Paulo

Leased

Macapá

Amapá

Leased

Maceió

Alagoas

Leased

Monte Claros

Minas Gerais

Leased

Parnamirim

Rio Grande do Norte

Leased

Paraíso do Tocantins

Tocantins

Leased

Pelotas

Rio Grande do Sul

Leased

Ponta Grossa

Paraná

Owned

Pouso Alegre

Minas Gerais

Leased

Ribeirão Preto

São Paulo

Leased

Santa Maria

Rio Grande do Sul

Leased

Santos

São Paulo

Leased

São José do Ribamar

Maranhão

Leased

São José dos Campos

São Paulo

Owned

Seabra

Bahia

Leased

Sorocaba

São Paulo

Leased

Teresina

Piauí

Leased

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Environment

Our activities are subject to strict environmental laws and regulations at municipal, state and federal levels, which regulate the aspects related to water, effluents, solid wastes, atmospheric emissions, noise and smells. Our operations are also subject to environmental licensing procedures at federal, state and/or municipal levels.

Failure to comply with the environmental laws and regulations can result in civil and criminal penalties against the offender, in addition to indemnification payments for environmental damages. Civil penalties may include summons, fines, temporary or permanent bans, the suspension of subsidies by public bodies and the temporary or permanent shutdown of commercial activities. Criminal penalties include fines and prison (for individual offenders) and liquidation (for legal entities). Fines for operating without a license vary from state to state in accordance with the environmental damages caused. Furthermore, under Brazil’s environmental legislation, the corporate entity of a company will be disregarded if necessary to guarantee the payment of costs related to environmental damages.

We have an Environmental Policy that is based on the guidelines and principles established in the ISO14001 certification. This policy seeks to ensure that our activities and growth are carried out in accordance with the environmental legislation. We have established a set of standards to be used in the company’s environmental management. The monitoring of implementation of these standards is undertaken through technical indicators, with targets that are established on an annual basis. Corrective actions are established to resolve deviations that have been found. An assessment is carried out to make sure that the environmental management system is being observed.

We have eight plants which have received ISO 14001 certification, of which seven are located in Brazil and one in the Netherlands. These plants were audited by regulatory bodies and undergo regular recertification.

Environmental management is part of our daily operations. Our internal controls are built to improve sustainability in our operations. We also take part in initiatives to preserve the environment and focus on developing alternative technologies for the generation and use of sustainable energy and have structured a program with our integrated producers to collect animal waste.

The partnership that we have with the integrated producers is one of the strategies we use to leverage global standards in our activities and those of our suppliers. We are responsible for the licensing projects of our integrated producers and for providing technical support and guidance to help them deal with environmental questions in the best possible way.

We have professional technicians in the environmental area and have trained them in the main environmental aspects. Our plants are built in line with the applicable environmental regulations. Our environmental structure is composed by experts, engineers and environmental analysts to assist the implementation and the monitoring of legal requirements and internal guidelines. We also have the support of the environmental legal department for legal assistance.

Despite our efforts to comply with the legislation and the environmental regulations, we have occasionally been required to sign environmental agreements with the Brazilian federal and local government related to the non-compliance with environmental licensing requirements. We are required, under these agreements, among other things, to repair any damages caused. If we do not comply with these obligations, we are subject to the payment of fines accrued on a daily basis.

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On April 10, 2007, we executed a TAC with the Environmental Resource Agency of the Bahia State, in order to recover degraded areas and enhance industrial water waste treatment, air emissions monitoring and waste management of the facility located in São Gonçalo. The TAC is waiting for completion procedures.

On December 14, 2007, we executed a consent agreement with the public prosecutors’ office of the State of Santa Catarina in order to promote recovery and compensation of the environmental damage caused by disposal of industrial waste without proper treatment in the Capinzal facility. The TAC is in progress.

On May 20, 2008, we executed a consent agreement with the State of Mato Grosso in order to settle environmental liabilities identified by the Environment Secretary of State aiming to make, adapt, correct, restore or minimize the effects of degradation in rural property of our facility located in Lucas do Rio Verde.  The process is waiting for completion formalities.

On June 4, 2008, we executed a consent agreement with the public prosecutors’ office of the State of Minas Gerais to regularize the death of fish and air pollution through the production and emission of gases coming from the company's activities causing smell in the facility located in Uberlândia. The process is waiting for completion formalities.

On October 16, 2008, we executed a consent agreement with the Environment Foundation (Fundação Ambiental) of the Santa Catarina State relating to a missing environmental license for fire prevention that affected our unit in Videira. It seeks the regularization of the industrial park and permits the reconstruction of the stricken area and construction of extension work through the establishment of compensatory measures.  The TAC is in progress.

On May 10, 2010, we executed a consent agreement with the Environment Secretary of the State of Mato Grosso, in order to regularize the change of water abstraction of the facility located in Mirassol D' Oeste.  The process is waiting for completion formalities.

On May 30, 2011, we executed a consent agreement with the Regional Superintendencies of Environmental Regulation (Superintendências Regionais de Regularização Ambiental, “SUPRAM”), Uberlândia, the State of Minas Gerais, for the settlement of legal reserves of rural properties.  The TAC is in progress.

On September 16, 2011, we executed a consent agreement with the Brazilian Institute for the Environment – IBAMA to plant in an area of 332.55 hectares and keep planted the equivalent to a volume of 79.813 meters, based on volumetric of Eucalyptus clonal forest with high-tech application in land good natural fertility, equivalent to the forest raw materials consumed by the company of our facility in Dourados. The TAC is in progress.

On December 7, 2011, we executed a consent agreement with the public prosecutors’ office of the Rio Grande do Sul State, whose objective is to fill the non-vegetated areas, providing adequate soil cover with native tree species and the consequent minimization of the effects of erosion on the slope protection and the banks of the stream in the facility located in Lajeado. The TAC is in progress.

On February 28, 2012, we signed a consent agreement with the Environmental Institute of Paraná (Instituto Ambiental do Paraná, or “IAP”), resulting from particulate emissions at the facility in Toledo in the State of Paraná. We committed to implementing improvements in plant equipment and have invested R$2.5 million.  The process is waiting for completion formalities.

On August 23, 2012, we executed a consent agreement with the Municipal Environment Agency of Itumbiara, in the State of Goiás, due to the need for pre-treatment of effluents directed tailing ponds of the facility located in Itumbiara.  The process is waiting for completion formalities.

On September 11, 2012, we executed a consent agreement with SUPRAM Triângulo Mineiro and Alto Parnaíba for the settlement of the legal reserve of the facility located in Uberlândia.  The TAC is in progress.

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On October 9, 2012, we executed a consent agreement with the Municipal Department of Environment and Urban Control of Fortaleza, in the Ceará State, related to the expansion project of the distribution center located in that city. The TAC is waiting for completion procedures.

On January 24, 2013, we executed a consent agreement with SUPRAM with respect to the facility located in Uberlândia, which did not have proper licenses.  The unit's operating license was issued in January 2014. We are now just waiting for the approval of the conclusion of the TAC process.

On April 5, 2013, we executed a consent agreement with the civil prosecutors’ office of Rio Casca in the State of Minas Gerais for the inactivation of an old station of treatment of industrial effluents and for the restoration of the station area.  The TAC is in progress.

On June 13, 2013, we executed a consent agreement with the federal public prosecutors’ office, aiming at complying with applicable rules with respect to the production and marketing of cattle obey.  The TAC is in progress.

On April 24, 2014, we executed a consent agreement with the public prosecutors’ office of the State of Goiás because of irregularities in the ground activity resulting from approximate 300 tons of solid material, which did not have proper treatment in the facility located in Rio Verde. The TAC is in progress.

On July 13, 2015, we executed a consent agreement with the SUPRAM Triângulo Mineiro and Alto Parnaíba because of irregularities in the irrigation system of the facility located in Uberlândia. The TAC is in progress.

On July 21, 2015, we executed a consent agreement with the public prosecutor office of the Mato Grosso do Sul State in order to renew the operation license of the facility located in Dourados. The process is waiting for completion formalities.

On September 18, 2015, we executed a consent agreement with the public prosecutor office of the Rio de Janeiro State in order to regularize the environmental license of the facility located in Duque de Caxias. The TAC is in progress.

On February 20, 2016, we executed a consent agreement with the public prosecutor office of the Santa Catariana State in order to compensate for the environmental damage caused by the disposal of industrial waste without proper treatment in the Xanxerê facility. The TAC is in progress.

On April 4, 2016, we executed a consent agreement with the public prosecutor office of the Goiás State in order to compensate for the environmental damage caused by the disposal of industrial waste without proper treatment in the Jataí facility. The TAC is in progress.

New investments that involve an increase in production or alteration in the process include the analysis of environmental controls and indicators. This procedure is part of the BRF environmental management system.

 

Insurance Coverage

We purchase insurance to cover all of our plants, equipment and inventories for losses, including business interruption insurance. In addition, we maintain a comprehensive products liability policy, which covers damages arising from the manufacture, distribution and sale of our products.  We consider the amounts of our insurance coverage to be typical for a company of our size and adequate to meet the foreseeable risks associated with our operations.

ITEM 4A.     UNRESOLVED STAFF COMMENTS

None.

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ITEM 5.            OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A.                  Operating Results

Overview

BRF S.A. is one of the largest producers of fresh and frozen protein foods in the world, with a portfolio of over five thousand SKUs. We are the holder of brands such as Sadia, Perdigão, Qualy, Chester, Perdix, Paty, Bocatti and Calchaqui, among others.

BRF was created from the merger of Perdigão and Sadia, whose consolidation was announced in 2009 and completed in 2012, and operates in the frozen meat (poultry and pork), processed meat foods, margarine, pasta, pizza and frozen vegetable markets. BRF is responsible for 16.3% of the world trade in poultry.

With 35 plants in Brazil, BRF has among its main assets a widespread distribution network that enables its products to reach Brazilian consumers through 551,050 monthly deliveries and 47 distribution centers, 20 of which are in the domestic market and 27 of which are in our export markets.

In Argentina, we were the leading producer, distributor and seller of hamburgers in 2016 with a market share of approximately 54.0%. In franks, our market share was 27.3% in 2016.

In the international market, BRF has a leading brand, Sadia, in various categories in Middle Eastern countries. We maintain 27 sales offices outside of Brazil serving customers of more than 150 countries on five continents. We have nine industrial units in Argentina, five in Thailand, two in Europe (BRF UK and BRF Holland), one in the United Arab Emirates (Abu Dhabi) and one in Malaysia.

BRF has been a public company since 1980. Our shares have been listed on the BM&FBovespa as BRFS3 since 2006, and we are also traded on the New York Stock Exchange (NYSE - ADR level III). Since 2005, BRF has been part of BM&FBovespa’s Corporate Sustainability Index (ISE) portfolio in acknowledgement of its strong commitment to sustainable development. This commitment has been reinforced and internationally recognized since 2012, upon our entrance into the portfolio of Emerging Markets of Dow Jones Sustainability Index.

A breakdown of our products is as follows:

·         Meat products:

  • frozen whole and cut chickens 
     
  • frozen pork cuts and beef cuts, which we refer to in this Form 20-F, together with frozen whole and cut chickens, as in natura meat

·         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, salami, bacon and other smoked products 
     
  • frozen processed meats, such as hamburgers, steaks, breaded meat products, kibes and meatballs

·         Other processed products:

  • frozen prepared entrees, such as lasagna and pizzas, as well as other frozen foods 
     
  • margarine

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  • mayonnaise, mustard and ketchup

·         Other:

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

In 2016, net sales totaled R$33.7 billion and net loss was R$0.4 billion. Net equity as of December 31, 2016 totaled R$12.2 billion.

In 2016, we generated 39.3% of our net sales from in natura poultry, 6.8% from in natura pork, 1.3% from in natura beef, 48.8% from processed meat and other processed products, and 3.6% from other products. Our Brazil sales accounted for 43.9% of our total net sales in 2016 while our sales to international markets and other segments accounted for 56.1%.

We are able to reach substantially all of the Brazilian population through a nationwide network of 20 distribution centers. 

In the Brazilian market, we operate 35 meat processing plants, three margarine processing plants, three pasta processing plants,one dessert processing plant and three soybean crushing plants, all of them near our raw material suppliers or the main consumer centers. We have an advanced logistic system in our domestic market, with 20 distribution centers, being eight owned by BRF and 12 leased by third parties, which serve supermarkets, retail stores, wholesale stores, restaurants and other clients.

In our international markets, we operate 12 meat processing plants in Argentina, Netherlands, United Kingdom, Thailand, the United Arab Emirates and Malaysia; one margarine and oil processing plant in Argentina; one sauce and mayonnaise processing plant in Argentina; and one frozen vegetables processing plant in Argentina. We have 27 distribution centers located overseas, as well as commercial offices in the United Kingdom, France, Spain, Italy, Austria, Hungary, Netherlands, Russia, Singapore, South Korea, China, Japan, Saudi Arabia, the United Arab Emirates, Qatar, Oman, Kuwait, South Africa, Argentina, Uruguay, Chile, Turkey and Malaysia.

 

On November 1, 2013 we entered into an agreement to allocate our cattle operations to Minerva in exchange for 29 million common shares, representing on the date of the conclusion of the transaction, a percentage equivalent to 16.8% of the total and voting capital stock of Minerva that will amount to approximately 15.2% when the entire conversion of mandatory convertible debentures issued by Minerva occurs in 2015. This transaction was concluded on October, 1, 2014.

In 2014, we entered into an agreement with Lactalis for the sale of the assets of our dairy segment, including plants and trademarks, which deal was closed in 2015. As a result, this segment is reported as discontinued operations, which requires the presentation of prior periods of this segment as discontinued operations. Unless stated otherwise, the results and cash flows that we present in this annual report do not consider the results and cash flows from this discontinued operation (dairy segment).

 

Principal Factors Affecting Our Results of Operations

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

  • Economic conditions in Brazil and globally; 
     
  • The effect of trade barriers and other restrictions on imports; 
     
  • Concerns over bird flu and other diseases of animal origin;

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  • Sensibility of the domestic market to changes in global demand, including the impact of decisions by our main Brazilian competitors and temporary increases in supply from producers in other countries;
     
  • Changes in commodity prices; 
     
  • Fluctuations in the exchange rate and inflation; 
     
  • Interest rates; and
     
  • Freight costs.
     
  • We present a more detailed description of each of these factors below.

Brazilian and Global Economic Conditions

Brazilian monetary policy framework is of inflation targeting. The National Monetary Council (Conselho Monetário Nacional - “CMN”) set the target inflation at 4.5% for 2016, with a range of two percentage points higher or lower. However, inflation rate has been consistently above the target at 6.41%, 10.67% and 6.29% in 2014, 2015 and 2016, respectively. Price increases reduce consumers’ purchasing power, particularly among the lower income class, which eventually limits consumption.

The Brazilian labor market registered an average unemployment rate of 11.5% in 2016, according to the IBGE’s National Household Sample Survey (Pesquisa Nacional por Amostra de Domicílios, or “PNAD”), showing deterioration from 8.5% a year before. Also, wages rose 6.4% in 2016 in nominal terms (compared to 8.7% in 2015), meaning a decrease in real terms of 2.3% (compared to a decrease of 0.3% in 2015). Additionally, after several years of rising consumption, Brazilian consumer confidence decreased to 73.3 points in December 2016, which is well below the average of the previous five years (105.7), according to a Consumer Survey of Fundação Getúlio Vargas (FGV).

 

Given a weak domestic demand and a strong monetary tightening cycle, inflation slowed down, pushed by the adjustment in both regulated and market prices, which declined from 18.07% and 8.51% to 4.72% and 4.78%, in 2015 and 2016, respectively. To control rising inflation and to curb inflation expectations, the Brazilian Central Bank’s monetary policy committee (Comitê de Política Monetária, or the “COPOM”) kept the base interest rate, known as “SELIC” (Sistema Especial de Liquidação e de Custódia), at 14.25% throughout almost all of 2016, only cutting the SELIC rate in October and December to 13.75%.

The Brazilian economy has been experiencing a slowdown – GDP growth rates were 1.9%, 3.0% and 0.5% in 2012, 2013 and 2014, respectively, but GDP decreased 3.8% and 3.6% in 2015 and 2016, respectively.

Regarding the currency, Brazilian Real appreciated 16.5% against the US dollar in 2016 going from R$3.90 to R$3.26 per dollar. This outlook of appreciation hindered the competitiveness of Brazilian exports by increasing costs in US dollars. In such a scenario, the financial revenues generated by exports decreased when converted into reais.

For a discussion on the global economic conditions and further information on the conditions on our export markets and the Brazilian market, see “D. Trend Information”.

 

Effects of Trade and Other Barriers

Global demand for Brazilian poultry and pork products is significantly affected by trade barriers, whether: (i) tariff barriers, or high rates that ultimately protect certain markets; and (ii) non-tariff barriers, mainly import quotas, sanitary barriers (which are the most common type of barriers faced by the meat industry) and technical/religious barriers. In addition, some countries employ subsidies for production and exports, which tend to distort international trade and interfere with our business.

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With regard to sanitary requirements, most countries demand specific sanitary agreements so that Brazilian producers can export to them. Moreover, zoonosis outbreaks may result in banishment to imports.

In addition to trade barriers, the economic conditions of a particular market (national or international) may interfere with the demand for all types of poultry, swine and bovine meat, as well as other processed products.

We continuously monitor trade barriers and other import restrictions in the global poultry, pork and beef markets, since these restrictions significantly affect the demand for our products and the levels of our exports. These restrictions often change, as illustrated by the following examples:

Tariff barriers (classical form and derived from trade defense disputes)

The EU (since 2007) and Russia (since 2012) have protected their meat industries by applying import quotas and high tariffs (occasionally prohibitive) on volumes imported outside of the quota.

In September 2013, South Africa raised duties on chicken products originating in all countries except the EU (due to a free trade agreement between them that establishes zero tariff on poultry products). Tariffs increased to 82% on whole chicken, 12% on boneless cuts and 37% on bone-in cuts.

In December 2016, Saudi Arabia has increased its import tariff for poultry meat from 5% to 20%.

Non-tariff barriers 

Import quotas

In 2005, Brazil obtained a favorable result in a panel against the EU at the WTO regarding the reclassification (and tariff increase) of salted chicken breast meat exports. In return, the EU introduced quotas on imports of certain tariff codes, especially for salted chicken breast, marinated turkey breast and processed chicken, and  in July 2007 Brazil was awarded the majority of these quotas.

Russia utilizes quotas to control the imports of pork, beef and poultry. As part of the negotiations surrounding its accession to the WTO, Russia has made some changes to its quota criteria as of 2013. Regarding chicken imports, Russia defined a quota of 250,000 tons of bone-in products, with no geographical breakdown. The intra-quota tariff is 25% and the extra-quota is 80%. There is also a quota of 70,000 tons of boneless cuts, of which 56,000 tons are reserved for the EU. As for swine, it was defined at a 400,000 tons quota with zero tariff on intra-quota volumes and 65% for volumes imported outside the quota. For bovine imports, Russia has established a quota of 530,000 tons for all WTO members, of which 60,000 belong to the EU and 3,000 to Costa Rica.

In December 2015, Mexico renewed its import poultry meat quota of 300 thousand tons until the end of 2017.

Sanitary barriers

Several major markets (despite progress in trade negotiations) are not yet open to Brazilian meat products due to sanitary barriers. Some examples are the EU, Korea and Colombia for swine meat, and Taiwan and Panama for poultry meat.

Outbreaks of avian flu have already harmed the consumption and exports of chicken meat in several countries, like the U.S., China/Hong Kong, Mexico and many European countries.

Technical barriers

In December 2015, the WTO established a panel requested by the Brazilian government in order to investigate technical barriers imposed by Indonesia in the imports of poultry meat.

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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 requirements in order to minimize their effect on our net export sales. In the long term, these restrictions affect the growth rate of our business.

Effect of Animal Diseases 

Avian Influenza (H5N1)

Demand for our products can be significantly affected by outbreaks of animal diseases like avian influenza.  For example, global demand for poultry products decreased in 2006 due to concerns over the spread of avian influenza. Although there have been no reported cases of this disease in Brazil, in 2006, the demand for our poultry products in our export markets was significantly lower, resulting in lower net sales of such products in our export markets in that period. Although net sales of poultry products in the domestic market increased in 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 and in 2007 and 2008, poultry exports, demand, production and global inventories gradually improved.

However, if significant numbers of new avian influenza cases were to develop in humans, even if they do not occur in any of our markets, the 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 2006, requiring the inspection of Brazilian states’ sanitary systems. In addition to the Brazilian government plan, we have implemented our own regional 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.

2016 was a year where dozens of countries reported outbreaks of avian influenza in different regions of the world. Even though Brazil is free from his disease, 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. Exports would be affected in the short-term if a case of high pathogenic avian influenza occurred in Brazil, as markets tend to restrict imports until the exporting country proves that the situation is under control. 

A(H1N1) Influenza 

In 2009, A(H1N1) influenza, spread to many countries. 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). On August 10, 2010, the WHO terminated the level six influenza pandemic alert and shifted its focus to a post-pandemic period. During this period, localized outbreaks of different magnitudes may show significant levels of A(H1N1) transmission. In China, for instance, at least 20 people died of A(H1N1) influenza in 2011.

According to the WHO, between September 2011 and January 2012, A(H1N1) influenza viruses circulated at very low levels in general, with some exceptions in Asia and the Americas. Regional A(H1N1) activity was reported by a few countries in Asia and Central America, and there were sporadic human cases reported by United States of America.

Any further outbreak of A(H1N1) influenza could lead to the imposition of costly preventive controls on pork imports in our export markets and could have a negative impact on the consumption of pork in those markets or in Brazil. In addition, any future significant outbreak of A(H1N1) influenza in Brazil could eventually 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. Accordingly, any spread of

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A(H1N1) influenza, or increasing concerns about this disease, may have a material and adverse effect on our company.

Other Animal Diseases

In addition, 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.  We do not raise hogs in Mato Grosso do Sul and Paraná. However, these bans have affected Brazilian exports into Russia generally and, at the time, 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.

A viral disease named as Pork and epidemic diarrhea (PED) was diagnosed in North America and Asia in the last few years. The principal clinical signs are enteric symptoms, stunting and high mortality. In these places the disease was responsible for significant reduction in terminated animals and consequent increasing price due to low offer. There isn’t yet a vaccine to prevent the disease but general management and biosecurity reduce the impact.

 

Effect of Export Market Demand on the Domestic Market

Demand fluctuations for poultry, pork and beef products in our export markets often have an effect on the supply and selling prices of those products in the Brazilian market. This is a result of a demand decrease in key export markets caused by the imposition of trade barriers, global economic factors, and concerns about animal disease outbreaks, among others. Brazilian exporters generally redirect the products for that market to the domestic market, increasing the supply of those products internally and often negatively impacting the selling price. This consequently affects our net sales in the domestic market.

For example, in 2014 Russia, banned pork and poultry imports from the United States, Canada and Europe causing a lack of supply of products in the Russian market (and consequently much higher prices), which led Brazilian players to redirect their products to Russia, causing lower supply and higher prices in Brazil. In 2015, some countries banned poultry imports from the United States, in response to the avian flu outbreak. Generally, countries have adopted a policy to ban only the specific region in which the outbreaks occurred. However, China and South Korea have been stricter, banning the country as a whole. In the last months of 2016, many cases of avian flu were reported across Europe and in some Asian countries, such as Japan and South Korea. Those cases did not have a huge impact in world trade due to the fact that importers banned specific regions of the European countries. In Korea, until December 2016, the country was forced to cull 22.5 million poultry, which is approximately 15% of the country’s poultry stock.

We monitor the actions of our domestic competitors since they are also impacted by external market changes and may also redirect their products to the domestic market. In addition, we pay close attention to fluctuations in supply generated by producers in the U.S., the EU and other regions since increases in production in those markets can lead to a greater supply in other countries.

 

Commodity Prices 

Many of our raw materials are commodities whose prices consistently fluctuate in response to market forces of supply and demand. We purchase large quantities of corn, soybean meal, vegetable oils and soybeans (grain), which we use to produce substantially all of 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 and are influenced by exchange rate fluctuations. Purchases of corn, soybean meal and soybeans represented approximately 29.4% of our cost of production in 2016 and 27.4% in 2015. Although we produce most of the hogs we use for our pork products, in 2016 we also purchased hogs on the spot market.

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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 with them. In 2016, the average corn price in Brazil was 60.2% higher than the average corn price in 2015.  Besides that, corn prices in December 2016 were 9.1% higher than in December 2015.  In 2016, the average soybean meal price in Brazil was 8.4% higher than the average price in 2015. In December 2016, soybean meal prices in Brazil were 11.0% lower than in December 2015. 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.

The following graph illustrates the movements in the price of corn in Ponta Grossa in the State of Paraná (a commonly used reference price for corn in Brazil) for the periods indicated, as reported by Safras & Mercados Ltda., a private Brazilian consulting firm.

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

Current Brazilian government estimates of the Brazilian corn harvest in 2016-2017 forecast 87.4 million tons in total production, according to a survey undertaken in February 2017 by the National Supply Company (Companhia Nacional de Abastecimento, or “CONAB”), an agency of the Brazilian Ministry of Agriculture, Husbandry and Supply. This estimate represents an increase of 31.4% from the 66.5 million tons harvested in 2015-2016. Of these 87.4 million tons, 28.8 million tons are forecast for the summer crop and 58.6 million tons for the second crop, to be harvested from July to September 2017.

The following graph illustrates the movements in the price of soybean meal in Ponta Grossa in the State of Paraná (a commonly used reference price for soybean meal in Brazil) for the periods indicated, as reported by Safras & Mercado Ltda.

Wholesale Soybean meal Prices at Ponta Grossa, State of Paraná (R$ per metric ton)

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 According to a survey released by CONAB in February 2017, current Brazilian government estimates of the Brazilian soybean harvest in 2016-2017 will be 105.6 million tons. This estimate represents an increase of 10.6% compared to the soybean harvest in 2015-2016.

The estimated total exports of soybeans crop in 2016-2017 is 59.5 million tons, which represents an increase of 9.4% from the 2015-2016 harvest of 54.4 million tons. Inventory volumes for the 2016-2017 harvest may increase compared to 2015-2016.  CONAB estimates Brazilian inventories of 1.8 million tons, while in the last season they reached 0.8 million tons.

In 2016, the soybeans average prices was 14.0% higher than the last year. The prices in December 2016 were 2.2% lower than the same period of 2015.

For further information about trends in commodity prices in 2017, see “—D. Trend Information––Raw 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 Index of Consumer Prices (Índice Nacional de Preços ao Consumidor, or “INPC”), IPCA and IGP-M.

 

2016

2015

2014

Depreciation of the real against the U.S. dollar

16.51%

(47.01%)

(13.39%)

Period-end exchange rate (U.S.$1.00)

R$3.26

R$3.90

R$2.66

Average (daily) exchange rate (U.S.$1.00) (1)

R$3.48

R$3.34

R$2.35

Period-end Basic interest rate SELIC (2)

13.75%

14.25%

11.65%

Inflation (INPC) (3)

6.58%

11.28%

6.23%

Inflation (IPCA) (4)

6.29%

10.67%

6.41%

Inflation (IGP-M) (5)

7.17%

10.54%

3.69%

 

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 11 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)   The 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, and the opposite occurs when the real depreciates against those currencies.

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$10,318.7 million at December 31, 2016, representing 54.4% 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 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 affected by movements in Brazilian and foreign interest rates. At December 31, 2016, 23.5% of our total liabilities with respect to indebtedness and derivative instruments of R$15,845.8 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 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.

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

 

Average Interest for the Year Ended December 31,

 

2016

2015

2014

(%)

(%)

(%)

TJLP

7.5

6.3

5.0

CDI

14.1

13.4

10.8

Six-month LIBOR

1.1

0.49

0.33

 

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 2016, freight costs represented approximately 4.3% of our net sales. In 2015 and 2014, freight costs represented approximately 4.9% and 5.5% 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.

Results of Operations                                                                       

The following discussion should be read in conjunction with our consolidated financial statements included elsewhere in this annual report. The following table sets forth the components of our results of operations as a percentage of net sales for 2016, 2015 and 2014.

 

Year Ended December 31,

 

2016

2015

2014

 

(%)

(%)

(%)

Continuing Operations

     

Net sales

100.0%

100.0%

100.0%

Cost of sales

77.7%

68.7%

70.7%

Gross profit

22.3%

31.3%

29.3%

Operating income (expenses):

 

 

 

Selling expenses

14.7%

14.9%

14.5%

General and administrative expenses

1.7%

1.6%

1.4%

Other operating (expenses), net

0.6%

1.4%

1.5%

Income (loss) from associates and joint ventures

0.1%

(0.3)%

0.1%

Operating income

5.2%

13.1%

11.8%

Financial expenses

(13.4)%

(15.6)%

(8.9)%

Financial income

7.0%

10.4%

5.4%

Income before taxes

(1.1)%

7.9%

8.4%

Current income tax

0.5%

0.1%

0.4%

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Year Ended December 31,

 

2016

2015

2014

 

(%)

(%)

(%)

Deferred income tax

(0.3)%

(1.3)%

0.8%

Income from Continuing Operations

(1.0)%

9.2%

9.6%

 

 

 

 

Income from Discontinued Operations

0.0%

0.6%

0.3%

Net profit

(1.0)%

9.8%

9.9%

Attributable to

 

 

 

Controlling shareholders

(1.0)%

9.7%

9.9%

Non-controlling shareholders

0.0%

0.1%

0.0%

 

Unless stated otherwise, the results that we present below do not consider the results from our discontinued operation (dairy segment).

Presentation of Net Sales Information

Since 2016, we have reported net sales in the following seven segments: Brazil; Europe; Middle East and North Africa (MENA); Africa; Asia; Latin America (LATAM) and Other Segments, which primarily reflect our geographical structure. We include in “Other Segments” all volumes of our non-core products, such as animal feed, flours, beef, amoung others, conducted by Global Desk. The financial information for prior years included in this annaul report has been adjusted to reflect our seven segments.

Within our seven segments, we disclose below a breakdown of net sales by the following products: (i) poultry (whole poultry and in natura cuts), (ii) pork (in natura cuts); (iii) processed (processed foods, frozen and processed products derived from poultry, pork and beef, margarine, vegetable and soybean-based products); and (iv) other sales (including animal feed, soy meal and refined soy flour). Because we use the same assets to produce products for all our segments, we do not identify assets by segment, except for intangible assets. See Note 5 to our consolidated financial statements for the year ended December 31, 2016 for a breakdown of net sales by segment and product line and for a breakdown of intangible assets by each reportable segment.

We report net sales after deducting taxes on gross sales and discounts and returns. Our total sales deductions can be broken down as follows:

  • ICMS Taxes — ICMS is a state value-added tax levied on our gross sales in the domestic market at rates that vary by state and product. Our average ICMS tax rate in 2016 was approximately 10.0%.
     
  • PIS and COFINS Taxes — The PIS and the COFINS taxes are federal social contribution taxes levied on gross sales in the domestic market and the rates are 1.65% for PIS and 7.60% for COFINS. However, there are some products with a zero tax rate (in natura meat of porks and poultry and beef cuts).
     
  • 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 export markets.

The table below sets forth our gross sales and deductions for the years ended December 31, 2016, 2015 and 2014:

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Year Ended December 31,

 

2016

 

2015

 

2014

 

(in millions of reais)

Gross sales

         

Brazil

18,621.2

 

19,011.7

 

17,808.1

Europe

4,066.2

 

3,853.3

 

3,307.5

MENA

6,877.2

 

6,886.2

 

5,065.2

Africa

778.8

 

756.9

 

844.0

Asia

4,824.3

 

3,432.4

 

3,109.7

LATAM

2,492.8

 

2,438.8

 

1,878.2

Other segments

1,401.9

 

855.3

 

933.9

 

39,062.4

 

37,234.6

 

32,946.6

 

         

Sales deduction

         

Brazil

(3,813.1)

 

(3,756.1)

 

(3,244.0)

Europe

(265.9)

 

(213.7)

 

(214.9)

MENA

(650.6)

 

(527.9)

 

(193.7)

Africa

(11.0)

 

(17.7)

 

(5.7)

Asia

(75.5)

 

(142.8)

 

(36.7)

LATAM

(408.5)

 

(306.4)

 

(171.2)

Other segments

(104.8)

 

(73.4)

 

(73.6)

 

(5,329.4)

 

(5,038.0)

 

(3,939.8)

 

 

 

 

 

 

Net profit

         

Brazil

14,808.1

 

15,255.5

 

14,564.1

Europe

3,800.4

 

3,639.6

 

3,092.6

MENA

6,226.5

 

6,358.3

 

4,871.5

Africa

767.8

 

739.2

 

838.3

Asia

4,748.8

 

3,289.6

 

3,072.9

LATAM

2,084.3

 

2,132.4

 

1,707.0

Other segments