F-1 1 d278992df1.htm F-1 F-1
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As filed with the Securities and Exchange Commission on February 6, 2017

No. 333-•

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Azul S.A.

(Exact name of Registrant as specified in its charter)

 

 

 

Federative Republic of Brazil

 

4512

  Not applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial
Classification Code Number)

  (I.R.S. Employer Identification No.)

Edifício Jatobá, 8th floor, Castelo Branco Office Park

Avenida Marcos Penteado de Ulhôa Rodrigues, 939

Tamboré, Barueri, São Paulo, SP 06460-040, Brazil.

+55 (11) 4831 2880

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

 

National Corporate Research, Ltd.

10 East 40th Street, 10th Floor

New York, NY 10016

(212) 947-7200

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies of all communications, including communications sent to agent for service, should be sent to:

 

Stuart K. Fleischmann, Esq.

Shearman & Sterling LLP

599 Lexington Avenue

New York, NY 10022

 

Filipe B. Areno, Esq.

J. Mathias von Bernuth, Esq.

Skadden, Arps, Slate, Meagher & Flom LLP

Av. Brigadeiro Faria Lima, 3311, 7th Floor

São Paulo, SP, 04538-133, Brazil

 

 

Approximate date of commencement of proposed sale of the securities to the public: As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box:  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

 

 

CALCULATION OF REGISTRATION FEE

 

Title of each class of securities to be registered

   Proposed Maximum
Aggregate Offering Price(1)
   Amount of
registration fee

Preferred shares including in the form of ADSs(2)(3)

   US$100,000,000    US$11,590

 

(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act. In accordance with Rule 457(p) under the Securities Act, an aggregate fee of US$13,640 was previously paid in connection with the Registration Statement No. 333-188871 on Form F-1 filed on May 24, 2013, determined at the then-applicable rate of $136.40 per $1,000,000 of the then-proposed maximum aggregate offering price of US$100,000,000. The full unused amount of this fee shall be applied to off-set any registration fees due from time to time for this registration statement. Any additional registration fees will be paid subsequently on a pay-as-you-go basis.
(2) Includes preferred shares in the form of ADSs, which the underwriters may purchase solely to cover options to purchase additional shares, if any, and preferred shares which are to be offered in an offering outside the United States but which may be resold from time to time in the United States in transactions requiring registration under the Securities Act.
(3) A separate Registration Statement on Form F-6 will be filed for the registration of ADSs issuable upon deposit of the preferred shares registered hereby. Each ADS represents one preferred share.

 

 

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the U.S. Securities and Exchange Commission is effective. This prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PRELIMINARY PROSPECTUS (Subject to completion, dated February 6, 2017)

Preferred shares including preferred shares

in the form of American depositary shares

 

LOGO

(incorporated in the Federative Republic of Brazil)

 

 

This is an initial public offering by us and the selling shareholders referred to in this prospectus, or the Selling Shareholders, of                     of our non-voting preferred shares, of which                      preferred shares will be offered by us and                      preferred shares will be offered by the Selling Shareholders. The preferred shares may be offered directly or in the form of American depositary shares, or ADSs, each of which represents one preferred share (which ratio may be changed, as described in “Description of American Depositary Shares”) and may be evidenced by an American depositary receipt, or ADR, or may be held in uncertificated form (as described in “Description of American Depositary Shares”). This prospectus relates to the offering by the international underwriters of preferred shares, including in the form of ADSs in the United States and elsewhere outside of Brazil. Concurrently, we and the Selling Shareholders are selling preferred shares in Brazil through the Brazilian underwriters by way of a Brazilian prospectus in Portuguese. We refer to the international offering in the United States and elsewhere outside Brazil and the concurrent offering in Brazil as the “global offering.” The closings of the international and Brazilian offerings are conditioned upon each other.

No public market currently exists for our preferred shares or ADSs. We anticipate that the initial public offering price will be between R$                     and R$                     per preferred share and between US$                 and US$                     per ADS, calculated at the exchange rate of R$                     per US$1.00 at                     , 2017. We have applied to list the ADSs on the New York Stock Exchange, or NYSE, under the symbol “•.” We have applied to list our preferred shares on the Level 2 (Nível 2) segment of the São Paulo Stock Exchange (BM&FBOVESPA S.A.—Bolsa de Valores Mercadorias e Futuros), or BM&FBOVESPA, under the symbol “AZUL4”.

 

 

Investing in our preferred shares, including in the form of ADSs, involves risks. See “Risk Factors” beginning on page 22 of this prospectus.

 

     Per Preferred
Share
   Per ADS    Total

Public offering price

   R$    US$    US$

Underwriting discounts and commissions(1)

   R$    US$    US$

Proceeds, before expenses, to us

   R$    US$    US$

 

(1) See “Underwriting” for a description of all compensation payable to the Underwriters.

 

 

The Selling Shareholders have granted the international underwriters and Brazilian underwriters an option to purchase for a period of 30 days beginning on the date hereof up to                     , 2017 additional preferred shares, including in the form of ADSs, at the initial public offering price less the underwriting discount to cover options to purchase additional shares. We will not receive any proceeds from the sale of preferred shares including in the form of ADSs, by the Selling Shareholders. See “Underwriters—Option.”

Neither the Securities and Exchange Commission, or the SEC, the Brazilian Securities Commission (Comissão de Valores Mobiliários), or the CVM, nor any state securities commission has approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Delivery of the ADSs will be made through the facilities of The Depository Trust Company, or DTC, on or about                     , 2017. Delivery of our preferred shares not sold in the form of ADSs will be made in Brazil through the book-entry facilities of BM&FBOVESPA on or about                     , 2017.

 

 

 

 

Global Coordinators

 

 
Citigroup   Deutsche Bank Securities   Itaú BBA

 

Banco do Brasil Securities LLC   Bradesco BBI   JPMorgan  

Raymond

James

  Santander

The date of this prospectus is                     , 2017

 


Table of Contents

 

LOGO


Table of Contents

 

LOGO


Table of Contents

TABLE OF CONTENTS

 

GLOSSARY OF AIRLINE AND OTHER TERMS

     iii   

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

     ix   

SUMMARY FINANCIAL AND OPERATING DATA

     11   

THE OFFERING

     16   

RISK FACTORS

     22   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     47   

USE OF PROCEEDS

     49   

EXCHANGE RATES

     50   

CAPITALIZATION

     51   

DILUTION

     52   

SELECTED CONSOLIDATED FINANCIAL INFORMATION

     54   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     59   

REGULATION

     96   

INDUSTRY

     108   

BUSINESS

     111   

MANAGEMENT

     142   

PRINCIPAL AND SELLING SHAREHOLDERS

     153   

RELATED PARTY TRANSACTIONS

     160   

DESCRIPTION OF CAPITAL STOCK

     164   

DESCRIPTION OF AMERICAN DEPOSITARY SHARES

     175   

MARKET INFORMATION

     188   

DIVIDEND POLICY

     192   

TAXATION

     195   

ERISA CONSIDERATIONS

     207   

UNDERWRITERS (CONFLICTS OF INTEREST)

     208   

EXPENSES OF THE GLOBAL OFFERING

     226   

VALIDITY OF SECURITIES

     227   

EXPERTS

     228   

WHERE YOU CAN FIND MORE INFORMATION

     229   

ENFORCEABILITY OF CIVIL LIABILITIES

     230   

INDEX TO FINANCIAL STATEMENTS

     F-1   

 

 

This prospectus has been prepared by us solely for use in connection with the proposed offering of preferred shares, including in the form of ADSs, in the United States and elsewhere outside Brazil. Citigroup Global Markets Inc., Deutsche Bank Securities Inc., Itau BBA USA Securities, Inc., Banco do Brasil Securities LLC, Bradesco Securities Inc., J.P. Morgan Securities LLC, Raymond James & Associates, Inc. and Santander Investment Securities Inc., will collectively act as international underwriters with respect to the offering of the ADSs and as agents, on behalf of the Brazilian underwriters, with respect to the offering of preferred shares sold outside of Brazil not in the form of ADSs.

 

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Neither we, the Selling Shareholders, the international underwriters or the Brazilian underwriters, nor any of their respective agents, have authorized anyone to provide any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we may have referred you. We, the Selling Shareholders, the international underwriters, the Brazilian underwriters and their respective agents take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. Neither we, the Selling Shareholders, the international underwriters or the Brazilian underwriters, nor their respective agents, are making an offer to sell the preferred shares, including in the form of ADSs, in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus (except as otherwise indicated), regardless of the time of delivery of this prospectus or any sale of the preferred shares, including in the form of ADSs. Our business, financial condition, results of operations, cash flows and prospects may have changed since the date on the front cover of this prospectus.

We are also offering preferred shares in Brazil by way of a Brazilian prospectus in Portuguese. The Brazilian prospectus, which will be filed with the CVM for approval, has the same date as this prospectus and contains substantially the same information but has a different format and is not considered part of this prospectus. The international offering is made in the United States and elsewhere outside Brazil solely on the basis of the information contained in this prospectus. Investors should take this into account when making investment decisions.

 

 

In this prospectus, references to “Azul,” the “Company,” “we,” “us” and “our” refer to Azul S.A., a sociedade por ações incorporated under the laws of Brazil, and its subsidiaries on a consolidated basis, unless the context requires otherwise. The term “Selling Shareholders” refers to Saleb II Founder 13 LLC, Star Sabia LLC, WP-New Air LLC, Azul HoldCo, LLC, ZDBR LLC, Bozano, Maracatu LLC, Morris Azul, LLC, Trip Investimentos Ltda., Trip Participações S.A. and Rio Novo Locações Ltda. For more information, see “Principal and Selling Shareholders.” The term “Brazilian underwriters” refers to Banco Itaú BBA S.A., Citigroup Global Markets Brasil, Corretora de Câmbio, Títulos e Valores Mobiliários S.A., Deutsche Bank S.A. – Banco Alemão, BB – Banco de Investimento S.A., Banco Bradesco BBI S.A., Banco J.P. Morgan S.A. and Banco Santander (Brasil) S.A., who will act collectively as Brazilian underwriters with respect to the sale of preferred shares in the public offering in Brazil. The term “international underwriters” refers to Citigroup Global Markets Inc., Deutsche Bank Securities Inc., Itau BBA USA Securities, Inc., Banco do Brasil Securities LLC, Bradesco Securities Inc., J.P. Morgan Securities LLC and Santander Investment Securities Inc., who will collectively act as underwriters with respect to the offering of the ADSs and as agents, on behalf of the Brazilian underwriters, with respect to the offering of preferred shares outside of Brazil not in the form of ADSs. Certain international underwriters will also act as placement agents for the Brazilian underwriters with respect to the placement of preferred shares outside Brazil, including in the United States.

The term “Brazil” refers to the Federative Republic of Brazil and the phrase “Brazilian government” refers to the federal government of Brazil. “Central Bank” refers to Banco Central do Brasil. References in the prospectus to “real,” “reais” or “R$” refer to the Brazilian real, the official currency of Brazil and references to “U.S. dollar,” “U.S. dollars” or “US$” refer to U.S. dollars, the official currency of the United States.

 

 

 

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GLOSSARY OF AIRLINE AND OTHER TERMS

The following is a glossary of industry and other defined terms used in this prospectus:

“ABEAR” means the Brazilian Association of Airline Companies (Associação Brasileira das Empresas Aéreas).

“ABRACORP” means the Brazilian Corporate Agencies Association (Associação Brasileira de Agências Corporativas).

“ADR” means American depositary receipts.

Aeroportos Brasil”, a private consortium that operates Viracopos airport jointly with INFRAERO.

The “Águia Branca Group”, or “Grupo Águia Branca”, is a Brazilian transportation and logistics conglomerate controlled by the Chieppe family.

“Airbus” means Airbus S.A.S.

“Airbus Group” means Airbus Group N.V.

“aircraft utilization” represents the average number of block hours operated per day per aircraft for our operating fleet, excluding spare aircraft and aircraft in maintenance.

“ANAC” refers to the Brazilian National Civil Aviation Agency (Agência Nacional de Aviação Civil).

“Atlantic Gateway” means Atlantic Gateway, SPGS, Lda., an entity jointly owned by our principal shareholder and another European investor.

“ATR” means aircraft with turboprop propulsion manufactured by Avions de Transport Régional G.I.E.

“audited consolidated financial statements” means our audited consolidated financial statements as of and for the years ended December 31, 2016, 2015 and 2014.

“available seat kilometers,” or “ASKs,” represents aircraft seating capacity multiplied by the number of kilometers the aircraft is flown.

“average fare” means total passenger revenue divided by passenger flight segments.

“stage length” means the average number of kilometers flown per flight segment.

“average ticket revenue per booked passenger” means total passenger revenue divided by booked passengers.

“block hours” means the number of hours during which the aircraft is in revenue service, measured from the time it closes the door at the departure of a revenue flight until the time it opens the door at the arrival on the gate at destination.

“Boeing” means The Boeing Company.

“booked passengers” means the total number of passengers booked on all passenger flight segments.

 

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“Bozano” means Cia. Bozano, a Brazilian holding company part of the Bozano financial conglomerate.

“BR Distribuidora” means Petrobras Distribuidora S.A., a subsidiary of Petrobras.

“Calfinco” means Calfinco, Inc., a wholly-owned subsidiary of United, which owns a 4.67% economic interest in us.

“CADE” refers to the Brazilian Administrative Council for Economic Defense (Conselho Administrativo de Defesa Econômica).

“CAPA” means the Centre for Aviation, a provider of independent aviation market intelligence, analysis and data services.

“Cape Town Convention” means the Convention on International Interests in Mobile Equipment and its protocol on Matters Specific to Aircraft Equipment, concluded in Cape Town on November 16, 2001.

“CASK” represents total operating cost divided by available seat kilometers.

“CBP” means United States Customs and Border Protection.

“Class A preferred shares” means (i) prior to •, 2017, • Class A shares of our preferred stock then issued and outstanding and (ii) after the conversion of (A) our • Class C preferred shares into • Class A preferred shares and (B) our • Class D preferred shares into • Class A preferred shares, and immediately prior to the renaming of our Class A preferred shares to “preferred shares” on •, 2017, • Class A shares of our preferred stock then existing and outstanding.

“Class B preferred shares” means the 2,400,388 Class B preferred shares issued by us on December 23, 2013 in connection with our Private Placement, of which 2,141,897 were repurchased and cancelled on August 30, 2016 and November 30, 2016, and the remainder were redeemed and cancelled under the mandatory redemption provisions of their subscription on December 23, 2016.

“Class C preferred shares” means the 5,421,896 Class C preferred shares issued by us on June 26, 2015 in connection with an investment agreement entered into with Calfinco and United on June 26, 2015. These Class C preferred shares were converted into • Class A preferred shares on •, 2017, and all Class A preferred shares were simultaneously renamed “preferred shares”. See “Principal and Selling Shareholders—United Investment Agreement.”

“Class D preferred shares” means, collectively, (i) the 3,517,936 Class D preferred shares issued by us on August 3, 2016 upon conversion of the Class E preferred shares, (ii) the 21,080,633 Class D preferred shares issued by us on August 3, 2016 to Hainan and (iii) the 7,022,381 Class D preferred shares issues by us on September 28, 2016 to Hainan. These Class D preferred shares were converted into • Class A preferred shares on •, 2017, following which all Class A preferred shares were simultaneously renamed “preferred shares”. See “Principal and Selling Shareholders—Hainan Investment Agreement.”

“Class E preferred shares” means the 3,517,936 Class E preferred shares issued by us on June 7, 2016, in connection with an investment agreement entered into with Hainan on February 5, 2016, as amended on June 6 2016. These Class E preferred shares were converted into Class D preferred shares on August 3, 2016. See “Principal and Selling Shareholders—Hainan Investment Agreement.”

“completion rate” means the percentage of completion of our scheduled flights that were operated by us, whether or not delayed (i.e., not cancelled).

 

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“crewmembers” is a term we use to refer to all our employees, including aircraft crew, airport ground, call center, maintenance and administrative personnel.

“DECEA” means the Brazilian Department of Airspace Control (Departamento de Controle do Espaço Aéreo).

“departure” means a revenue flight segment.

“DOT” means the United States Department of Transportation.

“economic interest” means a participation in the total equity value of our company, calculated as if (i) all common shares issued and outstanding had been converted into preferred shares at the conversion ratio of 75.0 common shares to 1.0 preferred share pursuant to the mechanisms set forth in our by-laws such that our common shares would correspond to a total of 6,193,100 preferred shares outstanding on a theoretical fully converted basis prior to the completion of this global offering, and (ii) all Class C preferred shares and Class D preferred shares had been converted into Class A preferred shares at the conversion ratio of 1.0 Class C preferred shares to 1.0 Class A preferred share and 1.0 Class D preferred shares to 1.0 Class A preferred share, respectively, for a total of 127,285,633 Class A preferred shares outstanding, which we expect to occur prior to the completion of this global offering.

“E-Jets” refer to narrow-body jets manufactured by Embraer S.A.

“Embraer” means Embraer S.A.

“FAA” means the United States Federal Aviation Administration.

“FAPESP” means the State of São Paulo Research Foundation (Fundação de Amparo à Pesquisa do Estado de São Paulo), an independent public foundation established to foster research and the scientific and technological development of the state of São Paulo.

“FGV” refers to the Getúlio Vargas Foundation (Fundação Getúlio Vargas), a Brazilian higher education institution that was founded in December 1944.

“Fidelity” means, collectively, Fidelity Mt. Vernon Street Trust: Fidelity Growth Company Fund and Fidelity Securities Fund: Fidelity Blue Chip Growth Fund.

“Fifth Amended and Restated Shareholders’ Agreement” means that certain shareholders’ agreement, dated August 3, 2016, entered into by and among holders of our common shares and preferred shares, which will be replaced by the Post-IPO Shareholders’ Agreement following the consummation of this offering.

“flight hours” means the number of hours during which the aircraft is in revenue service, measured from the time it takes off until the time it lands at the destination.

“focus-city” means a destination from which an airline operates several point-to-point routes. A focus-city may also function as a smaller scale hub.

“FTEs” means full-time equivalent employees.

“FTEs per aircraft” means the number of FTEs divided by the number of operating aircraft.

 

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“Global Distribution System” or “GDS” means a system that enables automated transactions between airlines and travel agencies. Travel agencies traditionally rely on GDS for services, products and rates in order to provide travel-related services to end consumers. GDS can link services, rates and bookings consolidating products and services across different travel sectors including airline reservations, hotel reservations and car rentals. GDS charges participant airlines a booking fee per passenger and segment sold, typically applying additional charges for ticketing, credit card authorizations, real time connectivity, information pages and other ancillary services.

“Gol” means Gol Linhas Aéreas Inteligentes S.A.

“gross billings” means the result of the sale of points to commercial partners and the cash portion of points plus money transactions. It is not an accounting measurement. This revenue may affect the current period or may be recognized as revenue in future periods, depending on the time of redemption on the part of program participants.

“Hainan” means Hainan Airlines Co., Ltd.

“high-yield” means high profitability.

“IATA” means the International Air Transport Association.

“IBGE” means the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística).

“ICAO” means the International Civil Aviation Organization.

“IFRS” means International Financial Reporting Standards, as issued by the International Accounting Standards Board.

“INFRAERO” means Empresa Brasileira de Infraestrutura Aeroportuária—INFRAERO, a Brazilian state-controlled corporation reporting to the Ministry of Transportation, Ports and Civil Aviation that is in charge of managing, operating and controlling federal airports, including control towers and airport safety operations.

“Innovata” means Innovata LLC, a provider of travel content management that maintains a flight schedule database in partnership with IATA.

“Investors” means Star Sabia LLC, WP-New Air LLC, Azul HoldCo, LLC, Maracatu LLC, ZDBR LLC, Kadon Empreendimentos S.A., Bozano Investments LLC, JJL Brazil LLC and Morris Azul, LLC.

“JetBlue” means JetBlue Airways Corporation.

“LATAM” means LATAM Airlines Group S.A. including all of its subsidiaries. LATAM was formed in 2012, through the acquisition of TAM S.A., or TAM Linhas Aéreas S.A., by Lan Airlines S.A.

“load factor” means the percentage of aircraft seats actually occupied on a flight (RPKs divided by ASKs).

“main competitors” refers to Gol and LATAM, our competitors in the Brazilian market that have a market share larger than ours and publicly disclose their results of operations from time to time. When used in the singular, the term “main competitor” refers to Gol, our only direct competitor for which stand-alone information is publicly available.

 

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“Multiplus” means Multiplus S.A., LATAM’s loyalty program.

“on-time performance” refers to the percentage of an airline’s scheduled flights that were operated and that arrived within 30 minutes of the scheduled time.

“operating fleet” means aircraft in service, spare aircraft and aircraft undergoing maintenance.

“passenger flight segments” means the total number of revenue passengers flown on all passenger flight segments.

“Petrobras” means Petróleo Brasileiro S.A., a mixed economy corporation in the oil and gas industry that is majority owned by the Brazilian government.

“pitch” means the distance between a point on one seat and the same point on the seat in front of it.

“Post-IPO Shareholders’ Agreement” means that certain shareholders’ agreement, to be executed upon the effectiveness of this offering, by and between us and our current shareholders. The Post-IPO Shareholders’ Agreement will replace the Fifth Amended and Restated Shareholders’ Agreement.

“PRASK” means passenger revenue divided by ASKs.

“PRASK premium” refers to the positive difference between an airline’s PRASK and its main competitor’s PRASK over a given time period.

“preferred shares” means (i) with respect to the period prior to •, 2017, our 90,242,787 Class A preferred shares, our 5,421,896 Class C preferred shares, and our • Class D preferred shares, and (ii) after •, 2017, our • preferred shares.

“principal shareholder” means David Neeleman.

“Private Placement” means the private placement offering of our Class B preferred shares under Section 4(a)(2) of the U.S. Securities Act of 1933, or the Securities Act, to Fidelity, Maracatu, LLC and Bozano on December 24, 2013 and that were later repurchased and redeemed in the second half of 2016.

“RASK” or “unit revenue” means operating revenue divided by ASKs.

“revenue passenger kilometers” or “RPKs” means one-fare paying passenger transported per kilometer. RPK is calculated by multiplying the number of revenue passengers by the number of kilometers flown.

“route” means a segment between a pair of cities.

“Smiles” means Smiles S.A., Gol’s loyalty program.

“stage length” means the average number of kilometers flown per flight.

“TAP” means TAP – Transportes Aéreos Portugueses, SGPS, S.A.

 

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“TAP bonds” means Tranche A 7.5% bonds due March 2026 issued by TAP and convertible into TAP special shares that, once issued, will represent certain capital and voting equity, and which are entitled to a right to receive certain dividends.

“TRIP” means the entity formerly known as TRIP Linhas Aéreas S.A.

“TRIP acquisition” means our 2012 acquisition of TRIP.

“trip cost” represents operating expenses divided by departures.

“TRIP’s former shareholders” means, collectively, the Caprioli family and the Águia Branca Group.

“TSA” means the United States Transportation Security Administration.

“Viracopos” means the main airport of Campinas, located approximately 100 km from the city of São Paulo.

“yield” represents the average amount one passenger pays to fly one kilometer.

 

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PRESENTATION OF FINANCIAL AND OTHER INFORMATION

Financial Statements

We maintain our books and records in reais. Our audited consolidated financial statements as of and for each of the years ended December 31, 2016, 2015 and 2014 are included in this prospectus. Our audited consolidated financial statements were prepared in accordance with the International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board, or IASB. We acquired TRIP, a former competitor airline, in 2012. Our results for 2016, 2015, 2014 and 2013 fully reflect the integration and consolidation of TRIP into our financial results.

The financial information presented in this prospectus should be read in conjunction with our audited consolidated financial statements and the related notes included elsewhere in this prospectus and the section of this prospectus entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

In this prospectus, we present (i) EBITDA, which is defined as net income (loss) minus interest income (comprised of interest on short-term investments), plus interest expense (comprised of interest on loans and interest on factoring credit card and travel agencies receivables), current and deferred income tax and social contributions, and depreciation and amortization; and (ii) Adjusted EBITDA, which is defined as EBITDA adjusted to exclude foreign currency exchange, net, derivative financial instruments, net, other financial expenses, other financial income, and result from related parties, net (as applicable) and (iii) Adjusted EBITDAR, which is defined as Adjusted EBITDA further adjusted to exclude expenses related to aircraft and other rent.

EBITDA and Adjusted EBITDA are not financial performance measures determined in accordance with IFRS and should not be considered in isolation or as alternatives to operating income or net income or loss, or as indications of operating performance, or as alternatives to operating cash flows, or as indicators of liquidity, or as the basis for the distribution of dividends. Accordingly, you are cautioned not to place undue reliance on this information. A non-IFRS performance measure is generally defined as one that purports to measure financial performance, financial position or cash flows, but excludes or includes amounts that would not so be adjusted for in the most comparable IFRS measure. EBITDA and Adjusted EBITDA are included as supplemental disclosures because we believe they are useful indicators of our operating performance. EBITDA is a well-recognized performance measurement in the airline industry that is frequently used by investors, securities analysts and other interested parties in comparing the operating performance of companies in our industry. We have also adjusted our EBITDA for foreign currency exchange variations relating to U.S. dollars denominated assets and liabilities as these are mostly non-cash or non-operating expenses that impact our financial result, our result from related party transactions, net, and derivative financial instruments, net.

We also present herein for limited purposes Adjusted EBITDAR solely as a valuation metric. This metric is included as supplemental disclosure because (i) we believe EBITDAR is traditionally used by aviation analysts and investors to determine the equity value of airlines and (ii) EBITDAR is one of the metrics used in our material debt financing instruments for financial reporting purposes. We believe EBITDAR is useful for equity valuation purposes because (i) its calculation isolates the effects of financing in general, as well as the accounting effects of capital spending and acquisitions (primarily aircraft) which may be acquired directly subject to acquisition debt (loans and finance leases) or by operating leases, each of which is presented differently for accounting purposes and (ii) using a multiple of EBITDAR to calculate enterprise value allows for an adjustment to the balance sheet to recognize estimated liabilities arising from off-balance sheet operating leases. However, Adjusted EBITDAR is not a financial measure in accordance with IFRS, and should not be viewed as a measure of overall performance or considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution because it excludes the cost of aircraft and other rent and is provided for the limited purposes contained herein. As for the use of EBITDAR in our material debt financing instruments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loans and Financings”.

 

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The performance measures EBITDA and Adjusted EBITDA and the valuation measure Adjusted EBITDAR have limitations as analytical tools. Some of these limitations are: (i) EBITDA, Adjusted EBITDA and Adjusted EBITDAR do not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (ii) EBITDA, Adjusted EBITDA and Adjusted EBITDAR do not reflect changes in, or cash requirements for, our working capital needs; (iii) EBITDA, Adjusted EBITDA and Adjusted EBITDAR do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debts; (iv) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future and EBITDA, Adjusted EBITDA and Adjusted EBITDAR do not reflect any cash requirements for such replacements; and (v) EBITDA, Adjusted EBITDA and Adjusted EBITDAR are susceptible to varying calculations and therefore may differ materially from similarly titled measures presented by other companies in our industry, limiting their usefulness as comparative measures. Because of these limitations EBITDA, Adjusted EBITDA and Adjusted EBITDAR should not be considered in isolation or as a substitute for financial measures calculated in accordance with IFRS. Other companies may calculate EBITDA, Adjusted EBITDA and Adjusted EBITDAR differently than us. For a calculation of EBITDA, Adjusted EBITDA and Adjusted EBITDAR and a reconciliation of each to net income (loss), see “Summary Financial and Operating Data” and “Selected Consolidated Financial Information”.

Effect of Rounding

Certain amounts and percentages included in this prospectus, including in the section of this prospectus entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” have been rounded for ease of presentation. Percentage figures included in this prospectus have not been calculated in all cases on the basis of the rounded figures but on the basis of the original amounts prior to rounding. For this reason, certain percentage amounts in this prospectus may vary from those obtained by performing the same calculations using the figures in our audited consolidated financial statements. Certain other amounts that appear in this prospectus may not sum due to rounding.

Market and Industry Data

This prospectus contains data related to economic conditions in the market in which we operate. The information contained in this prospectus concerning economic conditions is based on publicly available information from third-party sources that we believe to be reasonable. Data and statistics regarding the Brazilian civil aviation market are based on publicly available data published by ANAC, INFRAERO, ABRACORP, Ministry of Transportation, Ports and Civil Aviation and Aeroportos Brasil, among others. Data and statistics regarding international civil aviation markets are based on publicly available data published by ICAO or IATA. We also make statements in this prospectus about our competitive position and market share in, and the market size of, the Brazilian airline industry. We have made these statements on the basis of statistics and other information from third-party sources that we believe to be reasonable, such as Innovata, ANAC and Dados Comparativos Avançados (Advanced Comparative Data, a monthly report issued by ANAC that contains preliminary information on the number of ASKs and RPKs recorded in the Brazilian civil aviation market), and ABEAR. In addition, we include additional operating and financial information about Gol, LATAM, Smiles and Multiplus, which is derived from the information released publicly by them, including disclosure filed with or furnished to the SEC and other information made available on their respective websites. Although we have no reason to believe any of this information or these reports are inaccurate in any material respect and believe and act as if they are reliable, neither we, the Selling Shareholders, the international underwriters, the Brazilian underwriters, nor their respective agents have independently verified it. Governmental publications and other market sources, including those referred to above, generally state that their information was obtained from recognized and reliable sources, but the accuracy and completeness of that information is not guaranteed. Neither we, the Selling Shareholders, the international underwriters, the Brazilian underwriters, nor their respective agents can guarantee the accuracy of such information. In addition, the data that we compile internally and our estimates have not been verified by an independent source.

 

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Fleet Data

As of December 31, 2016, our total fleet consisted of 139 aircraft, 39 of which we owned or held under finance leases or debt financing and 100 under operating leases of up to 12 years. The future obligations under operating leases are not recorded as debt on our balance sheet. Unless otherwise indicated, any reference to the number of aircraft that we own or operate includes aircraft leased under operating leases. Our fleet in service as of December 31, 2016 consisted of 74 Embraer E-Jets, 39 ATR aircraft, five next-generation Airbus A320neos and five widebody Airbus A330s, totaling 123 aircraft. The 16 aircraft not included in our fleet in service consisted of 15 aircraft that have been subleased to third parties and one aircraft that was not in service.

Financial Information in U.S. Dollars

We have translated some of the real amounts included in this prospectus into U.S. dollars. You should not construe these translations as representations by us that the amounts actually represent these U.S. dollar amounts or could be converted into U.S. dollars at the rates indicated. Unless otherwise indicated, we have translated the real amounts for the year ended December 31, 2016 according to the commercial selling real/U.S. dollar exchange rate (equivalent to R$3.2591 to US$1.00), published by the Central Bank on its website, available on December 31, 2016.

 

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PROSPECTUS SUMMARY

This summary highlights selected information about us and this global offering. It does not contain all of the information that may be important to you. Before investing in our preferred shares, including in the form of ADSs, you should read this entire prospectus carefully for a more complete understanding of our business and this global offering, including our financial statements and the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Overview

We are the largest airline in Brazil in terms of departures and cities served, with 784 daily departures serving 101 destinations, creating an unparalleled network of 203 non-stop routes as of December 31, 2016. As the sole airline on 70% of our routes, we are the leading airline in 66 Brazilian cities in terms of departures and carried approximately 21 million passengers in 2016. We are a low cost carrier and have generated a PRASK premium of at least 35% relative to our main competitor since our first year of operations. We derive this PRASK premium from our network, optimized fleet, operating efficiencies and high quality product offering. Complementing our extensive domestic network, we fly to select international destinations, including Fort Lauderdale, Orlando, and Lisbon. We wholly own our loyalty program TudoAzul, a strategic revenue-generating asset, which had 7.0 million members as of December 31, 2016.

Azul was founded in 2008 by entrepreneur David Neeleman, founder of JetBlue, as his fourth successful airline venture, to capture the market opportunities created by the expansion of the Brazilian aviation market. David Neeleman is our controlling shareholder as well as Chairman and Chief Executive Officer. In addition, we have a diverse group of key strategic shareholders, such as United and Hainan (a subsidiary of the HNA Group, a Fortune Global 500 conglomerate and the largest private airline operator in China).

Brazil is geographically similar in size to the continental United States and is currently the fourth largest market for domestic airline passengers in the world. Since 2008, the number of domestic airline passengers carried in Brazil has increased by more than 90% to 96 million in 2015, according to ANAC. Brazil’s air travel market continues to be significantly underpenetrated and is expected to increase to 131 million domestic passengers by 2021, according to ABEAR.

We have the most extensive route network in Brazil, serving 96 domestic destinations, about twice as many as our main competitors Gol and LATAM, which served 52 and 44 destinations, respectively, as of December 31, 2016. We are the only provider of scheduled service to 34 of our domestic destinations and hold the leading position in seven out of the ten largest domestic airports in which we operate in terms of departures. Through our network, we connect travelers to destinations exclusively served by us from our three hubs, which cater to the São Paulo, Belo Horizonte and Recife markets, among the largest metropolitan areas in the country. Notably, we are the leading airline at Viracopos airport, one of the São Paulo area’s principal airports and the largest domestic hub in South America in terms of non-stop destinations served, with a 97% share of its 159 daily departures as of December 31, 2016.

We operate a young, fuel-efficient fleet that we believe is better tailored for the Brazilian market than those of our main competitors as it allows us to serve cities with different demographics, ranging from large capitals to smaller cities. Our operating fleet of 123 aircraft as of December 31, 2016, comprised of 74 Embraer E-Jets, 39 ATR aircraft, five next-generation Airbus A320neos, and five Airbus A330s. Our fleet has an average age of 4.8 years, which is significantly younger than that of our main competitors. In December 2016, we began operating fuel-efficient, next-generation Airbus A320neos on longer, high demand domestic segments. We believe that our diversified fleet is optimized to efficiently match capacity to demand. This enables us to offer superior connectivity as well as more convenient and frequent non-stop service to more airports than our main competitors, which exclusively operate larger aircraft.

 



 

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A key driver of our profitability is our management team’s extensive experience in implementing a disciplined, low cost operating model. Our optimized fleet yields lower trip costs than our main competitor. For the nine months ended September 30, 2016, our average trip cost was R$23,993, which was 29% lower than that of Gol. With the introduction of the next-generation Airbus A320neos to our fleet, we expect to maintain our market-leading low trip cost advantage. In addition, our FTEs per aircraft were the lowest in Brazil at 85 compared to 112 for Gol as of September 30, 2016. Over the past three years we had one of the best on-time performance records among Brazilian carriers, and were recognized as the “Most On-Time Low Cost Carrier in the World” and the “Third Most On-Time Airline in the World” in 2015 by OAG.

We have built a strong brand by offering what we believe is a superior travel experience, based on a culture of customer service provided by a highly-motivated and well-trained team of crewmembers. Our service features include passenger seat selection, leather seats, individual entertainment screens with free live television at every seat in all our jets, extensive legroom with a pitch of 30 inches or more, complimentary beverage and snack services, and free bus service to key airports we serve. As a result of our strong focus on customer service, according to surveys we have conducted, 90% of our customers would recommend or strongly recommend Azul to a friend or relative as of December 31, 2016. In 2016 we were named “Best Low Cost Carrier in South America” for the sixth consecutive year and “Best Staff in South America” by Skytrax.

We continue to invest in and expand our loyalty program, TudoAzul, which had 7.0 million members and 77 program partners as of December 31, 2016. TudoAzul has been the fastest growing loyalty program in terms of members in Brazil for the past three years compared to Smiles and Multiplus, the loyalty programs of Gol and LATAM, respectively, and was elected “Best Loyalty Program in Brazil” in 2016 by a survey of 25,000 readers of Melhores Destinos, the largest web portal of airline fare promotions and loyalty programs in Brazil. Given our network strength, the expected growth of passenger air travel, credit card penetration and usage and customer loyalty in Brazil, we believe that TudoAzul is a key strategic asset for us. Unlike our main competitors, we own 100% of our loyalty program and benefit from all of TudoAzul’s cash flows. Since mid-2015, we have managed TudoAzul through a dedicated team and we are constantly evaluating opportunities to unlock value from this strategic asset.

We generate a PRASK premium from our unparalleled network, optimized fleet, operating efficiencies and high quality product offering, which resulted in revenues of R$6.7 billion in 2016. In addition to our PRASK premium, we remain focused on our disciplined low cost operating model as evidenced by having the lowest number of FTEs per aircraft and trip cost advantage compared to our main competitor as of September 30, 2016.

In 2016, we recorded operating income of R$344.3 million, representing an operating margin of 5.2%, and a net loss of R$126.3 million. Despite the contraction of the Brazilian economy, which started in 2014 and deepened in 2015 into the first half of 2016, we began to see a recovery during the second half of 2016, and recorded operating income of R$166.0 million for the three months ended September 30, 2016 and operating income of R$170.0 million for the three months ended December 31, 2016, representing an operating margin of 9.6% and 9.3%, respectively.

As a measure of our equity valuation, our Adjusted EBITDAR margin reached 27.1% in 2016, which we believe is one of the highest among publicly traded airlines in Latin America over the past three years. Adjusted EBITDAR should not be considered as a measure of overall performance since it excludes aircraft rent, which is a normal, recurring cash operating expense. In addition, Adjusted EBITDAR should not be considered in isolation or as an alternative to net income. For a reconciliation of our Adjusted EBITDAR to net income (loss), see “Summary Financial and Operating Data”.

 



 

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Our Competitive Strengths

We believe the following business strengths allow us to compete successfully:

Largest network in Brazil

We have the largest network in Brazil in terms of departures and cities served, with 784 daily departures serving 101 destinations, creating an unparalleled network of 203 non-stop routes as of December 31, 2016. Our connectivity at large hubs allows us to consolidate traffic, serving larger and medium-sized markets as well as smaller cities that do not generate sufficient demand for point-to-point service. We have grown our network organically and through the acquisition of TRIP in 2012, at that time the largest regional carrier in Latin America in terms of destinations served. We believe that our extensive network coverage allows us to connect more passengers than our competitors, who serve significantly fewer destinations. As of December 31, 2016, we served 96 destinations in Brazil, compared to 52 for Gol and 44 for LATAM. In addition, we were the sole airline on 70% of our routes and 34 of the destinations we served, and the leading player in 66 cities as of December 31, 2016. By comparison, Gol and LATAM were leading carriers in only 13 and 4 cities, respectively, as of December 31, 2016. Furthermore, as of December 31, 2016, 22% and 16% of our domestic network overlapped with that of Gol’s and LATAM’s, respectively, while Gol’s and LATAM’s networks had an overlap of more than 80% between them.

Our optimized fleet enables us to efficiently serve our target markets

Our fleet strategy is based on optimizing the type of aircraft for the different markets we serve. Our diversified fleet of ATR, E-Jets and Airbus aircraft enables us to serve markets that we believe our main competitors, who only fly larger narrow-body aircraft, cannot serve profitably. We believe our current fleet of aircraft allows us to match capacity to demand, achieve high load factors, provide greater convenience and frequency, and serve low and medium density routes and markets in Brazil that are not served by our main competitors. According to ANAC, 67% of the flights in Brazil carried fewer than 120 passengers in 2015. Our domestic fleet consists of modern Embraer E-Jets which seat up to 118 passengers, fuel-efficient ATR aircraft which seat up to 70 passengers, and next-generation Airbus A320neos which seat up to 174 passengers, while all the narrow-body aircraft used by Gol and LATAM in Brazil have between 144 and 220 seats. As a result, the average trip cost for our fleet of R$23,993 as of September 30, 2016 was 29% lower than that of larger Boeing 737-800 jets flown by Gol. We also operate Airbus A330s to serve international markets.

Our fleet plan focuses on maintaining a trip cost advantage relative to our main competitors while also providing us with flexibility for growth into new markets both domestically and internationally. We expect to add up to 58 new next-generation Airbus A320neos between 2017 and 2023, and 33 next-generation E-Jets starting in 2020 to replace older generation aircraft and serve high-density markets. These new generation aircraft are more fuel-efficient than older generation aircraft. We expect that our fleet plan will allow us to maintain market-leading trip costs and to reduce our CASK, both in absolute terms and relative to our main competitors.

Industry-leading PRASK

We utilize a proprietary yield management system that is key to our strategy of optimizing yield through dynamic fare segmentation and demand stimulation. We target both business travelers, to whom we offer convenient flight options, and cost-conscious leisure travelers, to whom we offer low fares to stimulate air travel and to encourage advanced purchases. This segmentation model has enabled us to achieve a market-leading PRASK of 25.3 real cents in 2016. In addition, in 2016, our PRASK represented a •% premium compared to Gol. We believe our superior network and product offering allows us to attract high-yield and frequent business travelers. According to ABRACORP, we held a 29% share in terms of Brazilian business-focused travel agency revenue, compared to a 17% market share in terms of RPKs as of December 31, 2016. In 2016, our average business-focused travel agency ticket price was 21% higher than our main competitor and our total average fare was •% higher than our main competitor.

 



 

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As an illustration of our ability to stimulate demand, the following table highlights the increase in average customers per day on certain routes from November 2008, shortly before we started operations, to December 2016:

 

     Total Direct
Flights
     Azul      Average Daily
Enplanements
(One Way)
 

Viracopos—Rio de Janeiro

        

November 2008

     6                 564   

December 2016

     21         19         1,773   

Viracopos—Salvador

        

November 2008

                     155 (1) 

December 2016

     4         4         480   

Viracopos—Belo Horizonte

        

November 2008

     5                 503   

December 2016

     13         13         1,160   

Belo Horizonte—Goiânia

        

November 2008

     1                 82   

December 2016

     3         3         292   

Viracopos—Porto Alegre

        

November 2008

                     241 (1) 

December 2016

     9         9         875   

 

Source: ANAC and internal data.

(1) Itinerary available through connecting flight only.

The increase in flights from Viracopos airport, our main hub, illustrates the success of our demand-stimulation model. Across Brazil, our Viracopos hub offers superior connectivity for connecting passengers, with the most non-stop services in the country as of December 31, 2016. As a result of our focus on underserved markets, we have been able to establish a successful platform that has significantly increased demand at Viracopos airport over the last eight years. In November 2008, before we began operations, airlines serving Viracopos airport offered just nine daily departures to eight destinations. As of December 31, 2016, Viracopos airport offered 159 daily departures to 55 destinations, and we held a 97% share of those daily departures.

Most efficient cost structure in the Brazilian market

We have leveraged our management team’s experience by implementing a disciplined, low cost operating model to achieve our operational efficiencies. We believe we have achieved these operational efficiencies primarily through:

 

    Optimized aircraft for markets and routes served;

 

    Low sales, distribution and marketing costs through direct-to-consumer marketing (approximately 86% of our total advertising expenses in 2016), low distribution costs (approximately 87% of all sales were generated by online channels in 2016) and associated use of social networking tools;

 

    Lower costs due to single class cabin configuration for our domestic flights;

 

    Operation of a modern fleet with better fuel-efficiency and lower maintenance costs than previous generation aircraft;

 

    Innovative and beneficial financial arrangements for our aircraft, as a result of being one of the largest customers for Embraer and ATR aircraft;

 



 

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    Investment in check-in technology to increase operating efficiencies; and

 

    Creation of a company-wide business culture focused on driving down costs.

As a result, we have achieved lower trip costs than our main competitor. For the nine months ended September 30, 2016, our average trip cost was R$23,993, which was 29% lower than that of Gol. In addition, our FTEs per aircraft were the lowest in Brazil at 85 compared to 112 for Gol as of September 30, 2016.

We have a robust and scalable operating platform that features advanced technology such as ticketless reservations, an Oracle financial system and electronic check-in kiosks at our main destination airports. We believe that our scalable platform provides superior reliability and safety and will generate economies of scale as we continue to expand.

Strategic global partnerships

Over the last two years, we have established long-term strategic partnerships with United, Hainan and TAP. In 2015, United, acting through a subsidiary, acquired shares representing approximately a 5% economic interest in our company for US$100 million. Our alliance with United has enhanced the reach of our mutual networks and created additional connecting traffic, as both we and United began selling each other’s flights on our websites through a code-share agreement. This code-share agreement also provides customers flying on both airlines with a seamless reservations and ticketing process, including boarding pass and baggage check-in to their final destination, and we are evaluating possible additional cooperation with United.

In August 2016, Hainan became our single largest equity shareholder following a strategic investment of US$450 million in exchange for shares representing approximately a 24% economic interest in our company. We have recently transferred two aircraft orders for future deliveries of Airbus A350s to certain Hainan affiliates. Furthermore, with Hainan, we are exploring global networking opportunities, code-sharing and new routes as well as evaluating additional ways in which we can cooperate with Hainan to capitalize on the substantial passenger traffic between China and Brazil.

As part of the privatization process of TAP, a consortium of private investors (including our principal shareholder) acquired a stake in TAP, and we invested €90 million in exchange for TAP bonds convertible into up to a 41.25% economic interest in TAP. Such economic interest is equivalent to up to 6% of TAP’s voting rights and, if converted, would make us TAP’s largest shareholder in terms of economic interest. For information on the conversion mechanism of TAP bonds, see “Business—Strategic Partnerships, Alliances and Commercial Agreements—TAP.” As of December 31, 2016, TAP served more than 75 destinations, including 10 destinations in Brazil, and was the leading European carrier serving Brazil in terms of number of seats. In addition, in June 2016, we successfully launched a non-stop flight between our and TAP’s main hubs, Viracopos airport and Lisbon. We are constantly evaluating the various ways in which we can cooperate with TAP and in 2016 subleased 15 aircraft to TAP as part of our fleet optimization plan, see “Business—Fleet” and “Business—Strategic Partnerships, Alliances and Commercial Agreements—TAP.”

As a result of our existing code-share agreements with United and TAP, our customers have access to more than 130 additional destinations worldwide. In October 2016, Hainan announced flights between China and Lisbon and in 2017, we expect to conclude a code-share agreement with Hainan, expanding our connectivity between Brazil and China. In addition, we believe that our strategic partnerships with these airlines provide our TudoAzul members with a broad range of attractive redemption options.

 



 

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High-quality customer experience through product and service-focused culture

We believe we provide a high-quality, differentiated travel experience and have a strong culture focused on customer service. Our crewmembers are trained to be service-oriented, focusing on providing the customer with a travel experience that we believe is unique among Brazilian airlines. We provide extensive training for our crewmembers that emphasizes the importance of both safety and customer service. We strive to hold our employees accountable to maintain the quality of our crew and customer service.

Our service features include passenger seat selection, leather seats, individual entertainment screens with free live television at every seat in all our jets, extensive legroom with a pitch of 30 inches or more, complimentary beverage and snack service, free bus service to key airports we serve (including between the city of São Paulo and Viracopos airport) and a fleet younger than Gol and LATAM.

We focus on meeting our customers’ needs and had one of the best on-time performance records among Brazil’s largest carriers for the last three years, at 89% for 2016, 91% for 2015 and 90% for 2014, according to OAG. OAG has also recognized us as the low cost airline with best on-time performance in the world in 2015. In addition, our completion rate has been consistently high, totaling 99% in 2016, 2015 and 2014.

Well-recognized brand

We believe we have been successful in building a strong brand by using innovative marketing and advertising techniques with low expenditures that focus on social networking tools to generate word-of-mouth recognition of our high quality service. As a result of our strong focus on customer service, surveys that we have conducted indicate that, as of December 31, 2016, 90% of our customers would recommend or strongly recommend Azul to a friend or relative. The strength of our brand has been recognized in a number of awards:

 

    Named “Best Airline in Brazil” in 2016 by Melhores Destinos, the largest web portal of airline fare promotions and loyalty programs in Brazil;

 

    Named “Best Low Cost Carrier in South America” in 2016 for the sixth consecutive year by Skytrax, an aviation research organization;

 

    Named “Best Staff in South America” in 2016 by Skytrax;

 

    Named “Best Regional Leadership” in 2016 based on our success in the Brazilian market by Flight Airline Business, an air transport industry news and analysis provider, as part of their Airline Strategy Awards;

 

    Recognized as the “Third Most On-Time Airline in the World” by OAG in 2015;

 

    Recognized as the “Most On-Time Low Cost Carrier in the World” by OAG in 2015;

 

    Named “Best Low Cost Carrier in The World” in 2012 by CAPA, an independent aviation research organization;

 

    Named one of the “50 Most Innovative Companies in The World” and “Most Innovative Company in Brazil” in 2011 by Fast Company, a business magazine; and

 

    Named one of the “50 Hottest Brands In The World” in 2010 by Ad Age, a leading marketing news source.

In addition, as a result of our strong brand awareness and focus on customer service, our TudoAzul loyalty program had 7.0 million members as of December 31, 2016 and has been recognized with the following awards:

 

    Named “Best Loyalty Program in Brazil in 2016” by Melhores Destinos;

 



 

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    Named “The Loyalty Program with the Best Rates in Brazil in 2016” by Melhores Destinos; and

 

    Recognized as having “The Most Innovative Co-Branded Credit Card” at the 2015 Loyalty Awards Event presented by Flight Global, a renowned website recognized by the global aviation community as a reliable source of news, data and expertise relating to the aviation and aerospace industries.

Experienced management team

We believe we benefit from our highly knowledgeable and experienced management team. Our senior management, which has senior airline experience both in Brazil and in the United States, includes:

 

    Our Chairman and Chief Executive Officer David Neeleman, a dual Brazilian and U.S. citizen, who has founded four airlines in three different countries, including JetBlue Airways;

 

    The President of our only operating subsidiary – Azul Linhas Aéreas Brasileiras S.A., or Azul Linhas, Antonoaldo Neves, who was appointed on January 27, 2014. He previously served as a Partner at McKinsey & Company where he worked for over ten years, during which time he led our integration process with TRIP, and was appointed by BNDES and the Civil Aviation Authority Secretary as a board member of INFRAERO from 2011 to 2012;

 

    Azul Linhas’ Chief Operating Officer, Flávio Costa, who has been part of the Azul founding team since inception and has more than 40 years of experience in the airline industry, having served as Technical and Operations Director at Pluna S.A., and OceanAir and as Technical Director at Varig;

 

    Our Chief Financial Officer and Investor Relations Officer, John Peter Rodgerson, who previously served as Director of Planning and Financial Analysis at JetBlue Airways for five years. He was responsible for implementing our financial strategy and cost structure since our inception;

 

    Our Chief Revenue Officer, Abhi Shah, who has more than 14 years of experience in the aviation industry and has previously held executive positions at JetBlue Airways and Boeing. He was responsible for developing our yield management, network planning and revenue structure;

 

    The Head of our TudoAzul loyalty program, Alexandre Wagner Malfitani, who previously served as our Director of Finance and Treasurer. Before joining Azul, Mr. Malfitani held the position of Managing Director of Treasury at United, having also worked in the finance industry, including as a fund manager at Deutsche Bank and as a trader at Credit Agricole Indosuez; and

 

    Our Vice President of Clients, Sami Foguel, is responsible for customer service, Azul Cargo and Quality assurance. Prior to joining Azul in 2014, Mr. Foguel held several executive positions at HSBC, including Head of Products, Segments, Customer Relationship Management and Customer Experience. Before joining HSBC, Mr. Foguel worked at McKinsey & Company for ten years.

Most of our senior management team has worked together for over eight years and has been with us since our launch. All non-Brazilian individuals on the team are residents of São Paulo with permanent work visas. In addition to Mr. Neeleman, all of our principal officers are also shareholders in our company, and all are motivated by participation in our stock option and restricted stock plans, which we believe aligns shareholders’ and management’s interests. Our management team has focused on establishing a successful working environment and employee culture. We believe the experience and commitment of our senior management team have been a critical component in our growth, as well as in the continuing enhancement of our operating and financial performance.

Our Growth Strategies

Our goal is to grow profitably and increase shareholder value by offering frequent and affordable services to our customers. We intend to implement the following strategic initiatives to achieve this objective:

 



 

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Adding new destinations, larger aircraft and increasing flight frequencies

We intend to continue identifying, entering into and rapidly achieving leading market presence in new markets or underserved markets with high growth potential. We also intend to continue to grow by adding new destinations to our network, further connecting the cities that we already serve with new non-stop service, increasing frequency in existing markets, and using larger aircraft in markets that we have developed over the years. Finally, we intend to apply our disciplined approach of selecting new destinations that can be served by our ATR or Embraer aircraft, with a continued focus on Brazilian cities where we believe there is the greatest opportunity for profitable growth, and on select destinations in South America with perceived high growth potential. Our ATR aircraft give us a significant strategic advantage in the ability to enter new cities and access previously untapped demand, since these aircraft only have 70 seats and, therefore, require fewer passengers for the flight to become profitable.

We believe there are significant opportunities to connect the cities we currently serve with non-stop service where none existed before. We believe that our Embraer fleet is the ideal fleet type to connect such cities due to the combination of seat count and low trip costs. For example, Azul is the only airline flying non-stop between Porto Alegre and Cuiabá, two of our focus-cities where only we have the optimized aircraft for this service.

On existing routes that we believe present additional demand, we intend to increase the number of daily flights with our E-Jets to achieve or further increase schedule superiority over our competitors. For example, we increased our daily departures on the Viracopos—Rio de Janeiro route from six to 19 between March 2009 and December 2016, and our daily departures on the Viracopos—Belo Horizonte route from four to 13 between August 2009 and December 2016. By providing this additional convenience to our customers, we aim to continue stimulating demand for our products and services.

We have also begun to introduce next–generation Airbus A320neos, which have 56 more seats than our current E-Jets, for longer-haul leisure and peak hour focus-city to focus-city service. For the longer distance leisure domestic markets, we believe the next-generation Airbus A320neo gives us industry leading low seat costs to compete in these markets. For example, in December 2016, we introduced four daily next-generation Airbus A320neo flights between our main hub in Viracopos airport and our regional hub in Recife. This approximately three hour flight provides us with significantly lower seat costs than our current E-Jets and provides sufficient seat capacity to connect customers between both hubs. We believe that by applying this strategy we can increase revenues and generate economies of scale by leveraging the infrastructure and staff at our existing destinations.

We plan to focus our international growth on connecting our strong presence in Brazil via Viracopos airport, Belo Horizonte and Recife and our current international destinations Fort Lauderdale, Orlando and Lisbon. We believe we are especially suited to stimulate additional demand for travel to key long-haul international destinations, which can be served by our Airbus A330s, by taking advantage of our focused domestic route structure, both in terms of passengers and overall connectivity throughout Brazil. We currently offer direct flights to 55 destinations out of our main hub in Viracopos airport, and we continue to leverage our position as the largest airline in Viracopos airport by offering international flights as well as connecting passengers throughout Brazil. Additionally, our new code-share flight with TAP between Viracopos airport and Lisbon enables us to connect our main hub with TAP’s main hub in Lisbon, thus enhancing our passenger connectivity between Brazil and Europe.

 



 

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Continue to unlock value from our TudoAzul loyalty program

As a result of the growth of our network, we believe there is an opportunity to further unlock value from our TudoAzul loyalty program. With 7.0 million members as of December 31, 2016, TudoAzul has been the fastest growing loyalty program among the three largest programs in Brazil for the past three years. TudoAzul sells loyalty points to business partners as well as directly to program members. Our current business partners include financial institutions (including American Express, Itaú, Santander, Livelo (Banco do Brasil’s and Bradesco’s loyalty joint venture), Caixa, and HSBC), retailers (including Apple, Walmart and Fast Shop) and travel partners (including Hertz, Avis and Booking.com).

In September 2014, we also launched an Azul-branded credit card in partnership with Banco Itaucard S.A. In addition, in December 2015, we launched Clube TudoAzul, an innovative, subscription-based product through which members pay a fixed recurring amount per month in exchange for TudoAzul points, access to promotions and other benefits. We also offer members the ability to buy points to complete the amount required for a reward, or pay a fee to renew expired points or transfer points to a different member’s account. We believe that our international flights and strategic partnerships with international carriers, including United and TAP, provide our TudoAzul members with a broad range of attractive redemption options.

We offer last-seat availability to TudoAzul members and have significant flexibility to price redemptions in a way that is competitive with other loyalty programs, thus helping to maximize TudoAzul’s attractiveness. We actively manage the price of our redemptions, offering very competitive fares in points when seat availability is high and optimizing margin in peak, high-demand flights. We have also developed an exclusive, proprietary pricing system, which provides ample flexibility to price redemptions within a given flight. This allows us to sell seats using several combinations of points and money. It also allows us to customize pricing using a number of different factors, such as a member’s elite tier, membership in Clube TudoAzul, and age (allowing us to offer lower prices to infants and children). We are confident that this proprietary system offers more flexibility than those of our main competitors, therefore allowing us to create promotions, stimulate cross-sell of other TudoAzul products, and more accurately price redemptions so as to maximize profitability.

Direct sales of points to TudoAzul members via monthly subscriptions to Clube TudoAzul members, internet direct point sales and other means have been the fastest-growing revenue segment for TudoAzul, with a monthly growth rate from direct sales of approximately 25% since December 31, 2015. This source of revenue is extremely attractive as it diversifies our customer base, with direct sales representing a significant volume of over 10% of TudoAzul’s external gross billings (excluding points sold to the airline), as of December 31, 2016. These direct sales generate recurring revenues and we expect to grow this segment by enhancing our customer offerings and introducing new products to our members.

In an effort to maximize the value creation potential of TudoAzul, we have been managing the program through a dedicated team since mid-2015. On a standalone basis, TudoAzul’s gross billings totaled R$680.0 million in 2016. Given the number of exclusive destinations we operate, our network strength, and the expected growth of passenger air travel, credit card penetration and usage and member loyalty in Brazil, we believe that TudoAzul is a strategic business for us. We plan to continue investing in TudoAzul’s expansion and evaluating opportunities to unlock value for this strategic asset.

 



 

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Continue to establish and extend strategic partnerships

As of December 31, 2016, we had a code-share agreement with United and TAP, as well as 18 interline and code-share agreements with a number of other international airlines, allowing us to handle passengers traveling on itineraries that require multiple flights on multiple airlines. As part of our plans to expand globally, over the last two years, we have established strategic partnerships with United, Hainan and through our investment in certain convertible bonds, also in TAP. We view these and possible future relationships with other airlines as strategic ways of allowing us to expand our network with connectivity throughout the United States, Europe and Asia without having to commit the full resources on our own. We believe that our existing and future customer base are increasingly taking advantage of the ability to fly internationally, and we aim to be able to offer our Brazilian customers a seamless ability to do so, whether by purchasing tickets on partner airlines on our website or through connected and complimentary schedules facilitating onward travel outside of Brazil. In addition to facilitating a more global network for us through these partnerships, we are exploring a variety of cooperative arrangements, including additional interline agreements, code-sharing, access to partner airlines’ frequent flyer programs and possible cobranding. We also see opportunities to leverage these relationships to facilitate greater operating efficiencies by utilizing partner expertise in maintenance, cargo transport and even possible pilot and crew training and redeployment, as well as redeployment of redundant or unneeded aircraft. We have started to observe such opportunities not just in relation to Azul and TAP code-share flights from Brazil to Lisbon, but also with the connectivity with Hainan between TAP’s hub in Lisbon and China announced in October 2016, the transfer of two aircraft orders for future deliveries of Airbus A350s to certain Hainan affiliates, the sublease of 15 aircraft in our fleet to TAP, and other measures. We are exploring joint ventures and other arrangements with our partners to determine the most effective and beneficial ways to leverage these relationships for all parties.

We view our partnerships as critical to our global connectivity but also as a way to addressing macroeconomic pressures in Brazil. By working with our partners we believe we have and can continue to adapt to any local economic conditions and do so swiftly in areas involving our fleet, crews and operating expenses. We expect to continue evaluating strategic partnership opportunities, including investments and acquisitions, that allow us to improve our network, offer more attractive benefits to our TudoAzul members, enhance our brand and build loyalty and revenue.

Continue to increase ancillary and other revenue

We intend to continue growing our ancillary and other revenue, by both leveraging our existing products and introducing new ones. We intend to focus on deriving further value from our existing ancillary and other revenue streams, which represented R$43.4 per passenger as of December 31, 2016 and included revenue from cargo services, passenger-related fees, upgrades, sales of advertising space in our various customer-facing formats, commissions on travel insurance sales, and revenues from airport parking at Viracopos airport. Since the launch of our international routes and aircraft with multi-class cabins in December 2014, we have been able to increase our ancillary revenue per passenger from R$31.3 as of December 31, 2015 to R$43.4 as of December 31, 2016, mostly due to the sale of upgrades to our “Espaço Azul”, “Economy Xtra”, “SkySofa” and business class sections. As a result of the introduction of the next-generation Airbus A320neos to our fleet, we expect to have more seat availability for our TudoAzul loyalty program and our Azul Viagens travel package business as well as additional cargo capacity.

Corporate Information

We are incorporated as a Brazilian Corporation (sociedade por ações), with headquarters at Avenida Marcos Penteado de Ulhôa Rodrigues, 939, Tamboré, Edifício Jatobá, 8th floor, Castelo Branco Office Park, Barueri, São Paulo, SP 06460-040, Brazil. Our investor relations office can be reached at +55 (11) 4831-2880 and our website address is www.voeazul.com.br. Information provided on our website is not part of this prospectus and is not incorporated by reference herein.

 



 

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SUMMARY FINANCIAL AND OPERATING DATA

The following tables summarize our financial and operating data for each of the periods indicated. You should read this information in conjunction with our financial statements and related notes, and the information included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” elsewhere in this prospectus.

This summary financial data as of and for the years ended December 31, 2016, 2015 and 2014 has been derived from our audited consolidated financial statements included elsewhere in this prospectus, which have been prepared in accordance with IFRS.

Statements of Operations Data

 

     For the Years Ended December 31,  
     2016     2016     2015     2014  
     (US$)     (R$)     (R$)     (R$)  
     (in thousands, except amounts per share and%)  

Operating revenue

        

Passenger revenue

     1,775,585        5,786,809        5,575,344        5,129,613   

Other revenue

     270,959        883,082        682,522        673,440   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     2,046,544        6,669,891        6,257,866        5,803,053   

Operating expenses

        

Aircraft fuel

     (478,728     (1,560,223     (1,917,606     (1,955,036

Salaries, wages and benefits

     (335,022     (1,091,871     (1,042,119     (991,449

Aircraft and other rent

     (356,206     (1,160,912     (1,171,325     (689,055

Landing fees

     (135,833     (442,692     (382,610     (314,402

Traffic and customer servicing

     (100,423     (327,289     (307,926     (240,783

Sales and marketing

     (84,748     (276,203     (258,214     (239,359

Maintenance, materials and repairs

     (217,465     (708,739     (643,897     (353,339

Depreciation and amortization

     (92,418     (301,201     (217,983     (197,755

Other operating expenses, net

     (140,062     (456,475     (483,773     (420,949
  

 

 

   

 

 

   

 

 

   

 

 

 
     (1,940,905     (6,325,605     (6,425,453     (5,402,127
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     105,638        344,286        (167,587 )      400,926   

Financial result

        

Financial income

     15,669        51,067        43,178        41,518   

Financial expense

     (224,356     (731,200     (685,919     (460,049

Derivative financial instruments, net

     3,314        10,800        (82,792     4,245   

Foreign currency exchange, net

     55,128        179,668        (184,305     (74,104
     (150,245     (489,665     (909,838     (488,390

Result from related party transactions, net

     50,028        163,045                 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) before income tax and social contribution

     5,421        17,666        (1,077,425 )      (87,464

Income tax and social contribution

     2,679        8,731        (1,366     (4,368

Deferred income tax and social contribution

     (46,857  

 

(152,711

    3,886        26,792   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss for the year

     (38,757     (126,314 )      (1,074,905 )      (65,040
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss for the year per common share R$/US$(2)

     (0.00     (0.01     (0.14     (0.01

Basic and diluted loss for the year per preferred share R$/US$

     (0.34     (1.10     (10.84     (0.69

 



 

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     For the Years Ended December 31,  
     2016      2016      2015     2014  
     (US$)      (R$)      (R$)     (R$)  
     (in thousands, except amounts per share and%)  

Other financial data (unaudited):

          

EBITDA(3)

     238,972         778,833         (449,148     437,601   

Adjusted EBITDA(4)

     198,057         645,487         50,396        598,681   

Adjusted EBITDAR(5)

     554,263         1,806,399         1,221,721        1,287,736   

Adjusted EBITDAR Margin(6)

     27.1%         27.1%         19.5%        22.2%   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) Reflects the conversion ratio of 75.0 common shares to 1.0 preferred share.
(3) We calculate EBITDA as net income (loss) minus interest income (comprised of interest on short-term investments), plus interest expense (comprised of interest on loans and interest on factoring credit card and travel agencies receivables), current and deferred income tax and social contribution and depreciation and amortization. We believe EBITDA is a well recognized performance measurement in the airline industry that is frequently used by investors, securities analysts and other interested parties in comparing the operating performance of companies in our industry. EBITDA is not a measure of financial performance in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution. Other companies may calculate EBITDA differently than us. EBITDA serves an indicator of overall financial performance, which is not affected by changes in rates of income tax and social contribution or levels of depreciation and amortization. Consequently, we believe that EBITDA serves as an important tool to periodically compare our operating performance, as well as to support certain administrative decision. Because EBITDA does not include certain costs related to our business, such as interest expense, income taxes, depreciation, capital expenditures and other corresponding charges, which might significantly affect our net income, EBITDA has limitations which affect its use as an indicator of our profitability.
(4) Adjusted EBITDA is equal to EBITDA adjusted to exclude foreign currency exchange, net, derivative financial instruments, net, other financial income (expense), and result from related party transactions, net. Adjusted EBITDA is not a measure of financial performance in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution. Other companies may calculate Adjusted EBITDA differently than us. Adjusted EBITDA serves as an indicator of overall financial performance that we believe serves as an important tool to periodically compare our operating performance, as well as to support certain administrative decisions. Because Adjusted EBITDA does not include certain costs related to our business, it has limitations which affect its use as an indicator of our profitability.
(5) Adjusted EBITDAR is equal to Adjusted EBITDA adjusted to exclude the expenses related to aircraft and other rent expenses. Adjusted EBITDAR is presented as supplemental information, because (i) we believe EBITDAR is a valuation metric traditionally used by aviation analysts and investors to determine the equity value of airlines and (ii) EBITDAR is one of the measures used in our material debt financing instruments for financial reporting purposes. We believe EBITDAR is useful for equity valuation purposes because (i) its calculation isolates the effects of financing in general, as well as the accounting effects of capital spending and acquisitions (primarily aircraft) which may be acquired directly subject to acquisition debt (loans and finance leases) or by operating leases, each of which is presented differently for accounting purposes and (ii) using a multiple of EBITDAR to calculate enterprise value allows for an adjustment to the balance sheet to recognize estimated liabilities arising from off-balance sheet operating leases. However, Adjusted EBITDAR is not a financial measure in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution because it excludes the cost of aircraft and other rent and is provided for the limited purposes contained herein. Other companies may calculate Adjusted EBITDAR differently than us. Adjusted EBITDAR should not be viewed as a measure of overall performance since it excludes aircraft rent, which is a normal, recurring cash operating expense. Adjusted EBITDAR has significant limitations which affect its use as an indicator of our profitability. Accordingly, you are cautioned not to place undue reliance on this information. For more information on the limitations of Adjusted EBITDAR as an analytical tool, see “Presentation of Financial and Other Information—Financial Statements.” As for the use of EBITDAR in our material debt financing instruments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loans and Financings”.
(6) Represents Adjusted EBITDAR divided by total operating revenue.

 



 

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The following tables present the reconciliation of the non-IFRS performance measures EBITDA and Adjusted EBITDA and the valuation metric Adjusted EBITDAR to net income (loss) for the periods indicated below:

 

           For the Years Ended December 31,  
     2016     2016     2015     2014  
     (US$)(1)     (R$)     (R$)     (R$)  
           (in thousands, except Adjusted EBITDAR
margin)
 

Reconciliation:

        

Net loss for the year

     (38,757     (126,314     (1,074,905     (65,040

Plus (minus):

        

Interest expense(2)

     152,667        497,557        450,960        364,255   

Interest income(3)

     (11,534     (37,591     (40,666     (36,945

Income tax and social contribution

     (2,679     (8,731     1,366        4,368   

Deferred income tax and social contribution

     46,857        152,711        (3,886     (26,792

Depreciation and amortization

     92,418        301,201        217,983        197,755   
  

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA(4)

     238,972        778,833        (449,148 )      437,601   

Foreign currency exchange, net(5)

     (55,127     (179,668     184,305        74,104   

Derivative financial instruments, net(6)

     (3,314     (10,800     82,792        (4,245

Other financial expenses(7)

     71,689        233,643        234,959        95,794   

Other financial income

     (4,135     (13,476     (2,512     (4,573

Result from related party transactions, net

     (50,028     (163,045              
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA(4)(8)

     198,057        645,487        50,396        598,681   

Aircraft and other rent

     356,206        1,160,912        1,171,325        689,055   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDAR(9)

     554,263        1,806,399        1,221,721        1,287,736   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDAR Margin (%)(10)

     27.1%        27.1%        19.5%        22.2%   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) Interest expense is interest on loans, factoring credit card, and travel agencies receivables, which is a component of financial expense. See note 25 to our audited consolidated financial statements.
(3) Interest income is interest on short-term investments, which is a component of financial income. See note 25 to our audited consolidated financial statements.
(4) EBITDA and Adjusted EBITDA, as calculated by us, may not be comparable to EBITDA and Adjusted EBITDA as used by other companies which may calculate Adjusted EBITDA in a manner which differs from ours. EBITDA and Adjusted EBITDA are not measures of financial performance in accordance with IFRS. They do not represent cash flow for the corresponding periods, and should not be considered as alternatives to net income or loss or as measures of operating performance, cash flow or liquidity, nor should they be considered for the calculation of dividend distribution.

 



 

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(5) Represents the foreign exchange remeasurement on U.S. dollar and Euros denominated assets and liabilities.
(6) Represents currency forward contracts used to protect our U.S. dollar exposure.
(7) Other financial expenses are a component of our financial expense. See Note 25 to our audited consolidated financial statements.
(8) Adjustments exclude the effects of the following items: (i) the foreign currency exchange variation relating to foreign currency denominated assets and liabilities; (ii) gains or losses in connection with our derivative instruments used to protect us against variations of the U.S. dollar compared to the real; (iii) other financial expenses (does not include interest expenses), which is a component of financial expenses; (iv) other financial income (does not include interest income), which is a component of financial income; and (v) result from related parties, net (as applicable). We believe that such adjustments are useful to indicate our operating performance.
(9) Adjusted EBITDAR is equal to Adjusted EBITDA adjusted to exclude the expenses related to aircraft and other rent expenses. Adjusted EBITDAR is presented as supplemental information, because (i) we believe EBITDAR is a valuation metric traditionally used by aviation analysts and investors to determine the equity value of airlines and (ii) EBITDAR is one of the measures used in our material debt financing instruments for financial reporting purposes. We believe EBITDAR is useful for equity valuation purposes because (i) its calculation isolates the effects of financing in general, as well as the accounting effects of capital spending and acquisitions (primarily aircraft) which may be acquired directly subject to acquisition debt (loans and finance leases) or by operating leases, each of which is presented differently for accounting purposes and (ii) using a multiple of EBITDAR to calculate enterprise value allows for an adjustment to the balance sheet to recognize estimated liabilities arising from off-balance sheet operating leases. However, Adjusted EBITDAR is not a financial measure in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution because it excludes the cost of aircraft and other rent and is provided for the limited purposes contained herein. Other companies may calculate Adjusted EBITDAR differently than us. Adjusted EBITDAR should not be viewed as a measure of overall performance since it excludes aircraft rent, which is a normal, recurring cash operating expense. Adjusted EBITDAR has significant limitations which affect its use as an indicator of our profitability. Accordingly, you are cautioned not to place undue reliance on this information. For more information on the limitations of Adjusted EBITDAR as an analytical tool, see “Presentation of Financial and Other Information—Financial Statements.” As for the use of EBITDAR in our material debt financing instruments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loans and Financings”.
(10) Represents Adjusted EBITDAR divided by total operating revenue.

Balance Sheet Data

The following table presents key line items from our historical balance sheet data:

 

     As of December 31,  
     2016      2016      2015     2014  
     (US$)(1)      (R$)      (R$)     (R$)  
     (in thousands)  

Cash and cash equivalents

     168,502         549,164         636,505        388,959   

Total assets

     2,577,524         8,400,409         7,839,164        6,239,199   

Loans and financing(2)

     1,237,917         4,034,495         4,810,945        3,259,184   

Equity

     307,443         1,001,987         (392,169     416,495   

Total liabilities and equity

     2,577,524         8,400,409         7,839,164        6,239,199   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) Includes current and non-current loans and financing.

 



 

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Operating Data

 

     As of and For the Years Ended December 31,  
     Unaudited  
     2016(1)     2016      2015      2014  

Operating Statistics (unaudited):

          

Operating aircraft at end of period

     123        123         144         138   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total aircraft at end of period

     124        124         152         153   

Cities served at end of period

     101        101         100         105   

Average daily aircraft utilization (hours)

     10.1        10.1         9.5         9.6   

Stage length (km)

     848        848         830         727   

Number of departures

     261,611        261,611         280,832         283,755   

Block hours

     403,888        403,888         435,683         422,873   

Passenger flight segments

     20,822,146        20,822,146         21,794,939         20,409,931   

Revenue passenger kilometers (RPKs) (million)

     18,236        18,236         18,636         15,671   

Available seat kilometers (ASKs) (millions)

     22,869        22,869         23,423         19,747   

Load Factor (%)

     79.7%        79.7%         79.6%         79.4%   

Passenger revenue (in thousands)

     US$1,775,585 (1)      R$5,786,809         R$5,575,344         R$5,129,613   

Passenger revenue per ASK (cents) (PRASK)

     US$7.76 (1)      R$25.30         R$23.80         R$25.98   

Operating revenue per ASK (cents) (RASK)

     US$8.95 (1)      R$29.17         R$26.72         R$29.39   

Yield per ASK (cents)

     US$9.74 (1)      R$31.73         R$29.92         R$32.73   

Trip cost

     US$7,419 (1)      R$24,179         R$22,880         R$19,038   

End-of-period FTEs per aircraft

     84        84         73         76   

CASK (cents)

     US$8.49 (1)      R$27.66         R$27.43         R$27.36   

CASK (ex-fuel) (cents)(2)

     US$6.39 (1)      R$20.84         R$19.25         R$17.46   

Fuel liters consumed (thousands)

     880,941        880,941         906,778         789,150   

Average fuel cost per liter

     US$0.54 (1)      R$1.77         R$2.11         R$2.48   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) CASK (ex-fuel) means CASK excluding all fuel costs.

 



 

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THE OFFERING

 

Issuer

Azul S.A.

 

The global offering

● preferred shares, to be offered in an international offering and a Brazilian offering, of which ● preferred shares will be offered by us and ● preferred shares will be offered by the Selling Shareholders. The number of preferred shares offered in the international offering and the Brazilian offering is subject to reallocation between the offerings. The closings of the international offering and the Brazilian offering are conditioned upon each other.

 

International offering

We and the Selling Shareholders are offering ● preferred shares, in the form of ADSs, through the international underwriters in the United States and elsewhere outside Brazil.

The international underwriters will also act as placement agents on behalf of the Brazilian underwriters with respect to the sale of preferred shares to investors located outside Brazil who are authorized to invest in Brazilian securities according to the rules of the Brazilian National Monetary Council (Conselho Monetário Nacional), or the CMN, and the CVM.

 

Brazilian offering

Concurrently with the international offering, we and the Selling Shareholders are offering preferred shares through the Brazilian underwriters to investors in Brazil in a public offering authorized by the CVM. The Brazilian offering will be made by means of a separate prospectus in Portuguese.

 

  A portion of these preferred shares offered through the Brazilian offering may be placed by the international underwriters in their capacity as placement agents outside of Brazil, as described above in the context of the international offering. We are offering a total of ● preferred shares when considering the preferred shares offered through the Brazilian underwriters to investors in Brazil together with the preferred shares placed by the international underwriters outside of Brazil.

 

  Payment for our preferred shares (other than preferred shares in the form of ADSs) must be made in reais through the facilities of the BM&FBOVESPA Central Depository. We expect to deliver our preferred shares in the Brazilian offering through the facilities of the BM&FBOVESPA Central Depository on or about ●, 2017. Trades in our preferred shares on the BM&FBOVESPA will settle through the facilities of the BM&FBOVESPA Central Depository.

 

Selling Shareholders

Saleb II Founder 13 LLC, Star Sabia LLC, WP-New Air LLC, Azul HoldCo, LLC, ZDBR LLC, Bozano, Maracatu LLC, Morris Azul, LLC, Trip Investimentos Ltda., Trip Participações S.A. and Rio Novo Locações Ltda.

 



 

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International underwriters

Citigroup Global Markets Inc., Deutsche Bank Securities Inc., Itau BBA USA Securities, Inc., Banco do Brasil Securities LLC, Bradesco Securities Inc., J.P. Morgan Securities LLC, Raymond James & Associates, Inc. and Santander Investment Securities Inc.

Citibank Global Markets Inc., Deutsche Bank Securities Inc. and Itau BBA USA Securities, Inc. will act as representatives, or the Representatives, for the international underwriters.

 

Brazilian underwriters

Banco Itaú BBA S.A., Citigroup Global Markets Brasil, Corretora de Câmbio, Títulos e Valores Mobiliários S.A., Deutsche Bank S.A. – Banco Alemão, BB – Banco de Investimento S.A., Banco Bradesco BBI S.A., Banco J.P. Morgan S.A. and Banco Santander (Brasil) S.A.

 

Shares outstanding immediately prior to this global offering

464,482,529 common shares and 127,285,633 preferred shares, including 37,042,846 preferred shares resulting from the conversion of the Class C preferred shares and Class D preferred shares into Class A preferred shares and the simultaneous renaming of the Class A preferred shares as “preferred shares” on ●, 2017, such that our capital is now composed of one single class of preferred shares, the class of preferred shares offered hereby. For more information, see “Principal and Selling Shareholders”.

 

  Each common share is convertible into preferred shares at the ratio of 75.0 common shares for 1.0 preferred share pursuant to our by-laws. After applying this conversion ratio, solely for the purposes of calculating each shareholder’s economic interest in our capital, we would have ● preferred shares outstanding prior to this global offering on a fully-converted basis. This conversion, however, is purely theoretical because, under Brazilian corporate law, the total number of shares with no or with limited voting rights may not exceed 50% of the total number of outstanding shares issued by a corporation.

 

Shares outstanding after this global offering

● common shares and ● preferred shares. After applying the 75 : 1 conversion ratio, solely for the purposes of calculating each shareholder’s economic interest in our capital, we would have ● preferred shares outstanding after this global offering on a theoretical fully-converted basis, as described in “—Shares outstanding immediately prior to this global offering” above.

 

Preferred shares being offered

Preferred shares without voting rights, except for the voting rights mentioned in “Description of Capital Stock—Voting rights” for as long as our company is listed on the Level 2 segment of BM&FBOVESPA. Holders of our preferred shares benefit from certain tag-along rights, the right to receive 75 times the dividends paid on our common shares and liquidation preferences, all as described in “Description of Capital Stock.”

 

ADSs

Each ADS represents one preferred share and may be represented by American depositary receipts, or ADRs. The ADSs will be issued under a deposit agreement entered into among us, Citibank, N.A., as depositary, and the registered holders and beneficial owners from time to time of ADSs issued under the deposit agreement.

 



 

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Options to purchase additional ADSs and preferred shares

The Selling Shareholders will grant the international underwriters an option, exercisable by ●, on behalf of the international underwriters, upon prior written notice to the other international underwriters, us and the Selling Shareholders, for 30 days from and including the first day of trading of our preferred shares on BM&FBOVESPA, to purchase up to ● additional preferred shares, in the form of ADSs (less any preferred shares sold to the Brazilian underwriters under their option referred to below), at the initial public offering price less the underwriting discount, solely to cover options to purchase additional shares, if any, provided that the decision to allocate the additional preferred shares (including in the form of ADSs) is made jointly by the Brazilian and international underwriters at the time the price per preferred share and ADS is determined. See “Underwriting—Option.” If any additional ADSs are purchased using this option, the international underwriters will offer them on the same terms as the ADSs being offered in the international offering.

 

  The Selling Shareholders will grant the Brazilian underwriters an option, exercisable by ●, on behalf of the Brazilian underwriters upon prior written notice to the other Brazilian underwriters, us and the Selling Shareholders, for 30 days from and including the first day of trading of our preferred shares on BM&FBOVESPA, to purchase up to ● additional preferred shares (less any preferred shares in the form of ADSs sold to the international underwriters under their option referred to above), at the initial offering price less the underwriting discount, solely to cover options to purchase additional shares, if any, provided that the decision to allocate the additional preferred shares (including in the form of ADSs) is made jointly by the Brazilian and international underwriters at the time the price per preferred share and ADS is determined. See “Underwriting—Option.”

 

Offering price

We expect the offering price will be between R$● and R$● per preferred share and between US$ ● and US$ ● per ADS, calculated at the exchange rate of R$● per US$ at ●, 2017.

 

Use of proceeds

We estimate that the net proceeds that we will receive from this global offering will be R$● million, calculated at an offering price of R$● per preferred share, the midpoint of the indicative price range in this global offering. We intend to use these net proceeds (i) to repay indebtedness of R$333 million and (ii) for general corporate purposes. For further information, see “Use of Proceeds.”

 

  We will not receive any proceeds from the sale of preferred shares, including in the form of ADSs by the Selling Shareholders.

 



 

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Conflicts of Interest

As described in “Use of Proceeds,” we intend to use a portion of the net proceeds of the offering to repay R$333 million of indebtedness, including an import financing loan to Azul Linhas and a debenture issued by Azul Linhas (collectively, the “Financings”). Banco do Brasil S.A., the parent entity of Banco do Brasil Securities LLC and BB-Banco de Investimento S.A., underwriters of this offering, is a lender under the Financings and will receive at least 5% of the net offering proceeds and will, therefore, have a “conflict of interest” pursuant to FINRA Rule 5121(f)(5)(C)(i). Accordingly, this offering will be made in compliance with the applicable provisions of FINRA Rule 5121. Any underwriter that has a conflict of interest pursuant to the rule will not confirm sales to accounts in which it exercises discretionary authority without the prior written consent of the customer. Additionally, FINRA Rule 5121 requires that a “qualified independent underwriter” (as defined in the rule) participate in the preparation of the prospectus and perform its usual standard of due diligence for the offering. Deutsche Bank Securities Inc. has agreed to act as qualified independent underwriter for the offering and to perform a due diligence investigation and review and participate in the preparation of the prospectus.

 

Listing

We have applied to list the ADSs on the New York Stock Exchange, or NYSE, under the symbol “•” and to list our preferred shares on the Level 2 segment of BM&FBOVESPA under the symbol “AZUL4”. We cannot assure you that a trading market for our preferred shares or ADSs will develop or will continue if developed.

 

Transfer restrictions

Our preferred shares, including in the form of ADSs, will be subject to certain transfer restrictions as described under “Underwriting—Selling Restrictions.”

 

Dividends and dividend policy

Holders of our preferred shares are entitled to receive 75 times the value of dividends (and other distributions) distributed to holders of our common shares. Holders of our common and preferred shares are entitled to receive, subject to the proportion described above, an aggregate annual mandatory distribution of at least 0.1% of our adjusted net income as calculated and adjusted pursuant to Brazilian corporate law; however, our preferred shares do not carry priority rights to receive fixed or minimum dividends, and therefore will not be entitled to voting rights even if no dividends are paid. Holders of our preferred shares are entitled to the general voting rights provided in the Corporate Governance Rules of the Level 2 segment of BM&FBOVESPA. For further details, see the sections of this prospectus entitled “Description of Capital Stock—Voting Rights” and “Dividend Policy.”

 



 

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Lock-up agreement

We, the Selling Shareholders, our directors and officers and holders of at least 1.0% of our common shares and/or 1.0% of our economic interest have agreed, for a period of 180 days after the date of this prospectus, subject to certain exceptions, not to issue, offer, sell, contract to sell, pledge, deposit or otherwise transfer or dispose of, directly or indirectly, or file with the SEC or the CVM a registration statement relating to, any preferred shares, ADSs or securities convertible into or exchangeable or exercisable for preferred shares (including our common shares) or ADSs, or publicly disclose any intention to make any such issuance, offer, sale, pledge, deposit, transfer, disposition or filing, without the prior written consent of the Representatives.

 

  Additionally, pursuant to the regulations of the Level 2 segment of BM&FBOVESPA, our controlling shareholders, our directors and executive officers may not sell and/or offer to sell any common and/or preferred shares (or derivatives relating to common and/or preferred shares) owned immediately after this global offering, or any securities or other derivatives linked to securities issued by us, for six months from the effectiveness of the Level 2 segment of BM&FBOVESPA listing agreement. After the expiration of this 180-day period, our controlling shareholders, our directors and executive officers may not, for an additional 180-day period, sell and/or offer to sell more than 40% of the securities that each of we or they hold. See “Underwriting—No sale of similar securities.”

 

Controlling shareholder

Prior to this global offering, David Neeleman owns, directly or indirectly, 67% of our common shares, giving him 67% of the voting rights in our company. Following this global offering, Mr. Neeleman will continue to control all shareholders’ decisions, including the ability to appoint a majority of our board of directors.

 

Tag-along rights

Holders of our common and preferred shares have the right to participate in a public tender offer for control of Azul, on the same terms and conditions (taking into account the 75:1 conversion ratio) as are offered to our controlling shareholder in any sale of control transaction. The minimum price per common or preferred share to be offered for such common or preferred shares shall be at least 75 times the price per share paid for the controlling stake. See “Description of Capital Stock—Rights of our Common and Preferred Shares.”

 

  Our principal shareholders also have certain tag-along rights applicable to sales of common shares by them. See “Description of Capital Stock—Post-IPO Shareholders’ Agreement.”

 

Depositary

Citibank, N.A.

 



 

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Directed Share Program

At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of ● ADSs offered in this offering to persons who are our directors, officers or employees, or who are otherwise associated with us, through a directed share program. These reserved ADSs account for an aggregate of up to 5% of the ADSs offered in this global offering (assuming no exercise of the underwriters’ option to purchase additional shares). See “Underwriters—Directed Share Program.”

 

Brazilian Special Allocation Program

Between 10% and 20% of the preferred shares offered in the global offering will be offered to non-institutional investors. Our and Azul Linhas’ directors, officers or employees will have priority to purchase up to 50% of these preferred shares on ●, 2017 in amounts starting at R$1,000. These reserved preferred shares account for an aggregate of approximately ●% of the preferred shares offered in the global offering (assuming no exercise of the Brazilian underwriters’ option to purchase additional shares). See “Underwriters—Brazilian Retail offering and Special Allocation Program.”

 

Taxation

For a discussion of the material U.S. federal income tax consequences relating to an investment in our preferred shares, including in the form of ADSs, see “Taxation – Material U.S. Federal Income Tax Consequences.”

 

Risk factors

Investing in our preferred shares, including in the form of ADSs, involves risks. See “Risk Factors” beginning on page 25 and the other information included in this prospectus for a discussion of the factors you should consider before deciding to invest in our preferred shares, including in the form of ADSs.

 



 

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RISK FACTORS

This initial public offering and an investment in our preferred shares, including in the form of ADSs, involve a high degree of risk. You should carefully consider the risks described below before making an investment decision. We could be materially and adversely affected by any of these risks. The trading price of our preferred shares, including in the form of ADSs, could decline due to any of these risks or other factors, and you may lose all or part of your investment.

The risks described below are those that we currently believe may adversely affect us or our preferred shares, including in the form of ADSs. In general, investing in the securities of issuers in emerging market countries such as Brazil involves risks that are different from the risks associated with investing in the securities of U.S. companies and companies located in other countries with more developed capital markets.

To the extent that information relates to, or is obtained from sources related to, the Brazilian government or Brazilian macroeconomic data, industry data or other third parties, the following information has been extracted from official publications of the Brazilian government or other reliable third party sources and has not been independently verified by us.

Risks Relating to Brazil

The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. This involvement as well as Brazil’s political and economic conditions could adversely affect us and the price of our preferred shares, including in the form of ADSs.

The Brazilian government frequently exercises significant influence over the Brazilian economy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, increases in interest rates, changes in tax policies, price controls, foreign exchange rate controls, currency devaluations, capital controls and limits on imports. We have no control over and cannot predict what measures or policies the Brazilian government may take in the future. We and the market price of our securities may be adversely affected by changes in Brazilian government policies, as well as general economic factors, including, without limitation:

 

    growth or downturn of the Brazilian economy;

 

    interest rates and monetary policies;

 

    exchange rates and currency fluctuations;

 

    inflation;

 

    liquidity of the domestic capital and lending markets;

 

    import and export controls;

 

    exchange controls and restrictions on remittances abroad;

 

    modifications to laws and regulations according to political, social and economic interests;

 

    fiscal policy and changes in tax laws;

 

    economic, political and social instability;

 

    labor regulations;

 

    energy and water shortages and rationing;

 

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    the Brazilian government’s intervention, modification or rescission of existing concessions;

 

    the Brazilian government’s control of or influence on the control of certain oil producing and refining companies; and

 

    other political, social and economic developments in or affecting Brazil.

In addition, Brazil is currently experiencing a recession and weak macroeconomic conditions in Brazil are expected to continue in 2017, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Principal Factors Affecting Our Financial Condition and Results of Operations.” We cannot predict what measures the Brazilian federal government will take in the face of mounting macroeconomic pressures or otherwise.

Uncertainty over whether the Brazilian federal government will implement changes in policy or regulation affecting these or other factors in the future may affect economic performance and contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian capital market and securities issued by Brazilian companies. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Brazilian economic environment.”

The ongoing economic uncertainty and political instability in Brazil may adversely affect us and the price of our preferred shares, including in the form of ADSs.

Brazil’s political environment has historically influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect the confidence of investors and the general public, which have historically resulted in economic deceleration and heightened volatility in the securities issued by Brazilian companies.

The recent economic instability in Brazil has contributed to a decline in market confidence in the Brazilian economy as well as to a deteriorating political environment. Weak macroeconomic conditions in Brazil are expected to continue in 2017. In addition, various currently ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation, known as Lava Jato, have negatively impacted the Brazilian economy and political environment. Members of the Brazilian government as well as senior officers of large state-owned companies have faced or are currently facing allegations of corruption and money laundering as a result of these investigations. These individuals are alleged to have accepted bribes by means of kickbacks on contracts granted by the government to several infrastructure, oil and gas and construction companies. The profits of these kickbacks allegedly financed the political campaigns of political parties forming the previous government’s coalition that was led by former President Dilma Rousseff, which funds were unaccounted for or not publicly disclosed. These funds were also allegedly destined toward the personal enrichment of certain individuals. A number of senior politicians, including members of Congress, and high-ranking executives officers of major corporations and state-owned companies in Brazil have been arrested, convicted of various charges relating to corruption, entered into plea agreements with federal prosecutors and/or have resigned or been removed from their positions. The potential outcome of Lava Jato as well as other ongoing corruption-related investigations is uncertain, but they have already had an adverse impact on the image and reputation of those companies that have been implicated as well as on the general market perception of the Brazilian economy, political environment and the Brazilian capital market. We have no control over, and cannot predict, whether such investigations or allegations will lead to further political and economic instability or whether new allegations against government officials will arise in the future.

President Dilma Rousseff was suspended from office on May 12, 2016, when the Brazilian Senate voted to hold a trial on impeachment charges against her. President Rousseff was replaced by Vice-President Michel Temer, who served as acting President until Ms. Rousseff was permanently removed from office by the Senate on August 31, 2016. President Temer is expected to serve as President until December 2018. We cannot predict how the ongoing investigations and proceedings will affect us or the price of our preferred shares, including in the form of ADSs.

 

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Any of the above factors may create additional political uncertainty, which could have a material adverse effect on the Brazilian economy and, consequently, on us and the price of our preferred shares, including in the form of ADSs.

Exchange rate instability may have adverse effects on the Brazilian economy, us and the price of our preferred shares, including in the form of ADSs.

The Brazilian currency has been historically volatile and has been devalued frequently over the past three decades. Throughout this period, the Brazilian government has implemented various economic plans and used various exchange rate policies, including sudden devaluations, periodic mini-devaluations (during which the frequency of adjustments has ranged from daily to monthly), exchange controls, dual exchange rate markets and a floating exchange rate system. Although long-term depreciation of the real is generally linked to the rate of inflation in Brazil, depreciation of the real occurring over shorter periods of time has resulted in significant variations in the exchange rate between the real, the U.S. dollar and other currencies. The real depreciated against the U.S. dollar by 41.8% in 2015 as compared to 2014, and by 9.0% in 2014 as compared to 2013. The real/U.S. dollar exchange rate reported by the Central Bank was R$3.9048 per U.S. dollar on December 31, 2015 and R$3.2591 per U.S. dollar on December 31, 2016, reflecting a 16.5% appreciation in the real against the U.S. dollar, but there can be no assurance that the real will not again depreciate against the U.S. dollar or other currencies in the future.

Our revenues are denominated in reais and a significant part of our operating expenses, such as fuel, certain aircraft operating lease agreements, certain flight hour maintenance contracts and aircraft insurance, are denominated in, or linked to, foreign currency. In addition, we have and may incur substantial amounts of U.S. dollar-denominated operating lease or financial obligations, fuel costs linked to the U.S. dollar and U.S. dollar-denominated indebtedness in the future or similar exposures to other foreign currencies. As of December 31, 2015 and as of December 31, 2016, 57.5% and 53.5% of our operating expenses, respectively, were denominated in, or linked to, foreign currency.

We are not always fully hedged against fluctuations of the real. In light of the foregoing, there can be no assurance we will be able to protect ourselves against the effects of fluctuations of the real. Depreciation of the real could create inflationary pressures in Brazil and cause increases in interest rates, which could negatively affect the growth of the Brazilian economy as a whole, harm us, curtail access to financial markets and prompt government intervention, including recessionary governmental policies. Depreciation of the real can also, as in the context of the current global economic recovery, lead to decreased consumer spending, and reduced growth of the economy as a whole. Consequently, when the real appreciates, we incur losses on our monetary assets denominated in, or indexed to, a foreign currency, such as the U.S. dollar, and our liabilities denominated in, or indexed to, foreign currency, decreases as the liabilities and assets are translated into reais.

Any depreciation of the real against the U.S. dollar may have an adverse effect on us, including leading to a decrease in our profit margins or to operating losses caused by increases in U.S. dollar-denominated costs (including fuel costs), increases in interest expense or exchange losses on unhedged fixed obligations and indebtedness denominated in foreign currency.

Inflation and certain measures by the Brazilian government to curb inflation have historically adversely affected the Brazilian economy and Brazilian capital market, and high levels of inflation in the future would adversely affect us and the price of our preferred shares, including in the form of ADSs.

In the past, Brazil has experienced extremely high rates of inflation. Inflation and some of the measures taken by the Brazilian government in an attempt to curb inflation have had significant negative effects on the Brazilian economy generally. Inflation, policies adopted to curb inflationary pressures and uncertainties regarding possible future governmental intervention have contributed to economic uncertainty and heightened volatility in the Brazilian capital market.

 

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According to the National Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo), or IPCA, Brazilian inflation rates were 6.3%, 10.7% and 6.4% in 2016, 2015 and 2014, respectively. Brazil may experience high levels of inflation in the future and inflationary pressures may lead to the Brazilian government’s intervening in the economy and introducing policies that could adversely affect us and the price of our preferred shares, including in the form of ADSs. In the past, the Brazilian government’s interventions included the maintenance of a restrictive monetary policy with high interest rates that restricted credit availability and reduced economic growth, causing volatility in interest rates. For example, the official interest rate in Brazil oscillated from 7.25% in 2014 to 13.75% in 2016, as established by the Monetary Policy Committee (Comitê de Política Monetária do Banco Central do Brasil - COPOM). Conversely, more lenient government and Central Bank policies and interest rate decreases have triggered and may continue to trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect us and increase our indebtedness.

In the event that Brazil experiences high inflation in the future, we may not be able to adjust the prices we charge our passengers to offset the potential impacts of inflation on our expenses, including salaries. This would lead to decreased net income, adversely affecting us. Inflationary pressures may also adversely affect our ability to access foreign financial markets, adversely affecting us.

Developments and the perceptions of risks in other countries, including other emerging markets, the United States and Europe, may adversely affect the Brazilian economy and the price of Brazilian securities, including the price of our preferred shares, including in the form of ADSs.

The market for securities issued by Brazilian companies is influenced by economic and market conditions in Brazil and, to varying degrees, market conditions in other Latin American and emerging markets, as well as the United States, Europe and other countries. To the extent the conditions of the global markets or economy deteriorate, Brazilian companies may have their businesses adversely affected. The weakness in the global economy has been marked by, among other adverse factors, lower levels of consumer and corporate confidence, decreased business investment and consumer spending, increased unemployment, reduced income and asset values in many areas, reduction of China’s growth rate, currency volatility and limited availability of credit and access to capital. Developments or economic conditions in other emerging market countries have at times significantly affected the availability of credit to Brazilian companies and resulted in considerable outflows of funds from Brazil, decreasing the amount of foreign investments in Brazil.

Crises and political instability in other emerging market countries, the United States, Europe or other countries could decrease investor demand for Brazilian securities, such as our preferred shares, including in the form of ADSs. In June 2016, the United Kingdom had a referendum in which the majority voted to leave the European Union. We have no control over and cannot predict the effect of the United Kingdom’s exit from the European Union nor over whether and to which effect any other member state will decide to exit the European Union in the future. On January 20, 2017, Donald Trump became the President of the United States. We have no control over and cannot predict the effects of Donald Trump’s administration or policies. These developments, as well as potential crises and forms of political instability arising therefrom or any other as of yet unforeseen development, may adversely affect us and the price of our preferred shares, including in the form of ADSs.

Any further downgrading of Brazil’s credit rating could adversely affect the price of our preferred shares, including in the form of ADSs.

We can be adversely affected by investors’ perceptions of risks related to Brazil’s sovereign debt credit rating. Rating agencies regularly evaluate Brazil and its sovereign ratings, which are based on a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness metrics and the perspective of changes in any of these factors.

 

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Brazil has lost its investment grade sovereign debt credit rating by the three main U.S. based credit rating agencies, Standard & Poor’s, Moody’s and Fitch. Standard & Poor’s downgraded Brazil’s sovereign debt credit rating from BBB-minus to BB-plus in September 2015, subsequently reduced it to BB in February 2016, and maintained its negative outlook on the rating, citing Brazil’s fiscal difficulties and economic contraction as signs of a worsening credit situation. In December 2015, Moody’s placed Brazil’s Baa3 sovereign debt credit rating on review and downgraded Brazil’s sovereign credit rating in February 2016 to Ba2 with a negative outlook, citing the prospect for further deterioration in Brazil’s indebtedness figures amid a recession and challenging political environment. Fitch downgraded Brazil’s sovereign credit rating to BB-plus with a negative outlook in December 2015, citing the country’s rapidly expanding budget deficit and worse-than-expected recession, and further downgraded Brazil’s sovereign debt credit rating in May 2016 to BB with a negative outlook.

Brazil’s sovereign credit rating is currently rated below investment grade by the three main credit rating agencies. Consequently the prices of securities issued by Brazilian companies have been negatively affected. A prolongation or worsening of the current Brazilian recession and continued political uncertainty, among other factors, could lead to further ratings downgrades. Any further downgrade of Brazil’s sovereign credit ratings could heighten investors’ perception of risk and, as a result, adversely affect the price of our preferred shares, including in the form of ADSs.

Variations in interest rates may have adverse effects on us.

We are exposed to the risk of interest rate variations, principally in relation to the Long Term Interest Rate (Taxa de Juros de Longo Prazo), or TJLP, with respect to loans denominated in reais, the Interbank Deposit Rate, or CDI Rate, and with respect to operating and finance leases and debt-financed aircraft denominated in U.S. dollars, the London Interbank Offer Rate, or LIBOR.

If the TJLP, the CDI Rate or LIBOR were to increase, our repayments under loans, operating and finance leases would increase, and we may not be able to adjust the prices we charge to offset increased payments. For example, our repayments under many of our operating and finance leases and debt-financed aircraft are linked to LIBOR. The outstanding loan balance due on our finance lease and debt-financed aircraft contracts linked to LIBOR amounted to R$2,270.9 million as of December 31, 2015 and R$1,769.5 million as of December 31, 2016.

Significant increases in consumption, inflation or other macroeconomic pressures may lead to an increase in these rates. Variations in the TJLP, the CDI Rate or LIBOR may have adverse effects on us. For further information regarding our exposure to the risk of interest rate variations, please see “Management’s Discussion and Analysis—Principal Factors Affecting Our Financial Condition and Results of Operations—Effects of exchange rates, interest rates and inflation.”

Deficiencies in Brazilian infrastructure, particularly in airports and ports, may adversely affect us.

We offer products and services that depend on the performance and reliability of the infrastructure in Brazil and abroad. Historically, public investment in the construction and development of airports, ports, highways and railroads has been relatively low, which affects the demand for domestic tourism and could also affect our ability to carry out our operations or limit our expansion plans as well as cause delays and increase operational costs. For example, in 2007, Brazil passed through a significant crisis with its air traffic control systems, which negatively impacted air travel and the tourism industry as a whole. Insufficient public and/or private investment in the expansion of Brazilian infrastructure, particularly airports, ports and other travel hubs could lead to a decrease in sales or lower growth rates than we expect, which may adversely affect us and growth prospects. In particular, lack of or insufficient investment in the maintenance at our main hub in Viracopos airport could impact the general activity and operation of the airport, which would adversely impact us.

 

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Risks Relating to our Business and the Brazilian Civil Aviation Industry

Substantial fluctuations in fuel costs or the unavailability of fuel, which is mostly provided by one supplier, would have an adverse effect on us.

Historically, international and local fuel prices have been subject to wide price fluctuations based on geopolitical issues and supply and demand. Fuel expenses, which at times in 2007 and 2008 were at historically high levels, constitute a significant portion of our total operating expenses, accounting for 24.7% of our operating expenses for the year ended December 31, 2016 and 29.8% for the year ended December 31, 2015. Fuel availability is also subject to periods of market surplus and shortage and is affected by demand for both home heating oil and gasoline. Events resulting from prolonged instability in the Middle East or other oil-producing regions, or the suspension of production by any significant producer, may result in substantial price increases and/or make it difficult to obtain adequate supplies, which may adversely affect us. Natural disasters or other large unexpected disrupting events in regions that normally consume significant amounts of other energy sources could have a similar effect. The price and future availability of fuel cannot be predicted with any degree of certainty, and significant increases in fuel prices may harm our business. Our hedging activities may not be sufficient to protect us from fuel price increases, and we may not be able to adjust our fares adequately to protect us from this cost.

We purchase fuel from a number of distributors in Brazil, principally from BR Distribuidora, a subsidiary of Petrobras, Air BP Brasil Ltda. and Raízen Combustíveis Ltda., with whom we have agreements to exclusively purchase all of our jet fuel needs in certain locations. BR Distribuidora provides 66.1% of our fuel and is entitled to terminate its fuel supply contracts with us for a number of reasons, including (i) non-compliance with any contractual obligation, (ii) non-payment of invoices up to 60 days after expiration and (iii) in the event of our judicial or extrajudicial liquidation. In addition, BR Distribuidora may be unable to guarantee its fuel supply to us, for example due to difficulties in its production, import, refining or distribution activities. If we were unable to obtain fuel on similar terms from alternative suppliers, our business would be adversely affected. In addition, our agreement with BR Distribuidora enables us to lock in the cost of the jet fuel that we will consume in the future. Accordingly, in case this agreement is terminated, we will be required to enter into alternative hedging or pay higher prices, which would adversely affect us.

We and the airline industry in general are particularly sensitive to changes in economic conditions and continued negative economic conditions that would likely continue to adversely affect us and our ability to obtain financing on acceptable terms.

Our operations and the airline industry in general are particularly sensitive to changes in economic conditions. Unfavorable economic conditions, such as high unemployment rates, a constrained credit market, low or negative GDP growth, unfavorable exchange rates and increased business operating expenses, can reduce spending for both leisure and business travel. Unfavorable economic conditions can also impact our ability to raise fares to counteract increases in fuel, labor, and other expenses. In particular, the recent recession in the Brazilian economy and political instability has adversely affected industries with significant spending in travel, including government, oil and gas, mining and construction. In addition to decreases in load factors, reduced spending on business travel also affects the quality of demand, resulting in our inability to sell as many high-yield tickets.

An increasingly unfavorable economic environment would likely adversely affect us. In addition, a significant instability of the credit, capital and financial markets, could result in increasing our borrowing costs, adversely affect us. We typically finance our aircraft through operating and finance leases and debt-finance. We may not be able to continue to obtain financing on terms attractive to us, or at all. To the extent we cannot obtain such financing on acceptable terms or at all, we may be required to modify our aircraft acquisition plans or to incur higher than anticipated financing costs, which would adversely affect us and our growth strategy. These factors could also adversely affect our ability to obtain financing on acceptable terms and our liquidity in general.

 

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Because the airline industry is characterized by high fixed costs and relatively elastic revenues, airlines cannot quickly reduce their costs to respond to shortfalls in expected revenue and this may harm our ability to attain our strategic goals.

The airline industry is characterized by low gross profit margins; high fixed costs, such as such as aircraft ownership and leasing, headquarters facility and personnel, IT system license costs, training and insurance expenses; and revenues that generally exhibit substantially greater elasticity than costs. The operating costs of each flight do not vary significantly with the number of passengers flown and, therefore, a relatively small change in the number of passengers, fare pricing or traffic mix could have a significant effect on operating and financial results.

We expect to incur additional fixed costs, including contractual debt as we lease or acquire new aircraft and other equipment to implement our growth strategy or other purposes. As of December 31, 2016, we had 94 orders consisting of 58 next-generation Airbus A320neo family aircraft, to be delivered between 2017 and 2023, three Airbus A350 aircraft to be delivered between 2017 and 2018, eight ATRs to be delivered between 2019 and 2021, and 33 next-generation E-195-E2 aircraft with deliveries starting in 2020.

As a function of our fixed costs, we may (i) have limited ability to obtain additional financing, (ii) be required to dedicate a significant part of our cash flow to fixed costs resulting from operating leases and debt for aircraft, (iii) incur higher interest or leasing expenses for the event that interest rates increase or (iv) have a limited ability to plan for, or react to, changes in our businesses, the civil aviation sector generally and overall macroeconomic conditions. In addition, volatility in global financial markets may make it difficult for us to obtain financing to manage our fixed costs on favorable terms or at all.

As a result of the foregoing, we may be unable to quickly adjust our fixed costs in response to changes in our revenues. A shortfall from expected revenue levels could have a material adverse effect on us.

Changes to the Brazilian civil aviation regulatory framework may adversely affect us, our business and results of operations, including our competitiveness and compliance costs.

Brazilian aviation authorities monitor and influence the developments in Brazil’s airline market. For example, in July 2014, ANAC published new rules governing the allocation of slots at the main Brazilian airports, which consider operational efficiency (on-time performance and regularity) as the main criteria for the allocation of take-off and landing slots at Brazilian airports. The policies of Brazilian aviation authorities, including ANAC, may adversely affect us and our operations.

For a description of recent changes to the Brazilian civil aviation regulatory framework, see “Regulation—Airport Infrastructure”. For a description of recent changes to and pending legislation regarding the Brazilian civil aviation regulatory framework, see “Regulation—Pending Legislation”.

Changes to the Brazilian civil aviation regulatory framework, including the policies of ANAC and/or INFRAERO as well as other aviation supervisory authorities, could increase our costs and change the competitive dynamics of our industry and may adversely affect us. In addition, we cannot guarantee that any of the operating concessions that we hold will be renewed or that we will obtain new concession. Any change that requires us to dedicate a significant level of resources on compliance with new aviation regulations, for example, would result in additional expenditure on compliance and consequently adversely affect us.

 

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We operate in a highly competitive industry and actions by our competitors could adversely affect us.

We face intense competition on certain routes in Brazil from existing scheduled airlines, charter airlines and potential new entrants in our market and also with regards to our loyalty program TudoAzul. In particular, we face strong competition in routes and markets where our network overlaps with that of our main competitors. As of December 31, 2016, 24% and 15% of our domestic network overlapped with that of Gol and LATAM, respectively. Airlines increase or decrease capacity in markets based on perceived profitability. Decisions by our competitors that increase overall industry capacity, or capacity dedicated to a particular region, market or route, as well as any other management decisions that increase a potential competitor’s market share, could have a material adverse impact on us. Our growth and the success of our business model could stimulate competition in our markets through the development of similar strategies by our competitors. If these competitors adopt and successfully execute similar business models, we could be adversely affected.

Each year we may face increased competition from existing and new participants in the Brazilian market. The air transportation sector is highly sensitive to price discounting and the use of very aggressive pricing policies by some airlines. Other factors, such as flight frequency, schedule availability, brand recognition, and quality of offered services (such as loyalty programs, VIP airport lounges, in-flight entertainment and other amenities) also have a significant impact on market competitiveness. In addition, the barriers to entering the domestic market are relatively low and we cannot assure you that existing or new competitors in our markets will not offer lower prices, more attractive services or increase their route capacity in an effort to obtain greater market share. We may also face competition from international airlines as they introduce and expand flights to Brazil. In addition to competition among scheduled airlines and charter operators, the Brazilian airline industry faces competition from ground transportation alternatives, such as interstate buses and automobiles. Finally, the Brazilian government and regulators could give preference to new entrants or provide support to our competitors, for example, when granting new and current slots in Brazilian airports, as previously occurred with respect to new slots at Congonhas airport.

In addition, technology advancements may limit the desire for air travel. For example, video teleconferencing and other methods of electronic communication may reduce the need for in-person communication and add a new dimension of competition to the industry as travelers seek lower cost substitutes for air travel.

Furthermore, new competitors may target TudoAzul’s business partners and members or enter the loyalty marketing industry. We cannot assure you that an increase in competition faced by TudoAzul will not have an adverse effect on the growth of our business with respect to TudoAzul or in general. If we are unable to adjust rapidly to the changing nature of competition in our markets or if the Brazilian loyalty marketing industry does not grow sufficiently to accommodate new participants, it could have an adverse effect on us.

Further consolidation in the Brazilian and global airline industry may adversely affect us.

As a result of the competitive environment in which we operate, there may be further consolidation in the Brazilian and global airline industry, whether by means of acquisitions, joint ventures, partnerships or strategic alliances. We cannot predict the effects of further consolidation on the industry. Our competitors could increase their scale, diversity and financial strength and may have a competitive advantage over us, which would adversely affect us. Consolidations in the airline industry and changes in international alliances are likely to affect the competitive landscape in the industry and may result in the formation of airlines and alliances with increased financial resources, more extensive global networks and reduced cost structures than us.

 

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We routinely engage in analysis and discussions regarding our own strategic position, including alliances, code-share arrangements, investments, acquisitions, interline arrangements and loyalty program enhancements, and may have future discussions with other airlines regarding similar arrangements. To the extent we act as consolidators, we may not be able to successfully integrate the business and operations of companies acquired, governmental approvals may be delayed, costs of integration and fleet renovation may be greater than anticipated, synergies may not meet our expectations, our costs may increase and our operational efficiency may be reduced, all of which would negatively affect us. To the extent we do not engage in such consolidations, our competitors may increase their scale, diversity and financial strength and may have a competitive advantage over us, which would negatively affect us, including our ability to realize expected benefits from our own strategic partnerships.

We depend significantly on automated systems and any breakdown, hacking or changes in these systems may adversely affect us.

We depend on automated systems to operate our businesses, including our sales system, automated seat reservation system, fleet and network management system, telecommunications system and website. Significant or repeated breakdowns of our automated systems may impede our passengers and travel agencies’ access to our products and services, which may cause them to purchase tickets from other airlines, adversely affecting our net revenues. Our website and ticket sales system must accommodate a high volume of traffic and deliver important flight information. Substantial or repeated website, ticket sales, scheduling or telecommunication systems failures could reduce the attractiveness of our services and could cause our customers to purchase tickets from another airline. Any interruption in these systems or their underlying infrastructure could result in the loss of important data, increase our expenses and generally harm us.

These interruptions may include but are not limited to computer hackings, computer viruses, worms or other disruptive software, or other malicious activities. In particular, both unsuccessful and successful cyber-attacks on companies have increased in frequency, scope and potential harm in recent years. The costs associated with a major cyber-attack could include expensive incentives offered to existing customers to retain their business, increased expenditures on cyber security measures, lost revenues from business interruption, litigation and damage to our reputation. In addition, if we fail to prevent the theft of valuable information, protect the privacy of customer and employee confidential data against breaches of network or IT security, it could result in damage to our reputation, which could adversely impact customer and investor confidence. We may also implement certain changes to our systems that may result in breakdowns, reduced sales, fleet and network mismanagement or telecommunications interruptions, all of which would negatively affect us. Furthermore, the compromise of our technology systems resulting in the loss, disclosure, misappropriation of, or access to, customers’, employees’ or business partners’ information could result in legal claims or proceedings, liability or regulatory penalties under laws protecting the privacy of personal information or disruption to our operations. Any of these occurrences could result in a material adverse effect on us.

We, our reputation, and the price of our preferred shares, including in the form of ADSs, could be adversely affected by events outside of our control.

Accidents or incidents involving our aircraft could involve significant claims by injured passengers and others, as well as significant costs related to the repair or replacement of a damaged aircraft and its temporary or permanent loss from service. We are required by ANAC and lessors of our aircraft under our operating lease agreements to carry liability insurance. The amount of liability insurance we maintain may not be adequate and we may be forced to bear substantial losses in the event of an accident. Substantial claims resulting from an accident in excess of our related insurance coverage would harm our business and financial results. Moreover, any aircraft accident or incident involving our aircraft, even if fully insured, or the aircraft of any major airline could cause negative public perceptions about us, our aircraft or the air transport system, due to safety concerns or other problems, whether real or perceived, which would harm our reputation, financial results and the market price of our preferred shares, including in the form of ADSs.

 

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We may also be affected by other events that affect travel behavior or increase costs, such as the potential of epidemics or acts of terrorism. These events are outside of our control and may affect us even if occurring in markets where we do not operate and/or in connection with other airlines. Any future terrorist attacks or threats of attacks, whether or not involving commercial aircraft, any increase in hostilities relating to reprisals against terrorist organizations, including an escalation of military involvement in the Middle East, or otherwise and any related economic impact, could result in decreased passenger traffic and materially and adversely affect us.

Outbreaks or potential outbreaks of diseases, such as the Zika virus, Ebola, avian flu, foot-and-mouth disease, swine flu, Middle East Respiratory Syndrome, or MERS, and Severe Acute Respiratory Syndrome, or SARS, could have an adverse impact on global air travel. Any outbreak of a disease that affects travel behavior could have a material adverse impact on us and the price of shares of companies in the worldwide airline industry, including our preferred shares, including in the form of ADSs. Outbreaks of disease could also result in quarantines of our personnel or an inability to access facilities or our aircraft, which would harm us, our reputation, and the price of our preferred shares, including in the form of ADSs.

Natural disasters, severe weather conditions and other events outside of our control may affect and disrupt our operations. For example, in 2011, a volcanic eruption in Chile had a prolonged adverse effect on air travel, halting flights in, Argentina, Chile, Uruguay and the southern part of Brazil for several days. As a result, our operations to and from these regions were temporarily disrupted, including certain aircraft being grounded in the affected regions. In 2012, an incident with an aircraft from a cargo airline caused the closing of a runway at Viracopos airport for 45 hours, which negatively impacted our operations and forced us re-accommodate our passengers to new flights. Severe weather conditions can cause flight cancellations or significant delays that may result in increased costs and reduced revenue. Any natural disaster or other event that affects air travel in the regions in which we operate could have a material adverse impact on us.

Our insurance expenses may increase significantly as a result of a terrorist attack, war, aircraft accident, seizures or similar event, adversely affecting us.

Insurance companies may significantly increase insurance premiums for airlines and reduce the amount of insurance coverage available to airlines for civil liability in respect of damage resulting from acts of terrorism, war, aircraft accident, seizures or similar events, as was the case following the terrorist attacks of September 11, 2001 in the United States.

In response to substantial increases in insurance premiums to cover risks related to terrorist attacks following the events of September 11, 2001 in the United States, the Brazilian government enacted legislation, specifically Law No. 10.744, of October 9, 2003, authorizing the Brazilian government to assume civil liability to third parties for any injury to goods or persons, whether or not passengers, caused by terrorist attacks or acts of war against Brazilian aircraft operated by Brazilian airlines in Brazil or abroad. In addition, according to the abovementioned legislation, the Brazilian government may, at its sole discretion, suspend or cancel this assumption of liability. If the Brazilian government suspends its assumption of liability, Brazilian airlines will be required to assume the liability once more and obtain insurance in the market.

Airline insurers may reduce their coverage or increase their premiums in case of new terrorist attacks, war, aircraft accident, seizures and the Brazilian government’s termination of its assumption of liability or other events affecting civil aviation in Brazil or abroad. If there are significant reductions in insurance coverage, our potential liability would increase substantially. If there are significant increases in insurance premiums, our operating expenses would increase, adversely affecting us.

In line with global industry practice, we leave some business risks uninsured, including business interruption, loss of profit or revenue and consequential business losses arising from mechanical breakdown. To the extent that uninsured risks materialize, we could be materially and adversely affected. In addition, there is no assurance that our coverage will cover all potential risks associated with our operations and activities. To the extent that actual losses incurred by us exceed the amount insured, we may have to bear substantial losses which will have an adverse impact on us.

 

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Technical and operational problems in the Brazilian civil aviation infrastructure, including air traffic control systems, airspace and airport infrastructure, may have a material adverse effect on our strategy and, consequently, on us.

We are dependent on improvements in the coordination and development of Brazilian airspace control and airport infrastructure, which, mainly due to the large growth in civil aviation in Brazil in recent years, require substantial improvements and government investments. Technical and operational problems in the Brazilian air traffic control systems have led to extensive flight delays, higher than usual flight cancellations and increased airport congestion. The Brazilian government and air traffic control authorities have taken measures to improve the Brazilian air traffic control systems, but if the changes undertaken by the Brazilian government and regulatory authorities do not prove successful, these air traffic control related difficulties might recur or worsen, which may have a material adverse effect on us and our growth strategy.

Slots at Congonhas airport in São Paulo are fully utilized. The Santos Dumont airport in Rio de Janeiro, which is important for our operations, has certain landing rights restrictions. Several other Brazilian airports, for example Brasília, Salvador, Belo Horizonte (Confins), São Paulo (Guarulhos and Viracopos) and Rio de Janeiro (Galeão), have limited the number of landing rights per day due to infrastructural limitations at these airports. Any condition that would prevent or delay our access to airports or routes that are vital to our strategy, or our inability to maintain our existing landing rights and slots, and obtain additional landing rights and slots, could materially adversely affect us. New operational and technical restrictions imposed by Brazilian authorities in the airports we operate or in those we expect to operate may also adversely affect us. In addition, we cannot assure that any investments will be made by the Brazilian government in the Brazilian aviation infrastructure to permit a capacity increase at busy airports and consequently additional concessions for new slots to airlines.

Increases in labor benefits, union disputes, strikes, and other worker-related disturbances may adversely affect us, including our ability to carry out our normal business operations.

Our business is labor intensive. Our expenses related to our workforce (salaries, wages and benefits) represented 17.3%, 16.2% and 18.4% of our total operating expenses for the years ended December 31, 2016, 2015, and 2014, respectively. All Brazilian airline employees, including ours, are represented by regional aviation unions and by two national labor unions: the National Pilots’ and Flight Attendants’ Union (Sindicato Nacional dos Aeronautas) and the National Aviation Union (Sindicato Nacional dos Aeroviários). Negotiations regarding cost of living increases and salary payments are conducted annually between these unions and an association that represents all Brazilian airline companies, the National Union of Airline Companies (Sindicato Nacional das Empresas Aeroviárias), or SNEA. Work conditions and maximum work hours are regulated by government legislation and are not subject to labor negotiations. Future terms and conditions of collective agreements could become more costly for us as a result of an increase in threats of strikes and binding negotiations between the unions and SNEA. Furthermore, certain employee groups such as pilots, mechanics and other airport personnel have highly specialized skills and cannot be easily replaced. Our labor costs could increase if the size of our business increases. Any labor proceeding or other workers’ dispute involving unionized employees could adversely affect us or interfere with our ability to carry out our normal business operations.

Moreover, we are subject to periodic and regular investigations by labor authorities, including the Brazilian Ministry of Labor and the Public Prosecutor’s Office, with respect to our compliance with labor rules and regulations, including those relating to occupational health and safety. These investigations could result in fines and proceedings that may materially and adversely affect us.

 

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A failure to implement our growth strategy may adversely affect us.

Our growth strategy and the consolidation of our leadership in terms of markets served includes, among other objectives, increasing the number of markets we serve and increasing the frequency of the flights we provide. These objectives are dependent on obtaining approvals for operating new routes from local regulators and obtaining adequate access to the necessary airports. Certain airports that we serve or that we may want to serve in the future are subject to capacity constraints and impose landing rights and slot restrictions during certain periods of the day such as the Santos Dumont airport in Rio de Janeiro and the Juscelino Kubitschek airport in Brasília. We cannot assure you that we will be able to maintain our current landing rights and slots and obtain a sufficient number of landing rights and slots, gates, and other facilities at airports to expand our services as we propose. It is also possible that airports not currently subject to capacity constraints may become so in the future. In addition, an airline must use its slots on a regular and timely basis or risks having those slots reallocated to other airlines. Where landing rights and slots or other airport resources are not available or their availability is restricted in some way, we may have to modify our schedules, change routes or reduce aircraft utilization.

Some of the airports to which we fly impose various restrictions, including limits on aircraft noise levels, limits on the number of average daily departures and curfews on runway use. In addition, we cannot assure you that airports at which there are no such restrictions may not implement restrictions in the future or that, where such restrictions exist, they may not become more onerous. Such restrictions may limit our ability to continue to provide or to increase services at such airports, which may adversely affect us.

We cannot guarantee that we will be successful in the implementation of our growth strategy and the consolidation of our leadership in terms of markets served and, as a result, any factor preventing or delaying our access to airports or routes which are vital to our growth strategy (including our ability to maintain our current slots and obtain additional landing rights and slots at certain airports) may restrict our operations or the expansion of our operations and, consequently, adversely affect us, our financial results and our growth strategy.

Our current business plan contemplates the addition of Airbus and Embraer aircraft to replace older generation aircraft and serve high-density markets. Any disruption or change in the manufacturers’ delivery schedules for our new Embraer and Airbus aircraft may affect our operations and might negatively affect us because we may not be able to accommodate increased passenger demand or develop our growth strategies.

The successful execution of our strategy is partly dependent on the maintenance of a high daily aircraft utilization rate, making us especially vulnerable to delays.

In order to successfully execute our strategy, we need to maintain a high daily aircraft utilization rate. Achieving high aircraft utilization allows us to maximize the amount of revenue that we generate from each aircraft and dilute fixed costs. High daily aircraft utilization is achieved, in part, by reducing turnaround times at airports and developing schedules that enable us to fly more hours on average per day. Our aircraft utilization rate could be adversely affected by a number of factors that we cannot control, including air traffic and airport congestion, interruptions in the service provided by air traffic controllers, adverse weather conditions and delays by third-party service providers in respect of matters such as fueling and ground handling. Such delays could result in a disruption in our operating performance, leading to lower daily aircraft utilization rates and customer dissatisfaction due to any resulting delays or missed connections, which could adversely affect us.

Any expansion of our business activities will require us to incur additional costs and expenses and we ultimately may be unsuccessful in generating a profit from any such new activities, potentially adversely affecting us.

We intend to expand our business activities through additional products and services if we believe this expansion will increase our profitability or our influence in the markets in which we operate. As part of our growth strategy, we periodically acquire additional aircraft, including different types of aircraft than the ones we currently operate or have operated in the past, and enter into commitments for additional aircraft based on our expectations of increased traffic given the significant time frames for ordering and taking delivery of these assets. We cannot assure you that we will be able to successfully operate these new aircraft and maintain our historical operating performance.

 

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As the international and domestic markets develop and expand in Brazil, our expansion may also include additional acquisitions of existing service related businesses, aircraft hangars and other assets that are complementary to our core business and responsive to our perceived need to compete with our competitors. There can be no assurances that our plans to expand our business will be successful given a number of factors, including the possible need for regulatory approvals, additional facilities or rights, personnel and insurance. These new activities may require us to incur material costs and expenses, including capital expenditures, increased personnel, training, advertising, maintenance and fuel costs, as well as costs related to management oversight of any new or expanded activities. We may also incur additional significant costs related to integration of these assets and activities into our existing businesses and require significant ancillary expenditures for systems integration and expansion, financial modeling and development of pricing, traffic monitoring and other management tools designed to help achieve profitability from these new assets and activities.

Any expansion of our activities, change in management oversight and related costs may affect our results and financial condition until we are able to generate a profit from these new activities. Given the current and expected competitive landscape in the airline industry in general and in particular in Brazil, as well as other market factors and conditions, it is possible that there may be a significant period before we are able to generate profits relating to any such new or our existing activities and our overall business, and in certain circumstances we may never turn a profit at all, in each case potentially adversely affecting us.

We may not be able to grow our operations to or in the United States and Europe and may be adversely affected if Brazil does not maintain a favorable safety assessment or if we fail to comply with the United States and European civil aviation regulatory frameworks.

We cannot assure you that the laws and regulations of the jurisdictions to which we fly (including, without limitation, immigration and security regulations, which directly affect passengers) will not change or that new laws adverse to us will not be enacted, and any such events may adversely affect us and our ability to continue and expand our operations internationally.

For example, the FAA periodically audits the aviation regulatory authorities of other countries. As a result of their investigations, each country is given an International Aviation Safety Assessment, or IASA, rating. The IASA rating for Brazil is currently “Category 1”, which means that Brazil complies with the ICAO safety requirements. This allows us to continue our service from our hubs in Brazil to the United States in a normal manner and take part in reciprocal code-sharing arrangements with U.S. carriers. However, we cannot assure you that Brazil will continue to meet international safety standards, and we have no direct control over its compliance with IASA guidelines.

If Brazil does not maintain a favorable safety assessment or if we fail to comply with the United States and European civil aviation regulatory frameworks, our ability to continue or increase service to or in the United States and Europe could be restricted, which could in turn, adversely affect us.

We are highly dependent on our three hubs at Viracopos airport, Confins airport and Recife airport for a large portion of our business and as such, a material disruption at any of our hubs could adversely affect us.

Our business is heavily dependent on our operations at our three hubs at Viracopos airport, Confins airport and Recife airport. Many of our routes operate through these hubs, which account for a significant part of our daily arrivals and departures. Like other airlines, we are subject to delays caused by factors beyond our control and that could affect one or more of our hubs or other airports in any of the regions served by us. For example, in 2012, an incident with an aircraft from a cargo airline caused the closing of a runway at Viracopos airport, our main hub, for 45 hours, which negatively impacted our operations and forced us re-accommodate our passengers to new flights. Due to this geographical capacity concentration, we may not be able to react as quickly or efficiently as our competitors to any delays, interruption or disruption in service or fuel at any one or more of our hubs, which could have a material adverse impact on us.

 

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We fly and depend upon Embraer, ATR and Airbus aircraft, and we could suffer if we do not receive timely deliveries of aircraft, if aircraft from these companies become unavailable or subject to significant maintenance or if the public negatively perceives our aircraft.

As our fleet has grown, our reliance on Embraer, ATR and Airbus has also grown. Our operating fleet as of December 31, 2016 consisted of 74 Embraer E-Jets, 39 ATR aircraft, five next-generation Airbus A320neos, and five widebody Airbus A330s, totaling 123 aircraft.

Risks relating to Embraer, ATR and Airbus include: (i) our failure or inability to obtain Embraer, ATR or Airbus aircraft, parts or related support services on a timely basis because of high demand or other factors, (ii) the issuance by the aviation authorities of directives restricting or prohibiting the use of Embraer, ATR or Airbus aircraft, (iii) the adverse public perception of a manufacturer as a result of an accident or other negative publicity or (iv) delays between the time we realize the need for new aircraft and the time it takes us to arrange for Embraer, ATR and Airbus or from a third-party provider to deliver this aircraft.

Our ability to obtain these new aircraft from Embraer, ATR and Airbus may be affected by several factors, including (i) Embraer, ATR or Airbus may refuse to, or be financially limited in its ability to, fulfill the obligations it assumed under the aircraft delivery contracts, (ii) the occurrence of a fire, strike or other event affecting Embraer’s, ATR’s or Airbus’s ability to fulfill its contractual obligations in a complete and timely fashion and (iii) any inability on our part to obtain aircraft financing or any refusal by Embraer, ATR or Airbus to provide financial support. We may also be affected by any failure or inability of Embraer, ATR, Airbus (or other suppliers) to supply sufficient replacement parts in a timely fashion, which may cause the suspension of operations of certain aircraft because of unscheduled or unplanned maintenance. Any such suspension of operations would decrease passenger revenue and adversely affect us and our growth strategy.

The occurrence of any one or more of these factors could restrict our ability to use aircraft to generate profits, respond to increased demands, or could limit our operations and adversely affect us.

We could be adversely affected by expenses or stoppages associated with planned or unplanned maintenance on our aircraft, as well as any inability to obtain spare parts on time.

As of December 31, 2016, the average age of our operating fleet was 4.8 years. Our relatively new aircraft require less maintenance now than they will in the future. Our fleet will require more maintenance as it ages and our maintenance and repair expenses for each of our aircraft will be incurred at approximately the same intervals. In the event we cannot renew our fleet, our scheduled and unscheduled aircraft maintenance expenses will increase as a percentage of our revenue in future years. Any significant increase in maintenance and repair expenses would have a material adverse effect on us.

Our business would be significantly harmed by unplanned stoppages or suspensions of operations associated with planned or unplanned maintenance due to mechanical issues. For example, if a design defect or mechanical problem with E-Jets, ATRs or Airbus aircraft were to be discovered, this would cause our aircraft to be grounded while such defect or mechanical problem was being corrected. We cannot assure you that we would succeed in obtaining all aircraft and parts to solve such defect or mechanical problem, that we would obtain such parts on time, or that we would succeed in solving such defect or mechanical problem even if we obtained such parts. This could result in a suspension of the operations of certain of our aircraft, potentially for a prolonged period of time, while we attempted to obtain such parts and solve such defect or mechanical problem, which could have a materially adverse effect on us.

 

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Additionally, General Electric is the sole manufacturer and supplier of the CF34 engines on our Embraer E-Jets and of the LEAP engines on our next-generation Airbus A320neos, Pratt & Whitney is the sole manufacturer and supplier of the PW 127M engines on our ATR 72 aircraft, and Rolls Royce is the sole manufacturer of the Trent 700 engines for our A330 aircraft. As prices for the engines and parts are payable in U.S. dollars, they are subject to fluctuations in exchange rates and may result in us incurring substantial additional expenses in the event that the U.S. dollar appreciates. We have also outsourced all engine maintenance for our Embraer E-Jet and next-generation Airbus A320neo fleet to General Electric, for our ATR fleet to Pratt & Whitney, and the engine maintenance of our A330 fleet to Rolls Royce. If General Electric, Rolls Royce or Pratt & Whitney are unable to perform their contractual obligations or if we are unable to acquire engines from alternative suppliers on acceptable terms, we could lose the benefits we derive from our current agreements with General Electric, Pratt & Whitney and Rolls Royce, incur substantial transition costs, or suffer from the suspension of the operations of certain of our aircraft due to the need for unscheduled or unplanned maintenance while these contractual obligations are not being performed.

We rely on agreements with third parties to provide our customers and us with facilities and services that are integral to our business and the termination or non-performance of these agreements could harm us.

We have entered into agreements with third-party contractors to provide certain facilities and services required for our operations, such as aircraft maintenance, ground handling, baggage handling and television and internet services for our flights. All of these agreements are subject to termination on short notice. The loss or expiration of these agreements or our inability to renew these agreements or to negotiate new agreements with other providers at comparable term and conditions or at all could harm our business and results of operations. Further, our reliance on third parties to provide essential services on our behalf gives us less control over the costs, efficiency, timeliness and quality of those services. Any of these third parties may fail to meet their service performance commitments, may suffer disruptions to their systems that could impact the fulfillment of their obligations, or the agreements with such third parties may be terminated. The failure of any third-party contractor to adequately perform their services, or other interruptions of services, may adversely affect us, including reducing our revenues and increasing our expenses or preventing us from operating our flights or providing other services to our customers. In addition, we, including our reputation, could be materially adversely affected if our customers believe that our services or facilities are unreliable or unsatisfactory.

We rely on partner airlines for code-share and loyalty marketing arrangements and the loss of a significant partner through bankruptcy, consolidation, or otherwise, could adversely affect us.

Azul is a party to code-share agreements with international air carriers United and TAP. These agreements provide that certain flight segments operated by us are held out as United or TAP flights, as the case may be, and that certain United or TAP flights, as the case may be, are held out for sale as Azul flights. In addition, these agreements provide that our TudoAzul members can earn miles on or redeem miles for United or TAP flights, as the case may be, and vice versa. We receive revenue from flights sold under these code-share agreements. In addition, we believe that these frequent flyer arrangements are an important part of our TudoAzul program. The loss of a significant partner through bankruptcy, consolidation, or otherwise, could adversely affect us. We may also be adversely affected by the actions of one of our significant partners, for example, in the event of nonperformance of a partner’s material obligations or misconduct by such partner, which could potentially result in us incurring liabilities, or poor delivery of services by one of our partners, which could damage our brand.

We may be adversely affected if TudoAzul loses business partners or if these business partners change their policies in relation to the granting of benefits to their clients.

TudoAzul relies on its four largest business partners (which are the largest banks in Brazil) for a significant majority of its gross billings. We have no control or influence over TudoAzul’s business partners, which may terminate their relationship with TudoAzul or change their commercial policies with respect to the accumulation, transfer and redemption of miles, as well as choose to develop or offer their customers their own platforms for exchanging points for prizes, including airline tickets issued by other airlines. The loss of a significant TudoAzul business partner or changes to TudoAzul’s business partners’ policies could (i) make TudoAzul less attractive or efficient for our business partners’ customers, and (ii) increase competition with respect to TudoAzul, thereby reducing our gross sales and the demand for miles, factors that may negatively impact us. If we do not find satisfactory replacement business partners in the event of the loss of one or more of TudoAzul’s significant business partner or adapt satisfactorily to changes to TudoAzul’s business partners’ policies, we may be adversely affected.

 

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If actual redemptions by TudoAzul members are greater than expected, or if the costs related to redemption of reward points increase, we could be adversely affected.

We derive most of our TudoAzul revenues by selling TudoAzul points to business partners. The earnings process is not complete, however, at the time points are sold, as we incur most of our costs related to TudoAzul upon the actual redemption of points by our TudoAzul members. Based on historical data, the estimated period between the issuance of a TudoAzul point and its redemption is currently nine months; however, we cannot control the timing of the redemption of points or the number of points ultimately redeemed. Since we do not incur redemption-related costs for points that are not redeemed, our profitability depends in part on the number of accumulated TudoAzul points that are never redeemed by our TudoAzul members, or “breakage.” We experience breakage when TudoAzul points are not redeemed for any number of reasons.

Our estimate of breakage is based on historical trends. We expect that breakage will decrease from historical amounts as TudoAzul expands its network of business partners and makes available a greater variety of reward options to our TudoAzul members. We seek to offset the anticipated decrease in breakage through our pricing policy for points sold. If we fail to adequately price our points or actual redemptions exceed our expectations, TudoAzul’s profitability, and consequently our own profitability could be adversely affected. Furthermore, if actual redemptions exceed our expectations, we may not have sufficient cash on-hand to cover all actual redemption costs, which could materially adversely affect us.

We depend on our senior management team and the loss of any member of this team, including our Chairman and key executives, could adversely affect us.

Our business depends upon the efforts and skill of our senior management, including our Chairman, who has played an important role in shaping our company culture, as well as other key executives. Our future success depends on a significant extent on the continued service of our senior management team, who are critical to the development and the execution of our business strategies. Any member of our senior management team may leave us to establish or work in businesses that compete with ours. There is no guarantee that the compensation arrangements and non-competition agreements we have entered into with our senior management team are sufficiently broad or effective to prevent them from resigning in order to join or establish a competitor or that the non-competition agreements would be upheld in a court of law. In the event that our Chairman or a number of our senior management team leave our company, we may have difficulty finding suitable replacements, which could have a material adverse effect on us.

We may be unable to maintain our culture and to retain and/or hire skilled personnel as our business grows, such as pilots, which could have an adverse impact on us.

We believe that our growth potential and the maintenance of our results and customer oriented company culture are directly linked to our capacity to attract and maintain the best professionals available in the Brazilian airline industry. As we grow, we may be unable to identify, hire or retain enough people who meet the above criteria, or we may have trouble maintaining our company culture as we become a larger business. From time to time, the airline industry has experienced a shortage of skilled personnel, especially pilots. We compete against all other airlines, both inside and outside Brazil, for these highly-skilled personnel. We may have to increase wages and benefits to attract and retain qualified personnel or risk considerable employee turnover. Our culture is crucial to our business plan, and failure to maintain that culture could have an adverse impact on us.

 

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The airline industry is subject to increasingly stringent environmental regulations and non-compliance therewith may adversely affect us.

The airline industry is subject to increasingly stringent federal, state, local and foreign laws (including those of the United States and Europe), regulations and ordinances relating to the protection of the environment, including those relating to emissions to the air, levels of noise, discharges to surface and subsurface waters, safe drinking water, and the management of hazardous substances, oils and waste materials. As far as civil liabilities are concerned, Brazilian environmental laws adopt a strict and joint liability regime. In this regard we may be liable for violations by third parties hired to dispose of our waste, among other activities. These laws and regulations are enforced by various governmental authorities. Non-compliance with such laws and regulations may subject the violator to administrative and criminal sanctions, in addition to the obligation to repair or to pay damages caused to the environment and third parties. Pursuant to Brazilian environmental laws and regulations, the piercing of the corporate veil of a company may occur to help provide enough financial resources for the recovery of damages caused against the environment. As far as civil liabilities are concerned, Brazilian environmental laws adopt a strict and joint liability regime. Thus, we may be liable for violations by third parties hired to dispose of our waste.

Concerns about climate change and greenhouse gas emissions may result in additional regulation or taxation of aircraft emissions in Brazil, the United States or Europe. Future operations and financial results may vary as a result of the adoption of such regulations in Brazil, the United States or Europe.

The European Union has proposed a directive under which the existing emissions trading scheme, or ETS, in each European Union member state was to be extended to all airlines. This directive would require us to submit annual emission allowances in order to operate routes to and from European Union member states. As of the date of this prospectus, this proposal would affect only intra-European flights (which are not material to our business) but there is a possibility that the directive could be extended to all flights in the future. Currently, we operate one route to and from Europe, and service additional destinations in Europe through our code-sharing agreement with TAP. Although this proposal has been postponed for evaluation and it is uncertain whether it will be approved, it is increasingly likely that we will be required to participate in some form of an international aircraft emissions program in the future, which may involve significant costs.

We benefit from tax incentives on our purchases of jet fuel in Brazil and these tax incentives may be revoked at any time adversely affecting us.

The price of the jet fuel that we purchase in certain Brazilian states is subsidized through tax incentives provided to us by those states. Governmental authorities may revoke, suspend or fail to renew these tax incentives at any time, including if we fail to comply with our obligations in the tax incentive agreements that we have executed with those states. In addition, these tax incentives require approval from CONFAZ, the Brazilian National Council of Fiscal Policy, which have not yet been obtained and could therefore be canceled by the Brazilian Supreme Court at any time. If any of these tax incentives are canceled, revoked, suspended or not renewed, the prices that we pay for jet fuel would increase, which may lead to a significant increase in our costs and adversely affect us.

The agreements governing our debt contain covenants and restrictions that limit our ability to engage in change of control transactions, terminate our relationship with certain suppliers and incur certain levels of indebtedness.

Our financing agreements contain covenants and restrictions that restrict our and our subsidiaries’ ability to engage in change of control transactions and terminate concession agreements associated with such financing leases, whether through failure to renew or otherwise. In addition, certain of our financing instruments require us and our subsidiaries to meet financial covenants calculated as of December 31 of each year that, among other restrictions, limit our permissible ratios of debt to EBITDAR and debt to cash freely convertible into U.S. dollars. Our ability to comply with the covenants and restrictions contained in our financing agreements may be affected by economic, financial and industry conditions beyond our control. The breach of any of these covenants and restrictions could result in declaration of an event of default and acceleration of the maturity of indebtedness, which would require us to pay all amounts outstanding.

 

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As of December 31, 2016, we were not in compliance with certain financial covenants in our financing instruments requiring us to maintain certain ratios. We have obtained waivers from our creditors in connection with such noncompliance; nevertheless, had such waivers not been granted, we would have been in default under such financing instruments. For more information on the covenants and restrictions under our financing agreements see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loans and Financings.”

Unfavorable decisions in judicial or administrative proceedings could adversely affect us.

We and our subsidiaries are parties to various proceedings in the judicial and administrative spheres, including civil, labor, social security, tax, civil and regulatory actions. There is no way to guarantee that such lawsuits will be ruled favorably to us and/or our subsidiaries, or that the amounts provisioned are sufficient to cover amounts resulting from any unfavorable rulings. Decisions contrary to the interests of us and/or our subsidiaries that could eventually result in substantial payments, affect our image and/or the image of our subsidiaries or impede the performance of our business as initially planned may have a material adverse effect on our business, the business of our subsidiaries, our financial condition and our results of operations.

Any violation or alleged violation of anti-corruption, anti-bribery and anti-money laundering laws could adversely affect us, including our brand and reputation.

There can be no assurance that our employees, agents, and the companies to which we outsource certain of our business operations, will not take actions in violation of our anti-corruption, anti-bribery and anti-money laundering policies, for which we may be ultimately held responsible. As a result of this global offering, we will be subject to the United States Foreign Corrupt Practices Act of 1977, or the FCPA, by virtue of our shares being listed and traded in the United States, while in the past, our exposure was less significant due to our limited nexus with the United States. If we are not in compliance with anti-corruption laws, anti-money laundering laws and other laws governing the conduct of business with government entities, including under the FCPA and other United States and local laws, we may be subject to criminal and civil penalties and other remedial measures, which could harm our brand and reputation and have a material adverse impact on our business, financial condition, results of operations and prospects. Any investigation of any actual alleged violations of such laws could also adversely affect us, including our brand and reputation.

We are a holding company and do not have any material assets other than the shares of our subsidiaries.

We are a holding company that conducts its operations through a series of operating subsidiaries. We support these operating subsidiaries with technical and administrative services through our various other subsidiaries. All of the assets we use to perform administrative and technical services and to operate the concessions and authorizations are held at the subsidiary level. As a result, we do not have any material assets other than the shares of our subsidiaries. Dividends or payments that we may be required to make will be subject to the availability of cash provided by our subsidiaries. Transfers of cash from our subsidiaries to us may be further limited by corporate and legal requirements, or by the terms of the agreements governing our indebtedness. If a shareholder were to assert a claim against us, the enforcement of any related judgment would be limited to our available assets, rather than the assets of us and our combined subsidiaries.

 

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Risks Relating to the Global Offering and Our Preferred Shares, Including in the Form of ADSs

Our controlling shareholder has the ability to direct our business and affairs, and its interests may conflict with yours.

In accordance with Brazilian corporate law and our bylaws, our controlling shareholder has the legal power to, among other things, elect the majority of our directors and determine the outcome of any action requiring shareholder approval. This power includes the ability to control decisions with respect to related party transactions, corporate restructurings, dispositions, partnerships, sale of all or substantially all of our assets, withdrawal of our shares from the Level 2 segment of BM&FBOVESPA and the time for payment of any future dividends. Our controlling shareholder may choose to enter into acquisitions, dispositions, partnerships or enter into loans and financing or other similar transactions for us that could conflict with the interests of investors and that may negatively affect us. Upon completion of this global offering, assuming full exercise of the underwriters’ option to purchase additional shares, our controlling shareholder will own 67% of our voting capital and •% of our total capital. In particular, due to our capital structure, the capital contributions made by the holders of our common shares to date were considerably lower than those made by the holders of our preferred shares, which means that our controlling shareholder has the right to direct our business having considerably less economic exposure to any negative results of our activities than holders of our preferred shares. This difference in economic exposure may intensify conflicts of interests between our controlling shareholders and you.

Our controlling shareholder is entitled to receive significantly less dividends than holders of our preferred shares, which may cause his decisions on the distribution of dividends to conflict with your interests.

Holders of our common shares are entitled to receive an amount of dividends equivalent to 75 times less than the amount of dividends paid to holders of our preferred shares. The fact that our controlling shareholder receives a small portion of our dividends in each distribution in comparison to the amount of dividends to which holders of our preferred shares are entitled may influence his decisions on the distribution of dividends, which may differ from interests of the holders of our preferred shares. For more information on distribution of dividends and compensation of our management, see “Dividend Policy” and “Description of Capital Stock,” respectively.

New investors in our preferred shares, including in the form of ADSs, will experience immediate book value dilution after this offering and may experience further dilution in the future.

The initial public offering price of our preferred shares (including in the form of ADSs) is higher than the book value of such shares immediately after this global offering. In addition, this difference will increase further as a result of the exercise of stock options granted to our management.

We have established stock option and restricted stock plans for key personnel, including our officers, certain managers and other key crewmembers. Following the pricing of this global offering, all options that have vested will become exercisable, and any shares issued thereby will be subject to the lock-up restrictions discussed in the section of this prospectus entitled “Underwriters.” We estimate that 4,468,832 new preferred shares would be issued if all of our vested options are exercised by the holders thereof at a weighted average strike price of R$14.90.

Any of the events above could result in substantial dilution in book value to new investors as the initial public offering price for our preferred shares (including in the form of ADSs) will be higher than the book value of such shares immediately after this global offering or in the future upon the exercise of our stock options. See “Dilution” and “Management—Stock Option and Restricted Stock Plans.” In addition, in the event that we need to obtain capital for our operations by issuing new shares in the future, any such issuance may be made at a value below the book value of our preferred shares on the relevant date. In that event, the holders of our ADSs and preferred shares at such time would suffer an immediate and significant dilution of their investment.

 

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Our preferred shares, including in the form of ADSs, have not previously been traded on any stock exchange and, therefore, an active and liquid trading market for such securities may not develop, thereby potentially adversely affecting the price our preferred shares, including in the form of ADSs, after this global offering.

Before this global offering, none of our preferred shares, including in the form of ADSs, have ever been traded on any stock exchange. In connection with the global offering, we will apply to list ADSs representing our preferred shares on the NYSE and our preferred shares on BM&FBOVESPA. An active and liquid public trading market for our preferred shares, including in the form of ADSs, may not develop or, if developed, may not be sufficiently liquid. Active, liquid trading markets generally result in lower price volatility and more efficient purchases and sales of shares.

The investment in marketable securities traded in emerging countries, such as Brazil, usually represents higher levels of risk as compared to investments in securities issued in countries whose political and economic situations are more stable, and in general, such investments are considered speculative in nature. The Brazilian capital market is substantially smaller, less liquid, more volatile, and more concentrated than major international capital markets. BM&FBOVESPA listed companies had a market capitalization of R$2.5 trillion and a daily average trading volume of R$7.4 billion as of December 31, 2016. The top 10 stocks in terms of trading volume accounted for 59.8% and 54.3% of all shares traded on BM&FBOVESPA during 2016 and 2015, respectively. These market characteristics may substantially limit the capacity of holders of our preferred shares to sell them at the price and time of their preference and this may have an adverse effect on the market price of our preferred shares.

In addition, the price of shares of companies in the worldwide airline industry are relatively volatile and investors’ perception of the market value of these shares, including our preferred shares in the form of ADSs, may also be negatively impacted with additional volatility and decreases in the price of our ADSs and preferred shares.

The initial public offering price for our preferred shares, including in the form of ADSs, will be determined by negotiation between us, the international underwriters and the Brazilian underwriters based upon several factors, and the price of our preferred shares, including in the form of ADSs, after this global offering may decline below the initial public offering price. The market price of our preferred shares could vary significantly as a result of a number of factors, some of which are beyond our control. As a result, investors may experience a significant decrease in the market price of our preferred shares, including in the form of ADSs. If an active trading market does not develop or is not maintained, the liquidity and price of our preferred shares, including in the form of ADSs, could be seriously harmed.

Our preferred shares will have limited voting rights even if dividends are not paid.

Except under certain situations, our preferred shares, including in the form of ADSs, do not carry general voting rights. See “Description of Capital Stock—Voting Rights.” Our principal shareholders, who hold the majority of common shares with voting rights and control us, are therefore able to approve corporate measures without the approval of holders of our preferred shares, including in the form of ADSs. Accordingly, you will generally not have control over any matters, including the approval of corporate measures such as appointment of directors, approval of significant transactions or changes in our capital structure.

According to Brazilian corporate law, preferred shares with limited or no voting rights and with rights to fixed or minimum priority dividends, gain voting rights if the company ceases to pay the fixed or minimum dividends to which such shares are entitled for three consecutive fiscal years. However, pursuant to our bylaws, the dividends attributed to our preferred shares are not fixed or minimum priority dividends. Accordingly, our preferred shares will not be entitled to voting rights if we do not pay dividends for three consecutive fiscal years.

In addition, to the extent holders of our preferred shares are entitled to vote on certain limited matters pursuant to Brazilian corporate law, the provisions of our bylaws, and the provisions of or governing the deposited preferred shares, we cannot assure ADS holders that they will receive the voting materials in time to ensure that they can instruct the depositary to vote the preferred shares underlying their ADSs. Furthermore, there can be no assurance that ADS holders will be given the opportunity to vote or cause the custodian to vote on the same terms and conditions as the holders of our preferred shares. While ADS holders could exercise their right to vote directly if they withdraw the preferred shares, such ADS holders may not know about the meeting sufficiently enough in advance to withdraw the preferred shares. See “Description of Capital Stock—Voting Rights.”

 

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Holders of our preferred shares, including in the form of ADSs, may not receive any dividends or interest attributable to shareholders’ equity.

According to our bylaws, we must pay our common and preferred shareholders at least 0.1% of our annual adjusted net income as dividends or interest attributable to shareholders’ equity, as calculated and adjusted pursuant to Brazilian corporate law. Interim dividends and interest on our shareholders’ equity declared for each fiscal year may be attributed to our minimum obligatory dividend for the year in which it was declared. For more information, see “Dividend Policy.” This adjusted net income may be capitalized, used to absorb losses or otherwise retained as allowed under Brazilian corporate law, and may not be made available for payment as dividends or interest attributable to shareholders’ equity.

Additionally, Brazilian corporate law allows a company like ours to suspend the mandatory distribution of dividends in any particular fiscal year if our board of directors informs our shareholders that such distribution would be inadvisable in view of our financial condition. If these events were to occur, the holders of our preferred shares, including in the form of ADSs may not receive dividends or interest attributable to shareholders’ equity.

The sale of a significant number of our preferred shares, including in the form of ADSs, after the offering may negatively affect the trading price of our preferred shares, including in the form of ADSs.

We, the Selling Shareholders, all of our directors and officers and holders of at least 1.0% of our common shares and/or at least 1.0% of our economic interest have agreed not, within 180 days following the pricing of this global offering, subject to certain exceptions, to issue, offer, sell, contract to sell, pledge or otherwise transfer or dispose of, directly or indirectly, or file with the SEC or the CVM a registration statement relating to, any common and/or preferred shares, ADSs or securities convertible into or exchangeable or exercisable for preferred shares (including our common shares) or ADSs, or publicly disclose any intention to make any such offer, sale, pledge, deposit, disposition, loan contract, grant or filing, without the prior written consent of the Representatives.

In addition, pursuant to the regulations of the Level 2 segment of BM&FBOVESPA, our controlling shareholders, our directors and executive officers may not sell and/or offer for sale any common and/or preferred shares of our company or derivatives linked to our common and/or preferred shares, which we or they hold immediately after the offering, for a period of six months as of the effectiveness of the Level 2 segment of BM&FBOVESPA listing agreement. Following this initial six-month period, our controlling shareholders, directors and executive officers may not sell and/or offer for sale, for an additional six-month period, more than 40% of our common and/or preferred shares of our company (or derivatives linked to such shares) immediately after this global offering.

We or our principal shareholders may sell additional preferred shares, including in the form of ADSs, at any time following the termination of these lock-up restrictions. In addition, under a registration rights agreement, as amended and restated, or the Registration Rights Agreement, that we entered into on December 23, 2013 with our then principal shareholders, they have the right to require us to register additional preferred shares held by them with the SEC for future sale at any time commencing six months following this global offering. For further details of the registration rights agreement, see “Principal and Selling Shareholders—Registration Rights Agreement.”

A sale of a significant number of our preferred shares, including in the form of ADSs, or market perception of an intention to sell a significant number of our preferred shares, including in the form of ADSs, may negatively affect the trading price of our preferred shares, including in the form of ADSs.

 

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The participation of our controlling shareholder, members of our board of directors, our officers, the Brazilian underwriters, the international underwriters and any other person related to the offering and their respective relatives, in this global offering may adversely affect the liquidity of our preferred shares, including in the form of ADSs, and the determination of the offering price.

The offering price will be determined after a bookbuilding process, which may include purchase commitments by institutional investors, our controlling shareholder, members of our board of directors, our board of executive officers, the Brazilian underwriters, the international underwriters and any other person related to the offering and their respective relatives, subject to the applicable regulations. CVM Instruction No. 400 dated December 29, 2003 limits the participation in the bookbuilding process of institutional investors that are considered related persons. However, in the event that demand for our preferred shares, including in the form of ADSs, offered in the global offering is less than the number of securities offered plus one-third of this amount, institutional investors that are considered related persons may purchase up to 15% of the total preferred shares, including in the form of ADSs, offered in the global offering. Additionally, affiliates of the Brazilian underwriters may purchase preferred shares, including in the form of ADSs, for hedging purposes using derivate instruments for the account of and on behalf of their clients.

These transactions may influence the demand for our preferred shares, including in the form of ADSs, and the offering price, and the participation of these persons in the offering may have an adverse effect on the liquidity of our preferred shares, including in the form of ADSs, and determination of the offering price per ADS/preferred share.

Changes in Brazilian tax laws may have an adverse impact on the taxes applicable to a disposition of our preferred shares, including in the form of ADSs.

Law No. 10,833 of December 29, 2003 provides that the disposition of assets located in Brazil by a nonresident to either a resident or a nonresident of Brazil is subject to taxation in Brazil, regardless of whether the disposition occurs outside or within Brazil. This provision results in the imposition of income tax on the gains arising from a disposition of our preferred shares by a nonresident of Brazil to either a resident or a nonresident of Brazil. However, since currently there is no judicial guidance determining whether ADSs should be considered assets located in Brazil, we are unable to predict whether Brazilian courts may decide that income tax under Law No. 10,833 applies to gains assessed on dispositions of our ADSs. In the event that the disposition of assets is interpreted to include the disposition of our ADSs, this tax law would result in the imposition of withholding taxes on the sale of our ADSs by a nonresident of Brazil to either a resident or a nonresident of Brazil. Because any gain or loss recognized by a U.S. Holder (as defined in “Taxation—Material U.S. Federal Income Tax Consequences”) on the disposition of preferred shares or ADSs generally will be treated as U.S.-source gain or loss for U.S. foreign tax credit purposes, the U.S. Holder may not be able to benefit from a foreign tax credit for Brazilian income tax imposed on the disposition of preferred shares or ADSs unless the U.S. Holder can apply the credit against U.S. federal income tax payable on other income from foreign sources. See “Taxation—Material U.S. Federal Income Tax Consequences—Sale or Other Taxable Disposition of Preferred Shares, Including in the Form of ADSs.”

 

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The Brazilian government may impose exchange controls and significant restrictions on remittances of reais abroad, which would adversely affect your ability to convert and remit dividends or other distributions or the proceeds from the sale of our preferred shares, our capacity to make dividend payments or other distributions to non-Brazilian investors and would reduce the market price of our preferred shares, including in the form of ADSs, and our capacity to comply with payment obligations in foreign currency.

In case of serious imbalances, the Brazilian government may restrict the remittance abroad of proceeds of investments in Brazil and the conversion of the real into foreign currencies. The Brazilian government last imposed such remittance restrictions for a brief period in 1989 and early 1990. We cannot assure you that the Brazilian government will not take similar measures in the future. The return of any such restrictions would hinder or prevent your ability to convert dividends or other distributions or the proceeds from any sale of our preferred shares into U.S. dollars and to remit U.S. dollars abroad, our capacity to make dividend payments or other distributions to non-Brazilian investors, and our capacity to comply with payment obligations in foreign currency. The imposition of any such restrictions would have a material adverse effect on the stock market price of our preferred shares, including in the form of ADSs, and on our capacity to access foreign capital markets.

If you surrender your ADSs and withdraw preferred shares, you risk losing the ability to remit foreign currency abroad and certain Brazilian tax advantages.

As an ADS holder, you benefit from the electronic certificate of foreign capital registration obtained by the custodian for our preferred shares underlying the ADSs in Brazil, permitting the custodian to convert dividends and other distributions with respect to our preferred shares into non-Brazilian currency and remit the proceeds abroad. If you surrender your ADSs and withdraw preferred shares, you will be entitled to continue to rely on the custodian’s electronic certificate of foreign capital registration for only five business days from the date of withdrawal. Thereafter, upon the disposition of distributions relating to our preferred shares, unless you obtain your own electronic certificate of foreign capital registration, or you qualify under Brazilian foreign investment regulations that entitle some foreign investors to buy and sell shares on Brazilian stock exchanges without obtaining separate electronic certificates of foreign capital registration, you would not be able to remit abroad non-Brazilian currency. In addition, if you do not qualify under the foreign investment regulations, you will generally be subject to less favorable tax treatment of dividends and distributions on, and the proceeds from any sale of, our preferred shares.

If you attempt to obtain your own electronic certificate of foreign capital registration, you may incur expenses or suffer delays in the application process, which could delay your ability to receive dividends or distributions relating to our preferred shares or the return of your capital in a timely manner. The depositary’s electronic certificate of foreign capital registration may also be adversely affected by future legislative changes.

If we do not maintain a registration statement and no exemption from the Securities Act is available, U.S. Holders of ADSs will be unable to exercise preemptive rights with respect to our preferred shares.

We may, from time to time, offer preferred shares or preemptive rights to acquire additional preferred shares to preferred shareholders, including as a result of the Brazilian Corporate Law. We will not be able to offer such shares or rights to holders of ADSs unless a registration statement under the Securities Act is effective with respect to such preferred shares and preemptive rights, or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file such registration statement, and we cannot assure you that we will file a registration statement. If a registration statement is not filed and an exemption from registration does not exist, Citibank, N.A., as depositary, will attempt to sell such preemptive rights or preferred shares, as the case may be, and you will be entitled to receive the proceeds of the sale. However, if the depositary is unable to sell these preemptive rights or preferred shares, U.S. holders of ADSs will not receive any value in connection with such distribution.

 

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In the event that you are not entitled to preemptive rights, or are unable or unwilling to exercise preemptive rights in connection with the preferred shares, including in the form of ADSs, your investment could be subjected to dilution.

We will be required to assess our internal control over financial reporting on an annual basis and any future adverse findings from such assessment could result in a loss of investor confidence in our financial reports, significant expenses to remediate any internal control deficiencies and ultimately have an adverse effect on the market price of our preferred shares, including in the form of ADSs.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual Report on Form 20-F for the year ending December 31, 2018, our management will be required to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control over financial reporting. The rules governing the standards that must be met for management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. We are currently in the process of reviewing, documenting and testing our internal control over financial reporting, and can provide no assurance that from time to time we will not identify concerns that could require remediation. We may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal control over financial reporting. In connection with the attestation process by our independent registered public accounting firm, we may encounter problems or delays in completing the implementation of any requested improvements and receiving a favorable attestation. In addition, if we fail to maintain the adequacy of our internal control over financial reporting we will not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 which may have an adverse effect on us.

The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members or executive officers.

As a public company, we will incur significant legal, accounting and other expenses that we have not incurred as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with the Sarbanes-Oxley Act of 2002, as amended, and related rules implemented by the SEC. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations could also make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as our executive officers and may divert management’s attention. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our preferred shares, fines, sanctions and other regulatory action and potentially civil litigation which may adversely affect us.

If securities or industry analysts do not publish research or reports about our business, or publish negative reports about our business, the market price and trading volume of our preferred shares, including in the form of ADSs could decline.

The trading market for our preferred shares, including in the form of ADSs, depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our preferred shares, including in the form of ADSs, could decline, which might cause the market price and trading volume of our preferred shares, including in the form of ADSs to decline.

 

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Our status as a foreign private issuer allows us to follow alternate standards to the corporate governance standards of the NYSE, which may limit the protections afforded to investors.

We are a “foreign private issuer” within the meaning of the NYSE corporate governance standards. Under NYSE rules, a foreign private issuer may elect to comply with the practices of its home country and not comply with certain corporate governance requirements applicable to U.S. companies with securities listed on the exchange. We currently follow certain Brazilian practices concerning corporate governance and intend to continue to do so.

We intend to rely on certain exemptions as a foreign private issuer listed on the NYSE. For example, a majority of our board of directors will not be independent, and we do not plan to hold at least one executive session of solely independent members of our board of directors each year. Also, pursuant to Brazilian corporate law and Instruction No. 308, dated May 14, 1999, as amended, issued by CVM, our audit committee, unlike the audit committee of a U.S. issuer, will not be composed of directors only, will only have an “advisory” role and may only make recommendations for adoption by our board of directors, which will be responsible for the ultimate vote and final decision.

In addition, we do not intend to have a nominating committee as required for U.S. issuers under the NYSE rules and although we have a compensation committee and a corporate governance committee, we are not required to comply with the NYSE standards applicable to compensation or corporate governance committees of listed companies.

Furthermore, the corporate disclosure requirements that apply to us may not be equivalent to the disclosure requirements that apply to a U.S. company and, as a result, you may receive less information about us than you would receive from a comparable U.S. company. We are subject to the reporting requirements of the Securities Exchange act of 1934, as amended, or the Exchange Act. The disclosure requirements applicable to foreign private issuers under the Exchange Act are more limited than the disclosure requirements applicable to U.S. issuers. Publicly available information about issuers of securities listed on the CVM, which is provided in Portuguese, also provides less detail in certain respects than the information regularly published by listed companies in the United States or in certain other countries.

Accordingly, holders of our ADSs will not have the same protections afforded to shareholders of companies that are subject to all of the NYSE corporate governance requirements.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus includes estimates and forward-looking statements principally under the captions “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.”

These estimates and forward-looking statements are based mainly on our current expectations and estimates of future events and trends that affect or may affect our business, financial condition, results of operations, cash flow, liquidity, prospects and the trading price of our preferred shares, including in the form of ADSs. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to many significant risks, uncertainties and assumptions and are made in light of information currently available to us.

These statements appear throughout this prospectus and include statements regarding our intent, belief or current expectations in connection with:

 

    changes in market prices, customer demand and preferences and competitive conditions;

 

    general economic, political and business conditions in Brazil, particularly in the geographic markets we serve as well as any other countries we currently serve and may serve in the future;

 

    our ability to keep costs low;

 

    existing and future governmental regulations;

 

    increases in maintenance costs, fuel costs and insurance premiums;

 

    our ability to maintain landing rights in the airports that we operate;

 

    air travel substitutes;

 

    labor disputes, employee strikes and other labor-related disruptions, including in connection with negotiations with unions;

 

    our ability to attract and retain qualified personnel;

 

    our aircraft utilization rate;

 

    defects or mechanical problems with our aircraft;

 

    our ability to successfully implement our growth strategy, including our expected fleet growth, passenger growth, our capital expenditure plans, our future joint venture and partnership plans, our ability to enter new airports (including certain international airports), that match our operating criteria;

 

    management’s expectations and estimates concerning our future financial performance and financing plans and programs;

 

    our level of debt and other fixed obligations;

 

    our reliance on third parties, including changes in the availability or increased cost of air transport infrastructure and airport facilities;

 

    inflation, appreciation, depreciation and devaluation of the real;

 

    our aircraft and engine suppliers; and

 

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    other factors or trends affecting our financial condition or results of operations, including those factors identified or discussed as set forth under “Risk Factors.”

The words “believe,” “understand,” “may,” “will,” “aim,” “estimate,” “continue,” “anticipate,” “seek,” “intend,” “expect,” “should,” “could,” “forecast” and similar words are intended to identify forward-looking statements. You should not place undue reliance on such statements, which speak only as of the date they were made. Neither we nor the Selling Shareholders undertake any obligation to update publicly or to revise any forward-looking statements after we distribute this prospectus because of new information, future events or other factors. Our independent public auditors have neither examined nor compiled the forward-looking statements and, accordingly, do not provide any assurance with respect to such statements. In light of the risks and uncertainties described above, the future events and circumstances discussed in this prospectus might not occur and are not guarantees of future performance. Because of these uncertainties, you should not make any investment decision based upon these estimates and forward-looking statements.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of preferred shares, including in the form of ADSs, in this global offering will be approximately R$• million, after deducting commissions and estimated expenses payable by us, and assuming an initial public offering of R$• per preferred share (and US$ • per ADS, based on an exchange rate of R$• to US$1.00 as of •, 2017), which is the midpoint of the range set forth on the cover of this prospectus.

We intend to use the net proceeds from this global offering for the following purposes:

 

    R$333 million to repay indebtedness; and

 

    the balance for general corporate purposes.

We intend to use a portion of the proceeds from this global offering to pay down approximately R$333 million of debt with maturities ranging from April 2017 to December 2017 and an average weighted interest cost per annum of 120% of the CDI Rate, which was approximately 15.4% per annum as of the date of this prospectus. During the year ended December 31, 2016, proceeds from loans and debentures, which totalled R$620.5 million, were used principally to finance our fleet optimization, to substitute debts that were due for repayment and general corporate purposes. For additional information regarding our indebtedness, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loans and Financings” and “—Off Balance Sheet Arrangements.”

We will not receive any proceeds from the sale of preferred shares, including in the form of ADSs, by the Selling Shareholders.

The total amount of estimated proceeds from this offering excludes any proceeds resulting from the exercise of stock options that will be vested and exercisable following completion of this offering. See “Management—Stock Option and Restricted Stock Plans”.

 

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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.

Since 1999, the Central Bank has allowed the U.S. dollar-real exchange rate to float freely. Since then, the U.S. dollar-real exchange rate has fluctuated considerably.

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. See “Risk Factors—Risks Relating to Brazil—The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. This involvement as well as Brazil’s political and economic conditions could adversely affect us and the price of our preferred shares, including in the form of ADSs.”

The real may depreciate or appreciate against the U.S. dollar substantially. See “Risk Factors—Risks Relating to Brazil—Exchange rate instability may have adverse effects on the Brazilian economy, us, and the market price of our preferred shares, including in the form of ADSs.”

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 “Risk Factors—Risks Relating the Global Offering and to our preferred shares, including in the form of ADSs— The Brazilian government may impose exchange controls and significant restrictions on remittances of reais abroad, which would adversely affect your ability to convert and remit dividends or other distributions or the proceeds from the sale of our preferred shares, our capacity to make dividend payments or other distributions to non-Brazilian investors and would reduce the market price of our preferred shares, including in the form of ADSs, and our capacity to comply with payment obligations in foreign currency.”

The following table shows the period end, average, high and low commercial selling real/U.S. dollar exchange rate reported by the Central Bank on its website for the periods and dates indicated.

 

     R$ per US$1.00  

Year Ended December 31,

   Low      High      Average (1)      Period End  

2012

     1.70         2.11         1.95         2.04   

2013

     1.95         2.45         2.16         2.34   

2014

     2.20         2.74         2.35         2.66   

2015

     2.58         4.19         3.34         3.90   

2016

     3.12         4.16         3.48         3.26   

 

Month Ended

   Low      High      Average (2)      Period End  

August 2016

     3.13         3.27         3.21         3.24   

September 2016

     3.19         3.33         3.26         3.25   

October 2016

     3.12         3.24         3.19         3.18   

November 2016

     3.20         3.44         3.34         3.40   

December 2016

     3.26         3.47         3.35         3.26   

January 2017

     3.13         3.27         3.20         3.13   

February 2017 (through February 3, 2017)

     3.12         3.15         3.14         3.12   

 

(1) Represents the average of exchange rates on each day of each month during the periods indicated.
(2) Represents the average of the daily exchange rates during each day of the respective month indicated.

 

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CAPITALIZATION

The table below presents our consolidated capitalization as of December 31, 2016:

 

  (a) on a historical basis; and

 

  (b) as adjusted to reflect (i) the receipt by us of approximately R$• million in net proceeds from this global offering, after deducting commissions and estimated expenses payable by us (based on offering price of R$• per preferred share, the midpoint of the indicative price range in this global offering), and (ii) the repayment by us of total working capital debt of R$• million as described in “Use of Proceeds.”

The information presented below in the column marked “Actual” is derived from our audited consolidated financial statements as of December 31, 2016. This table should be read in conjunction with, and is qualified in its entirety by reference to, “Selected Consolidated Financial Information” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loan and Financings”, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Off Balance Sheet Arrangements,” and our audited consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     Actual      As Adjusted  
     US$(1)      R$      US$(1)      R$  
     (in thousands)  

Cash and cash equivalents

     168,502         549,164                   
  

 

 

    

 

 

    

 

 

    

 

 

 

Short-term investments

     101,626         331,210                   
  

 

 

    

 

 

    

 

 

    

 

 

 
           

Current loans and financing

     302,304         985,238                   

Noncurrent loans and financing

     935,613         3,049,257                   

Current derivative financial instruments liability

     64,781         211,128                   

Noncurrent derivative financial instruments liability

     6,205         20,223                   

Total equity

     307,443         1,001,987                   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capitalization(2)

     1,616,346         5,267,833                   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) Total capitalization corresponds to the sum of current and noncurrent loans and financing, current and noncurrent derivative financial instruments and total equity.

The calculations above assume that no stock options will be exercised by the holders thereof.

 

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DILUTION

As of December 31, 2016, our total equity was R$1,002.0 million represented by 464,482,529 common shares and 127,285,633 preferred shares outstanding. Total equity represents our total assets net of our total liabilities.

For purposes of this Dilution section, in order to account for the differences in economic interest between our different classes of shares, we have calculated our book value per preferred share on a pro forma basis assuming that (i) all our common shares have been fully converted on a theoretical basis into Class A preferred shares at a ratio of 75:1, such formula as set forth in our bylaws, resulting in 6,193,100 additional Class A preferred shares, (ii) all our Class C preferred shares and Class D preferred shares have been fully converted on a theoretical basis into Class A preferred shares at a ratio of 1:1, resulting in 37,042,846 additional Class A preferred shares, which we expect to occur in connection with this global offering and (iii) the renaming of our Class A preferred shares to preferred shares. After giving effect to these calculations, we would have 133,478,734 preferred shares outstanding as of December 31, 2016 on a pro forma basis, and our pro forma book value per preferred share as of December 31, 2016, calculated by dividing our total equity of R$1,002.0 million by 133,478,734 preferred shares, would have been R$7.51.

Using our pro forma book value per preferred share of R$7.51 as a base and assuming a single class of 133,478,734 preferred shares outstanding on a theoretical fully converted basis as of December 31, 2016 and giving further effect to:

 

  (i) the issuance of • new preferred shares in this global offering, including in the form of ADSs, at a price of R$• per preferred share (the midpoint of the indicative price range in this global offering), after deducting commissions and estimated expenses of the offering payable by us; and

 

  (ii) the issuance of 4,468,832 new preferred shares to our management at a weighted average strike price of R$14.90 as a result of the exercise of all stock options that will be vested and exercisable immediately following this global offering.

then our pro forma total equity as of December 31, 2016 would have been R$• million and there would be • preferred shares outstanding following these issuances and conversions, resulting in a pro forma book value per preferred share of R$•.

The issuance of new preferred shares as described above would therefore result in an immediate dilution in our book value of R$• per preferred share to purchasers in this global offering, compared to our pro forma book value per preferred share as of December 31, 2016, considering a single class of preferred shares and the theoretical full conversion of our common shares into preferred shares.

 

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The following table illustrates this dilution:

 

     R$ (except for
%)

Offering price per preferred share

  

Pro forma book value per preferred share as of December 31, 2016, (i) assuming the conversion of • common shares into • Class A preferred shares at a conversion ratio of 75.0 common shares to 1.0 Class A preferred share and (ii) reflecting the conversion of • Class C preferred shares into • Class A preferred shares, and of • Class D preferred shares into • Class A preferred shares and that all of our Class A preferred shares are renamed “preferred shares”

   R$7.51

Pro forma book value per preferred share as of December 31, 2016 giving effect to the conversions described above and the issuance of • new preferred shares in this global offering

  

Pro forma book value per preferred share as of December 31, 2016 giving effect to the conversions described above and the issuance of • new preferred shares in respect of stock options to management at a weighted average strike price of R$14.90

  

Increase in pro forma book value per preferred share attributable to the above matters

  

Dilution in pro forma book value per preferred share to new investors in this global offering attributable to the above matters

  

Percentage of dilution per share to new investors(1)

   •%

 

(1) The percentage of dilution in pro forma book value per share to new investors is calculated by dividing the dilution in pro forma book value per share to the new investors by the price per share of R$• which is the midpoint of the indicative price range in this global offering.

The actual offering price per preferred share, including in the form of ADS, will be established on the basis of a bookbuilding process and will not necessarily bear direct relationship to the book value of our preferred shares on either an actual or pro forma basis.

An increase of R$1.00 in the offering price per preferred share of R$• (which is the midpoint of the indicative initial offering price range per share included on the cover page of this prospectus) would, upon completion of this global offering, increase:

 

  (i) our equity by R$• million;

 

  (ii) our pro forma equity per preferred share by R$•; and

 

  (iii) the dilution in pro forma book value per preferred share to new investors in this global offering by R$•, in each case after giving effect to the issuances and related assumptions described above.

A decrease of R$1.00 in the offering price per preferred share of R$• (which is the midpoint of the indicative price range per share included on the cover page of this prospectus) would decrease the items described above by the same amounts.

 

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SELECTED CONSOLIDATED FINANCIAL INFORMATION

The following tables summarize our financial data for each of the periods indicated. You should read this information in conjunction with:

 

    our audited consolidated financial statements as of and for each of the years ended December 31, 2016, 2015 and 2014 and the related notes; and

 

    the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations;”

all included elsewhere in this prospectus.

Our selected financial data included below is derived from our audited consolidated financial statements, which were prepared in accordance with IFRS. Our selected financial data as of and for the years ended December 31, 2016, 2015 and 2014 is derived from our audited consolidated financial statements included elsewhere in this prospectus. Our financial data as of and for the years ended December 31, 2013 and 2012 has been derived from our audited consolidated financial statements in accordance with IFRS, not included in this prospectus.

Statements of Operations Data

 

     For the Years Ended December 31,  
     2016     2016     2015     2014     2013     2012  
     (US$)(1)    

(R$)

    (R$)     (R$)     (R$)     (R$)  
     (in thousands, except amounts per share and %)  

Operating revenue

            

Passenger revenue

     1,775,585        5,786,809        5,575,344        5,129,613        4,667,542        2,454,651   

Other revenue

     270,959        883,082        682,522        673,440        566,613        262,704   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     2,046,544        6,669,891        6,257,866        5,803,053        5,234,155        2,717,355   

Operating expenses

            

Aircraft fuel

     (478,728     (1,560,223     (1,917,606     (1,955,036     (1,779,300     (1,073,261

Salaries, wages and benefits

     (335,022     (1,091,871     (1,042,119     (991,449     (803,331     (510,435

Aircraft and other rent

     (356,206     (1,160,912     (1,171,325     (689,055     (532,498     (229,393

Landing fees

     (135,833     (442,692     (382,610     (314,402     (285,709     (156,468

Traffic and customer servicing

     (100,423     (327,289     (307,926     (240,783     (206,459     (130,076

Sales and marketing

     (84,748     (276,203     (258,214     (239,359     (207,759     (131,708

Maintenance, materials and repairs

     (217,465     (708,739     (643,897     (353,339     (331,725     (126,817

Depreciation and amortization

     (92,418     (301,201     (217,983     (197,755     (200,067     (106,013

Other operating expenses, net

     (140,062     (456,475     (483,773     (420,949     (419,065     (244,543
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (1,940,905     (6,325,605     (6,425,453     (5,402,127     (4,765,913     (2,708,714
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     105,638        344,286        (167,587     400,926        468,242        8,641   

Financial result

     —               

Financial income

     15,669        51,067        43,178        41,518        61,692        9,715   

Financial expense

     (224,356     (731,200     (685,919     (460,049     (316,462     (162,675

Derivative financial instruments, net

     3,314        10,800        (82,792     4,245        (12,027     10,009   

Foreign currency exchange, net

     55,128        179,668        (184,305     (74,104     (105,262     (37,659

Result from related party transactions, net

     50,028        163,045        —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) before income tax and social contribution

     5,421        17,666        (1,077,425     (87,464     96,183        (171,969

Income tax and social contribution

     2,679        8,731        (1,366     (4,368     (81,437       

 

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     For the Years Ended December 31,  
     2016     2016     2015     2014     2013      2012  
     (US$)(1)    

(R$)

    (R$)     (R$)     (R$)      (R$)  
     (in thousands, except amounts per share and %)  

Deferred income tax and social contribution

     (46,857     (152,711     3,886        26,792        5,965         1,127   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net (loss) income for the year

     (38,757     (126,314     (1,074,905     (65,040     20,711         (170,842
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Basic and diluted (loss) income for the year per common share R$/US$(2)

     (0.00     (0.01     (0.14     (0.01     0.01         (0.03

Basic and diluted (loss) income for the year per preferred share R$/US$

     (0.34     (1.10     (10.84     (0.69     0.23         (2.53

Other financial data (unaudited):

             

EBITDA(3)

     238,972        778,833        (449,148     437,601        547,762         61,395   

Adjusted EBITDA(4)

     198,057        645,487        50,396        598,681        668,309         114,654   

Adjusted EBITDAR(5)

     554,263        1,806,399        1,221,721        1,287,736        1,200,807         344,047   

Adjusted EBITDAR Margin (%)(6)

     27.1%        27.1%        19.5%        22.2%        22.9%         12.7%   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) Reflects the conversion ratio of 75.0 common shares to 1.0 preferred share.
(3) We calculate EBITDA as net income (loss) minus interest income (comprised of interest on short-term investments), plus interest expense (comprised of interest on loans and interest on factoring credit card and travel agencies receivables), current and deferred income tax and social contribution and depreciation and amortization. We believe EBITDA is a well recognized performance measurement in the airline industry that is frequently used by investors, securities analysts and other interested parties in comparing the operating performance of companies in our industry. EBITDA is not a measure of financial performance in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution. Other companies may calculate EBITDA differently than us. EBITDA serves an indicator of overall financial performance, which is not affected by changes in rates of income tax and social contribution or levels of depreciation and amortization. Consequently, we believe that EBITDA serves as an important tool to periodically compare our operating performance, as well as to support certain administrative decision. Because EBITDA does not include certain costs related to our business, such as interest expense, income taxes, depreciation, capital expenditures and other corresponding charges, which might significantly affect our net income, EBITDA has limitations which affect its use as an indicator of our profitability. See “Summary Financial and Operating Data” for a reconciliation of EBITDA to net income (loss).
(4) Adjusted EBITDA is equal to EBITDA adjusted to exclude foreign currency exchange, net, derivative financial instruments, net, other financial income (expense), and result from related party transactions, net. Adjusted EBITDA is not a measure of financial performance in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution. Other companies may calculate Adjusted EBITDA differently than us. Adjusted EBITDA serves as an indicator of overall financial performance that we believe serves as an important tool to periodically compare our operating performance, as well as to support certain administrative decisions. Because Adjusted EBITDA does not include certain costs related to our business, it has limitations which affect its use as an indicator of our profitability. See “Summary Financial and Operating Data” for a reconciliation of Adjusted EBITDA to net income (loss).
(5) Adjusted EBITDAR is equal to Adjusted EBITDA adjusted to exclude the expenses related to aircraft and other rent expenses. Adjusted EBITDAR is presented as supplemental information, because (i) we believe EBITDAR is a valuation metric traditionally used by aviation analysts and investors to determine the equity value of airlines and (ii) EBITDAR is one of the measures used in our material debt financing instruments for financial reporting purposes. We believe EBITDAR is useful for equity valuation purposes because (i) its calculation isolates the effects of financing in general, as well as the accounting effects of capital spending and acquisitions (primarily aircraft) which may be acquired directly subject to acquisition debt (loans and finance leases) or by operating leases, each of which is presented differently for accounting purposes and (ii) using a multiple of EBITDAR to calculate enterprise value allows for an adjustment to the balance sheet to recognize estimated liabilities arising from off-balance sheet operating leases. However, Adjusted EBITDAR is not a financial measure in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution because it excludes the cost of aircraft and other rent and is provided for the limited purposes contained herein. Other companies may calculate Adjusted EBITDAR differently than us. Adjusted EBITDAR should not be viewed as a measure of overall performance since it excludes aircraft rent, which is a normal, recurring cash operating expense. Adjusted EBITDAR has significant limitations which affect its use as an indicator of our profitability. Accordingly, you are cautioned not to place undue reliance on this information. For more information on the limitations of Adjusted EBITDAR as an analytical tool, see “Presentation of Financial and Other Information—Financial Statements.” As for the use of EBITDAR in our material debt financing instruments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loans and Financings”.
(6) Represents Adjusted EBITDAR divided by total operating revenue.

 

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The following table presents the reconciliation of the non-IFRS performance measures EBITDA and Adjusted EBITDA and the valuation metric Adjusted EBITDAR to net income (loss) for the periods indicated below:

 

     For the Years Ended December 31,  
     2016     2016     2015     2014     2013     2012  
     (US$)(1)    

(R$)

    (R$)     (R$)     (R$)     (R$)  
     (in thousands, except Adjusted EBITDAR margin)  

Reconciliation:

            

Net (loss) income for the year

     (38,757     (126,314     (1,074,905     (65,040     20,711        (170,842

Plus (minus):

            

Interest expense(2)

     152,667        497,557        450,960        364,255        262,381        134,850   

Interest income(3)

     (11,534     (37,591     (40,666     (36,945     (10,869     (7,499

Income tax and social contribution

     (2,679     (8,731     1,366        4,368        81,437        —     

Deferred income tax and social contribution

     46,857        152,711        (3,886     (26,792     (5,965     (1,127

Depreciation and amortization

     92,418        301,201        217,983        197,755        200,067        106,013   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA(4)

     238,972        778,833        (449,148     437,601        547,764        61,395   

Foreign currency exchange, net(5)

     (55,128     (179,668     184,305        74,104        105,262        37,659   

Derivative financial instruments(6)

     (3,314     (10,800     82,792        (4,245     12,027        (10,009

Other financial expenses(7)

     71,689        233,643        234,959        95,794        54,081        27,825   

Other financial income(8)

     (4,135     (13,476     (2,512     (4,573     (50,823     (2,216

Result from related party transactions, net

     (50,028     (163,045     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA(4)(9)

     198,057        645,487        50,396        598,681        668,309        114,654   

Aircraft and other rent

     356,206        1,160,912        1,171,325        689,055        532,498        229,393   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDAR(10)

     554,263        1,806,399        1,221,721        1,287,736        1,200,807        344,047   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDAR Margin (%)(11)

     27.1%        27.1%        19.5%        22.2%        22.9%        12.7%   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) Interest expense is interest on loans, factoring credit card, and travel agencies receivables, which is a component of financial expense. See Note 25 our audited consolidated financial statements.
(3) Interest income is interest on short-term investments, which is a component of financial income. See Note 25 to our audited consolidated financial statements.
(4) EBITDA and Adjusted EBITDA, as calculated by us, may not be comparable to EBITDA and Adjusted EBITDA as used by other companies which may calculate Adjusted EBITDA in a manner which differs from ours. EBITDA and Adjusted EBITDA are not measures of financial performance in accordance with IFRS. They do not represent cash flow for the corresponding periods, and should not be considered as alternatives to net income or loss or as measures of operating performance, cash flow or liquidity, nor should they be considered for the calculation of dividend distribution.

 

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(5) Represents the foreign exchange remeasurement on U.S. dollar and Euro denominated assets and liabilities.
(6) Represents currency forward contracts used to protect our U.S. dollar exposure.
(7) Other financial expenses are a component of our financial expense. See Note 25 to our audited consolidated financial statements.
(8) Other financial expenses for the year ended December 31, 2013 included R$47,423 for the fair value adjustment of other financial liabilities. Other financial income is a component of our financial income. See Note 25 to our audited consolidated financial statements.
(9) Adjustments exclude the effects of the following items: (i) the foreign currency exchange variation relating to U.S. dollars denominated assets and liabilities; (ii) gains or losses in connection with our derivative instruments used to protect us against variations of the U.S. dollar compared to the real; (iii) other financial expenses (does not include interest expense), which is a component of financial expense; (iv) other financial income and fair value adjustment of other financial liabilities (does not include interest income), which are components of financial income; and (v) related party transactions, net (as applicable). We believe that such adjustments are useful to indicate our operating performance.
(10) Adjusted EBITDAR is equal to Adjusted EBITDA adjusted to exclude the expenses related to aircraft and other rent expenses. Adjusted EBITDAR is presented as supplemental information, because (i) we believe EBITDAR is a valuation metric traditionally used by aviation analysts and investors to determine the equity value of airlines and (ii) EBITDAR is one of the measures used in our material debt financing instruments for financial reporting purposes. We believe EBITDAR is useful for equity valuation purposes because (i) its calculation isolates the effects of financing in general, as well as the accounting effects of capital spending and acquisitions (primarily aircraft) which may be acquired directly subject to acquisition debt (loans and finance leases) or by operating leases, each of which is presented differently for accounting purposes and (ii) using a multiple of EBITDAR to calculate enterprise value allows for an adjustment to the balance sheet to recognize estimated liabilities arising from off-balance sheet operating leases. However, Adjusted EBITDAR is not a financial measure in accordance with IFRS, and should not be considered in isolation or as an alternative to net income, an alternative to operating cash flows, a measure of liquidity, or the basis for dividend distribution because it excludes the cost of aircraft and other rent and is provided for the limited purposes contained herein. Other companies may calculate Adjusted EBITDAR differently than us. Adjusted EBITDAR should not be viewed as a measure of overall performance since it excludes aircraft rent, which is a normal, recurring cash operating expense. Adjusted EBITDAR has significant limitations which affect its use as an indicator of our profitability. Accordingly, you are cautioned not to place undue reliance on this information. For more information on the limitations of Adjusted EBITDAR as an analytical tool, see “Presentation of Financial and Other Information—Financial Statements.” As for the use of EBITDAR in our material debt financing instruments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loans and Financings”.
(11) Represents Adjusted EBITDAR divided by total operating revenue.

Balance Sheet Data

The following table presents key line items from our historical balance sheet data:

 

     As of December 31,  
     2016      2016      2015     2014      2013      2012  
     (US$)(1)     

(R$)

     (R$)     (R$)      (R$)      (R$)  
     (in thousands)  

Cash and cash equivalents

     168,502         549,164         636,505        388,959         546,283         271,116   

Total assets

     2,577,524         8,400,409         7,839,164        6,239,199         5,612,784         4,751,785   

Loans and financing(2)

     1,237,917         4,034,495         4,810,945        3,259,184         3,034,695         2,989,175   

Equity

     307,443         1,001,987         (392,169     416,495         476,313         351,031   

Total liabilities and equity

     2,577,524         8,400,409         7,839,164        6,239,199         5,612,784         4,751,785   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) Includes current and non-current loans and financing.

 

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Operating Data

 

     As of and For the Years Ended December 31,  
     Unaudited  
     2016(1)     2016      2015      2014      2013      2012  

Operating Statistics (unaudited):

                

Operating aircraft at end of period

     123        123         144         138         133         118   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total aircraft at end of period

     124        124         152         153         137         127   

Cities served at end of period

     101        101         100         105         103         100   

Average daily aircraft utilization (hours)

     10.1        10.1         9.5         9.6         10.3         11.5   

Stage length (km)

     848        848         830         727         726         777   

Number of departures

     261,611        261,611         280,832         283,755         275,976         143,363   

Block hours

     403,888        403,888         435,683         422,873         414,660         220,184   

Passenger flight segments

     20,822,146        20,822,146         21,794,939         20,409,931         19,808,882         11,718,784   

Revenue passenger kilometers (RPKs) (million)

     18,236        18,236         18,636         15,671         14,975         9,062   

Available seat kilometers (ASKs) (millions)

     22,869        22,869         23,423         19,747         18,928         11,495   

Load Factor (%)

     79.7%        79.7%         79.6%         79.4%         79.1%         78.8%   

Passenger revenue (in thousands)

     US$ 1,775,585  (1)      R$ 5,786,809         R$5,575,344         R$5,129,613         R$4,667,542         R$2,454,651   

Passenger revenue per ASK (cents) (PRASK)

     US$ 7.76 (1)      R$ 25.30         R$23.80         R$25.98         R$24.66         R$21.35   

Operating revenue per ASK (cents) (RASK)

     US$ 8.95 (1)      R$ 29.17         R$26.72         R$29.39         R$27.65         R$23.64   

Yield per ASK (cents)

     US$ 9.74 (1)      R$ 31.73         R$29.92         R$32.73         R$31.17         R$27.09   

Trip cost

     US$ 7,419 (1)      R$ 24,179         R$22,880         R$19,038         R$17,269         R$18,894   

End-of-period FTEs per aircraft

     84        84         73         76         74         76   

CASK (cents)

     US$ 8.49 (1)      R$ 27.66         R$27.43         R$27.36         R$25.18         R$23.56   

CASK (ex-fuel) (cents)(2)

     US$ 6.39 (1)      R$ 20.84         R$19.25         R$17.46         R$15.78         R$14.23   

Fuel liters consumed (thousands)

     880,941        880,941         906,778         789,150         749,861         469,458   

Average fuel cost per liter

     US$ 0.54 (1)      R$ 1.77         R$2.11         R$2.48         R$2.37         R$2.29   

 

(1) For convenience purposes only, the amounts in reais for the year ended December 31, 2016 have been translated to U.S. dollars using the rate R$3.2591 as of December 31, 2016, which was the commercial selling rate for U.S. dollars as of December 31, 2016, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. See “Exchange Rates” for further information about recent fluctuations in exchange rates.
(2) CASK (ex-fuel) means CASK excluding all fuel costs.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION S

You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this prospectus, as well as the data set forth in “Summary Financial and Operating Data” and “Selected Consolidated Financial Information.” The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in “Risk Factors.”

Overview

We are the largest airline in Brazil in terms of departures and cities served, with 784 daily departures serving 101 destinations, creating an unparalleled network of 203 non-stop routes as of December 31, 2016. As the sole airline on 70% of our routes, we are the leading airline in 66 Brazilian cities in terms of departures and carried approximately 21 million passengers in 2016. We are a low cost carrier and have generated a PRASK premium of at least 35% relative to our main competitor since our first year of operations. We derive this PRASK premium from our network, optimized fleet, operating efficiencies and high quality product offering. Complementing our extensive domestic network, we fly to select international destinations, including Fort Lauderdale, Orlando, and Lisbon. We wholly own our loyalty program TudoAzul, a strategic revenue-generating asset, which had 7.0 million members as of December 31, 2016.

Azul was founded in 2008 by entrepreneur David Neeleman, founder of JetBlue, as his fourth successful airline venture, to capture the market opportunities created by the expansion of the Brazilian aviation market. David Neeleman is our controlling shareholder as well as Chairman and Chief Executive Officer. In addition, we have a diverse group of key strategic shareholders, such as United and Hainan (a subsidiary of the HNA Group, a Fortune Global 500 conglomerate and the largest private airline operator in China).

Brazil is geographically similar in size to the continental United States and is currently the fourth largest market for domestic airline passengers in the world. Since 2008, the number of domestic airline passengers carried in Brazil has increased by more than 90% to 96 million in 2015, according to ANAC. Brazil’s air travel market continues to be significantly underpenetrated and is expected to increase to 131 million domestic passengers by 2021, according to ABEAR.

We have the most extensive route network in Brazil, serving 96 domestic destinations, about twice as many as our main competitors Gol and LATAM, which served 52 and 44 destinations, respectively, as of December 31, 2016. We are the only provider of scheduled service to 34 of our domestic destinations and hold the leading position in seven out of the ten largest domestic airports in which we operate in terms of departures. Through our network, we connect travelers to destinations exclusively served by us from our three hubs, which cater to the São Paulo, Belo Horizonte and Recife markets, among the largest metropolitan areas in the country. Notably, we are the leading airline at Viracopos airport, one of the São Paulo area’s principal airports and the largest domestic hub in South America in terms of non-stop destinations served, with a 97% share of its 159 daily departures as of December 31, 2016.

 

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We operate a young, fuel-efficient fleet that we believe is better tailored for the Brazilian market than those of our main competitors as it allows us to serve cities with different demographics, ranging from large capitals to smaller cities. Our operating fleet of 123 aircraft as of December 31, 2016, comprised of 74 Embraer E-Jets, 39 ATR aircraft, five next-generation Airbus A320neos, and five Airbus A330s. Our fleet has an average age of 4.8 years, which is significantly younger than that of our main competitors. In December 2016, we began operating fuel-efficient, next-generation Airbus A320neos on longer, high demand domestic segments. We believe that our diversified fleet is optimized to efficiently match capacity to demand. This enables us to offer superior connectivity as well as more convenient and frequent non-stop service to more airports than our main competitors, which exclusively operate larger aircraft.

A key driver of our profitability is our management team’s extensive experience in implementing a disciplined, low cost operating model. Our optimized fleet yields lower trip costs than our main competitor. For the nine months ended September 30, 2016, our average trip cost was R$23,993, which was 29% lower than that of Gol. With the introduction of the next-generation Airbus A320neos to our fleet, we expect to maintain our market-leading low trip cost advantage. In addition, our FTEs per aircraft were the lowest in Brazil at 85 compared to 112 for Gol as of September 30, 2016. Over the past three years we had one of the best on-time performance records among Brazilian carriers, and were recognized as the “Most On-Time Low Cost Carrier in the World” and the “Third Most On-Time Airline in the World” in 2015 by OAG.

We have built a strong brand by offering what we believe is a superior travel experience, based on a culture of customer service provided by a highly-motivated and well-trained team of crewmembers. Our service features include passenger seat selection, leather seats, individual entertainment screens with free live television at every seat in all our jets, extensive legroom with a pitch of 30 inches or more, complimentary beverage and snack services, and free bus service to key airports we serve. As a result of our strong focus on customer service, according to surveys we have conducted, 90% of our customers would recommend or strongly recommend Azul to a friend or relative as of December 31, 2016. In 2016 we were named “Best Low Cost Carrier in South America” for the sixth consecutive year and “Best Staff in South America” by Skytrax.

We continue to invest in and expand our loyalty program, TudoAzul, which had 7.0 million members and 77 program partners as of December 31, 2016. TudoAzul has been the fastest growing loyalty program in terms of members in Brazil for the past three years compared to Smiles and Multiplus, the loyalty programs of Gol and LATAM, respectively, and was elected “Best Loyalty Program in Brazil” in 2016 by a survey of 25,000 readers of Melhores Destinos, the largest web portal of airline fare promotions and loyalty programs in Brazil. Given our network strength, the expected growth of passenger air travel, credit card penetration and usage and customer loyalty in Brazil, we believe that TudoAzul is a key strategic asset for us. Unlike our main competitors, we own 100% of our loyalty program and benefit from all of TudoAzul’s cash flows. Since mid-2015, we have managed TudoAzul through a dedicated team and we are constantly evaluating opportunities to unlock value from this strategic asset.

We generate a PRASK premium from our unparalleled network, optimized fleet, operating efficiencies and high quality product offering, which resulted in revenues of R$6.7 billion in 2016. In addition to our PRASK premium, we remain focused on our disciplined low cost operating model as evidenced by having the lowest number of FTEs per aircraft and trip cost advantage compared to our main competitor as of September 30, 2016.

In 2016, we recorded operating income of R$344.3 million, representing an operating margin of 5.2%, and a net loss of R$126.3 million. Despite the contraction of the Brazilian economy, which started in 2014 and deepened in 2015 into the first half of 2016, we began to see a recovery during the second half of 2016, and recorded operating income of R$166.0 million for the three months ended September 30, 2016 and operating income of R$170.0 million for the three months ended December 31, 2016, representing an operating margin of 9.6% and 9.3%, respectively.

 

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As a measure of our equity valuation, our Adjusted EBITDAR margin reached 27.1% in 2016, which we believe is one of the highest among publicly traded airlines in Latin America over the past three years. Adjusted EBITDAR should not be considered as a measure of overall performance since it excludes aircraft rent, which is a normal, recurring cash operating expense. In addition, Adjusted EBITDAR should not be considered in isolation or as an alternative to net income. For a reconciliation of our Adjusted EBITDAR to net income (loss), see “Summary Financial and Operating Data”.

Principal Factors Affecting Our Financial Condition and Results of Operations

We believe our operating and business performance is driven by various factors that affect the global and Brazilian economy, the Brazilian airline industry, trends affecting the broader Brazilian travel industry, and trends affecting the specific markets and customer base that we target. The following key factors may affect our future performance.

Brazilian economic environment

As substantially all of our flight operations are within Brazil, our revenues and profitability are affected by conditions in the Brazilian economy. Our operations and the airline industry in general, are particularly sensitive to changes in economic conditions. Unfavorable economic conditions, such as high unemployment rates and a constrained credit market, can reduce spending for both leisure and business travel. Unfavorable economic conditions can also impact our ability to raise fares to counteract increased fuel, labor, and other expenses, and generally increase our credit rank, particularly with respect to our trade receivables.

The following table shows data for real GDP, inflation and interest rates in Brazil, the U.S. dollar/real exchange rate and crude oil prices for and as of the periods indicated.

 

            For the Years Ended
December 31,
 
     2016      2015      2014  

Real growth (contraction) in gross domestic product

     (4.0)%(1)         (3.8)%         0.1%   

Inflation (IGP-M)(2)

     7.2%         10.5%         3.7%   

Inflation (IPCA)(3)

     6.3%         10.7%         6.4%   

Long-term interest rates – TJLP (average)(4)

     7.5%         6.3%         5.0%   

CDI Rate (average)(5)

     14.0%         13.4%         10.8%   

LIBOR(6)

     0.7%         0.3%         0.2%   

Period-end exchange rate—reais per US$ 1.00

     3.254         3.905         2.656   

Average exchange rate—reais per US$ 1.00(7)

     3.485         3.339         2.355   

Average depreciation of the real vs. US$

     (4.4)%         (41.8)%         (9.0)%   

West Texas Intermediate, or WTI, crude price (average US$ per barrel during period)

     43.34         48.76         92.91   

Unemployment rate(8)

     11.5%         8.5%         6.8%   

 

Source: FGV, IBGE, Central Bank, Bloomberg and Energy information administration

(1) Estimates for the nine months ended September 30, 2016.
(2) Inflation (IGP-M) is the general market price index measured by the FGV.
(3) Inflation (IPCA) is a broad consumer price index measured by the IBGE.
(4) TJLP is the Brazilian long-term interest rate (average of monthly rates for the period).
(5) The CDI Rate is an average of inter-bank overnight rates in Brazil (daily average for the period).
(6) Average US dollar three-month London Inter-Bank Offer Rate.
(7) Average of the exchange rate on each business day of the year.
(8) Average unemployment rate for year as measured by IGBE.

 

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The Brazilian political and economic scenario has recently been characterized by high levels of uncertainty and instability, including a contraction of economic growth, despite a recent appreciation, an overall sharp depreciation of the real against the U.S. dollar, increased levels of unemployment and depressed levels of consumer confidence and spending. Due in part to a decrease in global commodities prices and amid wide-scale corruption probes focused on certain state-owned companies and uncertainty surrounding the eventual impeachment of former President Dilma Rousseff, Brazil entered into a recession in 2014. We have observed that this macroeconomic scenario generally impacted demand for air travel. While the number of passengers in the domestic market increased by 148% from 2005 to 2015, the number of domestic passengers in Brazil grew only 0.3% in 2015, reflecting the poor economic environment. In terms of passenger demand as measured by RPKs, the Brazilian domestic flight market contracted 5.7% in 2016, and grew 1.1% in 2015, 5.8% in 2014, 1.4% in 2013, 6.8% in 2012, 15.9% in 2011 and 23.5% in 2010 according to ANAC.

We have been able to successfully manage the recent downturn in the Brazilian economy. In 2015 and 2016, we raised a total of US$550 million through investments by United and Hainan. We continued to develop our loyalty program, TudoAzul, which is 100% owned by us, and we believe is a key strategic business driver for us. In 2016, we were also able to leverage our strategic partnerships with non-Brazilian airlines to, among other things, minimize our operating expenses by subleasing 15 aircraft to TAP and redelivering two aircraft that the lessor subsequently leased to TAP, while allowing us to maintain an optimized fleet for the Brazilian market. In addition, we have seen a positive trend in our results of operation starting in the second half of 2016, when the impeachment of former President Dilma Rousseff was finalized and former Vice-President Michel Temer took over the presidency.

Despite the recent economic downturn, we believe Brazil continues to show significant growth potential. According to Central Bank forecasts on January 13, 2016, the Brazilian economy is expected to recover in 2017 with an estimated GDP growth of 0.5% compared to a GDP contraction of 4.0% for 2016. We believe that our business model will allow us to benefit from Brazil’s economic growth potential, particularly among the middle class and in small- and medium-sized cities as well as in the economic strongholds of the São Paulo and Rio de Janeiro areas.

Net Operating Loss Carryforwards

We and our subsidiaries had net operating loss carryforwards of R$766.5 million as of December 31, 2016, represented by income tax losses and negative basis of social contribution. Certain of these net operating losses have been recorded at dormant subsidiaries and any future usage is dependent on transferring operating activities to such subsidiaries. Under Brazilian tax laws, we may only use our net operating losses to offset taxes payable up to 30% of the taxable income for each year. Based on our current calculations, we do not believe we will experience limitations on the use of these net operating losses in the future. See “—Principal Components of our Results of Operations—Taxes” and “—Critical Accounting Policies—Deferred Taxes.”

Impact of airline industry competition

The airline industry is highly competitive. The principal competitive factors in the airline industry are fare pricing, flight schedules, flight times, aircraft type, passenger amenities, number of routes served from a city, customer service, safety record and reputation, brand recognition, code-sharing relationships, and loyalty programs and redemption opportunities. Price competition occurs on a market-by-market, route-by-route and flight schedules basis through price discounts, changes in pricing structures, fare matching, target promotions and loyalty program initiatives.

 

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As of December 31, 2016, 24% and 15% of our domestic network overlapped with that of Gol and LATAM, respectively, while Gol’s and LATAM’s networks had an overlap of more than 80% with each other. At Viracopos airport, our primary hub, only two out of 52 domestic destinations faced direct competition from Gol or LATAM as of December 31, 2016.

In addition, we were the sole airline on 70% of our routes and 34 of the destinations we served, and the leading player in 66 cities as of December 31, 2016. By comparison, Gol and LATAM were leading carriers in only 13 and four cities, respectively, as of December 31, 2016.

Effects of aviation fuel costs

Aviation fuel costs have been subject to wide fluctuations in recent years. Fuel availability and pricing are also subject to refining capacity, periods of market surplus and shortage, and demand for heating oil, gasoline and other petroleum products, as well as meteorological, economic and political factors and events occurring throughout the world, which we can neither control nor accurately predict. We attempt to mitigate fuel price volatility through commodity forward agreements with banks or a fixed price agreement with BR Distribuidora. See “—Principal Components of Our Results of Operations—Operating Expenses.” In addition, the recent slowdown of GDP growth in China and the negative macro-economic outlook for Europe have generally impacted the demand for commodities, including fuel, with the consequent effect of reducing the average price of fuel worldwide. The average WTI price for 2016 was approximately 56% lower compared to the average price in 2013. Our fuel hedging practices are dependent upon many factors, including our assessment of market conditions for fuel, the pricing of hedges and other derivative products in the market and applicable regulatory policies. We had hedged 10.6% of our forecasted next twelve months fuel consumption as of December 31, 2016. Petrobras, the leading player in the Brazilian oil industry and the parent company of BR Distribuidora, has a strategy to equalize aviation fuel prices to international fuel prices every month. There are also regional differences based on different regional taxes.

Seasonality

Our operating revenue and results of operations are substantially dependent on overall passenger traffic volume, which is subject to seasonal and other changes in traffic patterns. Therefore, our operating revenue and results of operations for any interim period are not necessarily indicative of those for the entire year. We generally expect demand to be greater in the first, third and fourth quarters of each calendar year compared to the second quarter of each year. This demand increase occurs due to an increase in business travel during the second half of the year, as well as the Christmas season, Carnival and the Brazilian school summer vacation period. Although business travel can be cyclical depending on the general state of the economy, it tends to be less seasonal than leisure travel, which peaks during vacation season and around certain holidays in Brazil.

The table below shows our average fare in reais for the periods indicated, reflecting our total passenger revenue divided by passenger flight segments for such periods:

 

     Average Fare (R$)  

Year Ended December 31,

   First Quarter      Second
Quarter
     Third Quarter      Fourth
Quarter
 

2014

     253.4         251.4         254.4         246.6   

2015

     250.8         238.9         258.6         274.3   

2016

     280.7         259.3         286.3         283.3   

 

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Effects of exchange rates, interest rates and inflation

Our results of operations are affected by currency fluctuations. In 2016, 2015 and 2014, 89.8%, 93.2% and 99.6%, respectively, of our revenue was denominated in reais while 53.5%, 57.5%, and 45.7%, respectively, of our operating expenses were either payable in or affected by the U.S. dollar, such as aviation fuel, aircraft lease payments, certain flight hour maintenance contract payments and aircraft insurance. We also have certain aircraft debt denominated in U.S. dollars, see “—Loans and Financings.”

Inflation also had, and may continue to have, effects on our financial condition and results of operations. In 2016 and 2015, approximately 28.8% and 26.5%, respectively, of our operating expenses, including salaries, catering and ground handling expenses were impacted by changes in inflation.

We use short-term arrangements to hedge against exchange rate exposure related to our aircraft lease and other rent payment obligations.

The Central Bank changes the base interest rate in order to manage inflation. Variations in interest rate affect primarily our long-term obligations subject to variable interest rates, including our loans and financing. As of December 31, 2016, 2015 and 2014, we had R$4,034.5 million, R$4,810.9 million and R$3,259.2 million, respectively, in current and noncurrent loans and financing of which (i) 37.6%, 31.0% and 37.5%, respectively, was indexed to the CDI Rate, or overnight interbank/branch benchmark interest rate, (ii) 0%, 13.7% and 23.5%, respectively, was indexed to the TJLP rate and (iii) 52.6%, 53.9% and 38.3%, respectively, was indexed to LIBOR. In addition, interest rates also affect our financial income to the extent that we have investments indexed to the CDI Rate. The Central Bank has changed the base interest rate several times over the past years in order to keep inflation within its growth targets.

New IFRS standards that may affect our future results of operations

There are certain IFRS standards and interpretations currently issued but not yet in effect that could materially impact the presentation of our financial position or performance once such standard and interpretations become effective. See Note 3.19 to our audited consolidated financial statements.

Trend Information

We believe that demand for passenger aircraft travel in the markets we serve will be stronger in the coming year as a result of a better macroeconomic outlook for Brazil. We believe there is a strong growth opportunity in frequent point-to-point airline service on routes not served by us or underserved routes among larger, medium-sized, and regional cities in Brazil. In addition, we believe there is an opportunity to leverage our domestic network connectivity by serving additional select international destinations. In 2017, we expect our operating capacity in terms of ASKs to increase approximately 13% over 2016, mostly due to the planned introduction of 10 next-generation Airbus 320neos to our fleet, which have 56 more seats than our Embraer E-195s. In terms of number of aircraft, our fleet is expected to grow from 124 aircraft in service as of December 31, 2016 to 123 aircraft in service by the end of 2017.

 

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We believe that growth of our wholly-owned loyalty program TudoAzul will continue to be driven by a number of positive factors, including the increase in passenger traffic, higher penetration and usage of credit cards among the Brazilian population, and greater awareness about the loyalty sector, especially in cities served exclusively by Azul. By the end of 2017, we expect the number of members to grow by over one million, and points issued to grow by 20% compared to 2016, aided by a higher number of partners and the launch of new products.

Principal Components of Our Results of Operations

Operating Revenue

Our operating revenue is primarily derived from transporting customers in our aircraft. In 2015, 89.1% of our operating revenue was derived from passenger revenue, and 10.9% was derived from other revenue (ancillary revenue, including cargo revenue). In 2016, 86.8% of our operating revenue was derived from passenger revenue, and 13.2% was derived from ancillary revenue. For the year ended December 31, 2016, 89.8% of our operating revenue was denominated in reais. Passenger revenue is recognized either upon departure of the scheduled flight or when a purchased ticket expires unused, including revenue related to the redemption of TudoAzul points for Azul flights. Cargo revenue is recognized when transportation is provided. Other ancillary revenue consists primarily of ticket change fees, excess baggage charges, interest on installment sales, booking fees, other incidental services and aircraft subleases. Non-ticket revenue is generally recognized at the time the ancillary products are purchased or services are provided.

Passenger revenue depends on our capacity, load factor and yield. Capacity is measured in terms of ASKs, which represents the number of seats we make available on our aircraft multiplied by the number of kilometers these seats are flown. Load factor, or the percentage of our capacity that is actually used by paying customers, is calculated by dividing RPKs, which represents the number of kilometers flown by revenue passengers, by ASKs. Yield is the average amount that one passenger pays to fly one kilometer. We use RASK, or revenue divided by ASKs, and PRASK, or passenger revenue divided by ASKs, as our key performance indicators because we believe they enable us to evaluate the balance between load factor and yield. Since our first year of operations, we have maintained a significant RASK and PRASK premium compared to our competitors given our higher load factors and yields. We expect that our strategy will enable us to maintain that premium in the future.

Our revenues are net of certain taxes, including state-value added tax, the Tax on Circulation of Goods and Services (Imposto sobre Circulação de Mercadorias e Serviços), or ICMS; federal social contribution taxes, including the Social Integration Program (Programa de Integração Social), or PIS; social security contributions, or INSS; and the Social Contribution to Social Security Financing (Contribuição Social para o Financiamento da Seguridade Social), or COFINS. ICMS does not apply to passenger revenue. The average rate of ICMS on cargo revenues varies by state and ranges from 4% to 19%. In respect of passenger transportation revenues, the applicable rates of PIS and COFINS are 0.65% and 3%, respectively, due to a specific rule which enforces the use of the cumulative system of PIS and COFINS on these revenues. The remaining revenue related to air transportation activity is levied at rates of 1.65% and 7.60%, respectively. The Municipal Tax on Services (Imposto Sobre Serviços) is a municipal tax assessed at rates varying from 2% to 5% of our service rendered revenues. On January 1, 2013, the federal government of Brazil, through the “MP 540/12”, later converted into law No. 12,546/11, determined that the INSS contribution would be substituted by a Provisional Contribution on Gross Revenues, or CPRB, calculated at a monthly rate of 1%. On December 1, 2015, this monthly rate was increased to 1.5%. We present the CPRB contribution as a reduction of gross revenue.

The air transportation business is volatile and highly affected by economic cycles and trends. Fluctuations in aviation fuel prices, customer discretionary spending, fare initiatives, labor actions, weather and other factors have resulted in significant fluctuations in revenues and results of operations in the past.

 

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ANAC, the Brazilian civil aviation agency, may adopt regulations that influence our ability to generate revenue as it is responsible for approving the concession of landing rights slots, entry of new companies, launch of new routes, increases in route frequencies and lease or acquisition of new aircraft. Our ability to grow and to increase our revenues is dependent on approvals for new routes, increased frequencies and additional aircraft by ANAC.

Operating Expenses

We are committed to maintaining a low cost operating structure and we seek to keep our expenses low by operating a young and efficient fleet with a single-class of service on domestic routes, maintaining high employee productivity, investing significantly in technology, utilizing our fleet efficiently and deploying low-cost distribution processes.

Our largest operating expense is aviation fuel, which represented 29.8% of our total operating expenses in 2015 and 24.7% in 2016. Aircraft fuel prices in Brazil are much higher than in the United States, as the Brazilian infrastructure needed to produce, transport and store fuel is expensive and aviation fuel prices are controlled by a concentrated number of suppliers. Our aviation fuel expenses are variable and fluctuate based on global oil prices. Since global prices are denominated in U.S. dollars, our aviation fuel costs are also subject to exchange rate fluctuations between the real and U.S. dollar. In 2016, the WTI oil price decreased 11.1%, from US$48.8 per barrel as of December 31, 2015 to US$43.4 per barrel as of December 31, 2016.

We attempt to mitigate fuel price volatility related to global changes in fuel prices through commodity forward agreements with banks and also have the option to enter into hedge agreements with Petrobras, whose subsidiary BR Distribuidora is a key supplier of fuel for us. The Petrobras hedging product available to us enables us to lock in the cost of the jet fuel we will consume in the future, thereby offering a more tailored hedge than WTI or heating oil futures, which are not perfectly correlated to jet fuel. In addition, Petrobras offers us the option to lock the jet fuel price in reais, thereby hedging our exposure not only to fuel prices, but also to the real/U.S. dollar exchange rates as well. As of December 31, 2016, we were not party to hedge agreements with Petrobras.

In addition, local taxes applicable to the sale of jet fuel are high, ranging from 3.0% to 25.0%. Different states in Brazil apply different rates of value-added tax to fuel (which is not passed on to end consumers for passenger services), requiring us to continually adjust our fuel prices to optimize fuel uplift.

Salaries, wages and benefits paid to our crewmembers, include, among others, health care, dental care, child care reimbursement, life insurance, funeral assistance, psychosocial assistance (referred to as the “Anjo Azul” program), school aid (granted to expatriate executive officers only), housing allowance (granted to expatriate executive officers only), bonuses, pension plans, transportation tickets, food allowances and meal vouchers. We believe that we have a cost advantage compared to industry peers in salaries, wages and benefits expenses due to high employee productivity measured by the average number of employees per aircraft. While we had 85 FTEs per aircraft as of September 30, 2016, Gol had 112 as of the same date. We also benefit from generally lower labor costs in Brazil, when compared to other countries, which is somewhat offset by lower productivity due to government requirements over employee labor conditions and taxes on payroll.

Our aircraft and other rent expenses consist of monthly operating lease rents for aircraft, spare engines, flight simulators and other equipment under the terms of the related operating leases recognized on a straight-line basis. We use short-term arrangements to hedge against exchange rate exposure related to our aircraft lease and other rent payment obligations.

Landing fees include airport charges for each landing and aircraft parking, connecting fees as well as aeronautical and navigation fees. Most of these fees vary based on our level of operations and the rates are set by INFRAERO, DECEA, and private airports.

 

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Traffic and customer servicing includes the cost of airport facilities, ground handling expenses, customer bus service and inflight services and supplies. We provide complimentary bus services between a limited number of locations and certain strategic airports, such as transportation from the city of São Paulo to Viracopos airport, and we believe that the additional customers we attract by offering this service more than offset its cost.

Our sales and marketing expenses include commissions paid to travel and cargo agents, fees paid to credit card companies and advertising associated with the sale of our tickets and other products and services. We believe that our distribution costs are lower than those of our competitors because a higher proportion of our customers purchase tickets directly through our website instead of through traditional distribution channels, such as ticket offices, and we have comparatively fewer sales made through higher cost global distribution systems. We generated 87% of our passenger revenue through our website, including direct connect bookings with travel agencies, both in 2015 and 2016. We employ low-cost, innovative marketing techniques, focusing on social networking tools (Facebook, Twitter, YouTube and viajamos.com.br, a travel advice website created and owned by us) and generating word of mouth recognition, including visibly branded complimentary bus service and guerilla marketing campaigns to enhance brand recognition and provide promotions directed at our customers. We believe that we have an advantage compared to industry peers in sales and marketing expenses and expect this advantage will remain in the future.

Our maintenance, materials and repair expenses consist of line and scheduled heavy maintenance of our aircraft and engines. Since the average age of our operating fleet was 4.8 years as of December 31, 2016 and 4.2 years as of December 31, 2015, and most of the parts on our aircraft are under four-year warranties, our aircraft have required a low level of maintenance. As our aircraft age, these costs will increase. We do not own most of our spare parts inventories and the costs we incur to contract with third parties to maintain and provide us replacement parts when needed are included in maintenance costs.

Heavy maintenance on aircraft under operating leases is expensed as incurred. For owned aircraft, we employ the deferral method which results in the capitalization of engine shop visits for heavy maintenance. Under this method, the cost of major maintenance is capitalized and amortized as a component of depreciation and amortization expense until the next major maintenance event. The next major maintenance event is estimated based on the average removal times suggested by the manufacturer, and may change based on changes in aircraft utilization and changes in suggested manufacturer maintenance intervals. In addition, these assumptions can be affected by unplanned incidents that could damage a major component to a level that would require a major maintenance event prior to a scheduled maintenance event.

Depreciation and amortization expenses include the depreciation of all fixed assets we own or are under finance leases, including amortization of capitalized maintenance expenses.

Other operating expenses, net consist of general and administrative expenses, purchased services, equipment rentals, communication costs, professional fees, travel and training expenses for crews and ground personnel, provisions for legal proceedings, interrupted flights and all other overhead expenses.

The majority of our expenses, such as fuel, aircraft operating lease payments and maintenance, fluctuate with changes in the exchange rate between the real and the U.S. dollar. Aircraft rents are also partially exposed to interest rate fluctuations. We currently enter into arrangements to hedge against increases in fuel prices, foreign exchange and interest rates. See “—Quantitative and Qualitative Disclosures about Market Risk.”

 

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Financial Result

Our financial income includes interest earned on our cash and cash equivalents (which bear interest indexed to the CDI Rate) and short-term investments. Our financial expenses include interest expense on our owned aircraft debt, loans and financings and working capital facilities. As of December 31, 2014, 2015 and 2016, respectively, 44.2%, 22.8% and 17.9% of our aircraft debt was denominated in reais, respectively, and therefore not exposed to currency fluctuations. The balances of derivative financial instruments include gains or losses on our derivatives not designated for hedge accounting. Foreign currency exchange is the net gain or loss on our assets and liabilities related to the appreciation or depreciation of the real against the U.S. dollar and has limited impact on our cash position. Although all of our non-aircraft debt is in reais, we have both local and foreign currency aircraft-related debt instruments, and are using various financial instruments, including those used to limit our exposure to floating interest rates and foreign currency exchange rates.

Taxes

We account for income taxes using the liability method. We record deferred tax assets only when, based on the weight of the evidence, it is more likely than not that the deferred tax assets will be realized. Deferred taxes are recorded based on differences between the financial statement basis and tax basis of assets and liabilities and available tax loss and credit carryforwards. See “—Critical Accounting Policies—Deferred Taxes.” In assessing whether the deferred tax assets are realizable, our management considers whether it is more likely than not that some or all of the deferred tax assets will be utilized. We consider all available evidence, both positive and negative, in determining future taxable income on a jurisdiction by jurisdiction basis.

We and our subsidiaries had net operating loss carryforwards of R$766.5 million as of December 31, 2016, represented by income tax losses and negative basis of social contribution. See “—Principal Factors Affecting Our Financial Condition and Results of Operations—Net Operating Loss Carryforwards.”

Critical Accounting Policies and Estimates

The preparation of our audited consolidated financial statements in accordance with IFRS requires our management to adopt accounting policies and make estimates and judgments to develop amounts reported in our audited consolidated financial statements and related notes. Critical accounting policies are those that reflect significant judgments or estimates about matters that could potentially result in materially different outcomes under different assumptions and conditions. We believe that our estimates and judgments are reasonable. However, actual results and the timing of recognition of such amounts could differ from our estimates. For a discussion of these and other accounting policies, see Note 3 to our audited consolidated financial statements.

Property and Equipment. Property and equipment are recorded at acquisition or construction cost (which include interest and other financial charges) and are depreciated to estimated residual values over their estimated useful lives using the straight-line method. Under International Accounting Standard, or IAS, 16 “Property, Plant and Equipment,” major engine overhauls are treated as a separate asset component with the cost capitalized and depreciated over the period to the next overhaul. In estimating the lives and expected residual values of our airframes and engines, we primarily have relied upon actual experience with the same or similar aircraft types and recommendations from third parties. Subsequent revisions to these estimates, which can be significant, could be caused by changes to our maintenance program, changes in utilization of the aircraft, governmental regulations related to aging aircraft.

 

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We evaluate annually whether there is an indication that our property and equipment may be impaired. Factors that would indicate potential impairment may include, but are not limited to, significant decreases in the market value of long-lived assets, a significant change in the long-lived asset’s physical condition, and operating or cash flow losses associated with the use of long-lived assets. An impairment loss exists when the book value of an asset unit exceeds its recoverable amount, which is the higher of fair value less selling costs and value in use. The calculation of fair value less selling costs is based on information available of sales transactions regarding similar assets or market prices less additional costs for disposing of assets.

Lease accounting. Aircraft lease agreements are accounted as either operating or finance leases. When the risks and benefits of the lease are transferred to us, as lessee, the lease is classified as a finance lease. Finance leases are accounted as an acquisition obtained through financing, with the aircraft recorded as a fixed asset and a corresponding liability recorded as debt. Finance leases are recorded based on the lesser of the fair value of the aircraft or the present value of the minimum lease payments, discounted at an implicit interest rate, when it is clearly identified in the lease agreement, or market interest rate. The aircraft is depreciated by the lowest value between the remaining useful life of the lease assets or the contractual term, and impairment tests are performed on an annual basis. Interest expenses are recognized through the effective interest rate method, based on the implicit interest rate of the lease. Lease agreements that do not transfer risks and benefits to us are classified as operating leases. Operating lease payments are accounted as rent, and the lease expenses are recognized when incurred through the straight-line method.

Revenue Recognition. Flight revenue is recognized upon effective rendering of the transport service. Tickets sold and not used, corresponding to advanced ticket sales (air traffic liability) are recorded in current liabilities. Tickets expire one year after their purchase date. We recognize revenue upon the departure of the related scheduled flight and from tickets that are expected to expire unused (breakage). We estimate the value of future refunds and exchanges, net of forfeitures for all unused tickets once the flight date has already passed. These estimates are based on historical data and experience from past events and are assessed on an annual basis, or more frequently. The estimated future refunds and exchanges included in the account of advance ticket sales are compared monthly to actual refunds and exchange activity in order to monitor if the estimated amount of future refunds and exchanges is reasonable.

Other service revenues relate to ticket change fees, excess luggage, cargo transportation, “Espaço Azul” fee, charter and other services, which are recognized when services are provided. Interest income calculated based on the original effective interest rate for the relevant asset.

TudoAzul Program. Under the TudoAzul program, customers accrue points based on the amount spent on tickets flown. The amount of points earned per real spent depends on TudoAzul membership status, booking class and other factors, including promotional campaigns. Points expire two years after the date earned.

Upon the sale of a ticket, we recognize a portion of the fare paid as revenue when the transportation service occurs, as described above, and defer the portion corresponding to the points earned under the TudoAzul program, in accordance with IFRIC 13, Customer Loyalty Programs. The fair value of a point is estimated on an annual basis using the average points redeemed and the estimated value of purchased tickets with the same or similar restrictions as loyalty awards.

Besides awarding points for flights on Azul, we also sell points to our business partners, including credit card issuers and other companies, as well as our TudoAzul members. Our estimated selling price of points is based on the historical price we sell points to third parties. The related revenue is deferred and recognized as passenger revenue when points are redeemed and the related transportation service occurs.

We recognize revenue for points sold to members and to our business partners (including financial institutions, retailers and travel partners) and awarded that will never be redeemed by program members. We estimate such amounts annually based upon the latest available information regarding redemption and expiration patterns.

 

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Maintenance Materials and Repair Costs. For aircraft that we own, including aircraft held under finance leases, we use the deferral method pursuant to which we capitalize and amortize heavy maintenance costs as a component of our depreciation and amortization expense until the next major maintenance event. The frequency of major maintenance events is determined based on the suggestion of the products’ manufacturers, which is subject to variation based on, among other factors, actual utilization, revised guidance from the manufacturers and other unforeseen incidents, all of which could require the scheduling of a major maintenance event earlier (or later) than expected.

Heavy maintenance on aircraft held under operating leases is expensed as incurred.

Certain maintenance functions, including engine maintenance, are outsourced under contracts that require payment based on a performance measure such as flight hours. Costs incurred for maintenance and repair under flight hour maintenance contracts, where labor and materials price risks have been transferred to the service provider, are expensed based on contractual payment terms.

Repairs and routine maintenance service expenses are charged as incurred.

Maintenance Reserves. Our lease agreements provide that we pay maintenance reserves or supplement rent to aircraft lessors to be held as collateral in advance of the performance of major maintenance activities. Maintenance reserves are held as collateral in cash. These lease agreements provide that maintenance reserves are refundable to us upon completion of the maintenance event. The maintenance deposits paid under our lease agreements do not transfer either the obligation to maintain the aircraft or the cost risk associated with the maintenance activities to the aircraft lessor.

Substantially all of these maintenance reserve payments are calculated based on a utilization measure, such as flight hours or cycles, and are used solely to collateralize the lessor for maintenance time run off the aircraft until the completion of the maintenance of the aircraft. Maintenance reserves are denominated in U.S. dollars and paid to aircraft lessors in advance of the performance of heavy maintenance and are usually recorded as prepaid maintenance deposits on our balance sheet. We paid R$298.3 million (equivalent to US$91.5 million) and R$273.7 million (equivalent to US$84.0 million) in maintenance reserves to our lessors in the year ended December 31, 2016 and 2015, respectively. We have concluded that these prepaid maintenance deposits are likely to be recovered primarily due to the rate differential between the maintenance reserve payments and the expected cost for the related next maintenance event collateralized by the reserves. We have also negotiated with some lessors the replacement of maintenance reserve cash deposits with stand-by letters of credit issued by banks, and as a result, we present letters of credit of amounts equivalent to the deposit due as maintenance reserve to the lessor.

If at any point we determine that the recovery of the amounts retained by the lessor through future maintenance events is not probable, such amounts are expensed as maintenance cost if we consider that the amount will not be reimbursed due to the non-completion of the maintenance event required before the aircraft redelivery. For the years ended December 31, 2016 and 2015 we wrote-off R$4.0 million and R$9.9 million, respectively, for the events that we considered would probably not be reimbursed by the lessors due to the fact that we might not perform the maintenance event prior to the aircraft redelivery.

Our lease agreements also provide that most maintenance reserves held by the lessor at the expiration of the lease are nonrefundable to us and will be retained by the lessor. Consequently, we have determined that any usage-based maintenance reserve payments after the last major maintenance event are not substantively related to the maintenance of the leased asset and therefore are accounted for as contingent rent. We accrue contingent rent starting when it becomes probable and reasonably expected that we will incur such nonrefundable maintenance reserve payments. During the years ended December 31, 2016 and 2015, we did not accrue any contingent rent due to the fact that we considered it was probable and reasonably expected that all of them would be refundable.

 

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Since the maintenance reserves to aircraft lessors are denominated in U.S. dollars, the exchange rate differences on payments are recognized in our financial results. During the years ended December 31, 2016 and 2015, the amount recognized in our financial results due to the exchange rate differences on maintenance reserve deposits was a loss of R$153.5 million and an income of R$264.5 million, respectively.

See Note 12 to our audited consolidated financial statements.

Share-Based Payments. Our share-based compensation program is intended to grant awards priced at the fair market value of our common stock at the date of grant. The fair value of our common stock is estimated based on the market method that uses our estimates of revenue, driven by assumed market growth rates, and estimated costs, as well as appropriate discount rates. These estimates are consistent with the plans and estimates that we use to manage our business. We measure transactions with crewmembers settled with equity instruments at the grant date using the Black-Scholes option pricing model. The resulting amount, adjusted for forfeitures, is charged to expense over the period in which the options vest.

Derivative Financial Instruments. We account for derivative financial instruments in accordance with IAS 39—Financial Instruments: Recognition and Measurement, and record them at fair value. Subsequent changes in fair value are recorded in profit or loss, unless the derivative meets the criteria for hedge accounting. At the beginning of a hedge transaction, we designate and formally document the item covered by the hedge and how it will be effective in offsetting the changes in fair value or cash flows. Our derivative financial instruments are assessed quarterly to determine if they have been effective throughout the entire period for which they have been designated. Any gain or loss resulting from changes in the fair value of our derivative financial instruments during the quarter in which they are not qualified for hedge accounting, as well as the ineffective portion of the instruments designated for hedge accounting are recognized in financial results. When the fair value of financial assets and liabilities presented in our balance sheet cannot be obtained in an active market, we determine fair value using assessment techniques prevailing in the market, including the discounted cash flow method, and a certain level of judgment is required to establish fair value in this way. This judgment includes considerations on the data used, for example, liquidity risk, credit risk and volatility. Changes in assumptions about these factors could affect the fair value presented of financial instruments.

Impairment of Non-Financial Assets. We assess at each reporting period whether there is an indication that an asset may be impaired. If any such indication exists, or when the annual impairment testing for an asset is required, we make an estimate of the asset’s recoverable amount. An asset’s recoverable amount is the greater of an asset’s or cash-generating unit’s fair value less costs to sell or its value in use and is determined for an individual asset. When the carrying amount of intangibles exceeds its recoverable amount, an impairment charge is recorded and the asset is written down to its recoverable amount.

We operate as a single cash generating unit.

In estimating the value in use of assets, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects the weighted average cost of capital for the industry in which the cash-generating unit operates. The fair value less cost to sell is determined, whenever possible, based on a firm sales agreement carried out on an arm’s length basis between known and interested parties, adjusted for expenses attributable to asset sales, or when there is no firm sale commitment, based on the market price of an active market or most recent transaction price of similar assets, as well as based on discounted cash flows, when applicable.

 

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For assets excluding goodwill, an assessment is made at each reporting date to determine whether there is an indication that previously recognized impairment losses no longer exist or have decreased. If such indication exists, we estimate the recoverable amount. A previously recognized impairment loss is reversed only if there has been a change in the assumptions used to determine the asset’s recoverable amount since the last impairment loss was recognized. The reversal is limited so that the carrying amount of the asset does not exceed its recoverable amount, nor exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognized for the asset in prior years.

Provision for Tax, Civil and Labor Risks. We recognize provisions for tax, civil and labor suits when we have a present legal obligation, it is probable that an outflow of resources will be required to settle the obligation and a reliable estimate of the amount can be made. The assessment of probability of loss includes assessing the available evidence and jurisprudence, the hierarchy of laws and most recent court decisions, and their relevance in the legal system, or the assessment of independent counsels. Provisions are reviewed and adjusted to take into account changes in circumstances such as the applicable limitation period, findings of tax inspections and additional exposures identified based on new issues or decisions of courts.

Deferred Taxes. Deferred tax is provided using the liability method on temporary differences between the tax base of assets and liabilities and their book values for financial reporting purposes at the reporting time.

Deferred tax liabilities are recognized for all taxable temporary differences, except: (i) when the deferred tax liability arises from initial recognition of goodwill or assets or liabilities in a transaction that is not a business combination and, does not affect either accounting profit nor taxable profit or loss; and (ii) on the temporary differences related to investments in subsidiaries, when the timing of reversal of the temporary differences can be controlled and it is probable that the temporary differences will not be reversed in the foreseeable future.

Deferred tax assets are recognized for all deductible temporary differences and carryforward of unused tax credits and tax losses to the extent that it is probable that taxable profit will be available for their utilization, except: (i) when the deferred tax assets related to the deductible temporary difference arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, on the transaction date, does not affect either the accounting profit or taxable profit or loss; and (ii) on deductible temporary differences associated with investments in subsidiaries, deferred tax assets are recognized only to the extent that it is probable that the temporary differences will be reversed in the near future and taxable profit will be available so that the temporary differences may be used.

The book value of the deferred tax assets is reviewed on each balance sheet date and written off to the extent that it is no longer probable that taxable profits will be available to allow that all or part of the deferred taxes assets will be used. Unrecognized deferred tax assets are reassessed on each balance sheet date and are recognized to the extent that it becomes probable that future taxable profit will allow that the deferred tax assets be recovered.

Deferred tax assets and liabilities are presented net if there is a legal or contractual right to offset tax assets against tax liabilities and deferred taxes are related to the same taxable entity and subject to the same tax authority.

Our management regularly reviews deferred tax assets, taking into consideration historical operating results and probable term and level of future taxable profits, along with future available tax planning strategies. There are uncertainties regarding the interpretation of complex tax regulations and the amount and time of future taxable profit. Given the long-term nature and complexity of existing contractual instruments, differences between actual results and assumptions, or future changes in these assumptions could require future adjustments to amounts previously recorded.

 

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Goodwill and Intangible Assets. We allocate goodwill and intangible assets (such as certain slots and routes) with indefinite lives acquired through business combinations for impairment testing purposes to a single cash-generating unit. We are required to test goodwill for impairment annually or sooner if we experience indicators of impairment, by comparing the carrying amount to the recoverable amount of the cash-generating unit level that has been measured on the basis of its value-in-use. We make these impairment tests by applying cash flow projections in the functional currency based on our approved business plan covering a five-year period. Considerable judgment is necessary to evaluate the impact of operating and macroeconomic changes to estimate future cash flows and to measure the recoverable amount. Assumptions in our impairment evaluations are consistent with internal projections and operating plans. Airport operating rights which were acquired as part of the TRIP acquisition were recorded at fair value on the acquisition date, and are not amortized. These rights are considered to have indefinite useful lives due to several factors, including requirements for necessary permits to operate within Brazil and limited landing rights availability in Brazil’s most important airports in terms of traffic volume. The carrying values of the airport operating rights are reviewed for impairment at each reporting date, and are subject to impairment testing when events or changes in circumstances indicate that carrying values may not be recoverable. As of December 31, 2016 and 2015, no impairment on goodwill and other intangible assets was recognized.

Results of Operations

General. We believe we have created a robust network of profitable routes by stimulating demand through frequent and affordable air service. We select routes that we believe possess high demand and growth potential and are either not served or underserved by other airlines. We believe we can continue expanding our domestic network while simultaneously leveraging the strong connectivity we have created in Brazil to benefit from the addition of select international destinations in the United States and Europe.

The following chart includes certain operating information that evidences the evolution of our business between 2008 through December 31, 2016:

 

                   Total Aircraft at End of Period  

As of

   Cities Served      FTEs      Owned      Leased      Total(1)  

December 31, 2008

     3         712         3         2         5   

December 31, 2009

     15         1,541         8         6         14   

December 31, 2010

     27         2,940         15         13         28   

December 31, 2011

     42         4,323         22         27         49   

December 31, 2012(2)

     98         8,914         56         71         127   

December 31, 2013

     101         9,848         57         80         137   

December 31, 2014

     105         10,501         45         108         153   

December 31, 2015

     100         10,533         46         106         152   

December 31, 2016(3)

     101         10,311         39         100         139   

 

(1) Includes aircraft held under finance and operating leases. We do not record aircraft held under operating leases as assets on our balance sheet.
(2) Includes operating information resulting from the TRIP acquisition since November 30, 2012.
(3) Includes 15 aircraft subleased to TAP.

 

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The following table sets forth the composition of our operating fleet, which consists of all aircraft that are being operated by us, including spare aircraft, for the periods indicated.

 

            As of December 31,  

Operating Fleet

   Number of seats      2016      2015      2014  

Embraer aircraft

           

E-190

     106         10         22         22   

E-195

     118         64         66         59   

ATR aircraft

           

ATR 72

     68-70         39         49         48   

ATR 42

     46-48         0         0         4   

Airbus aircraft

           

A320neo

     274         5         0         0   

A330

     242-272         5         7         5   
     

 

 

    

 

 

    

 

 

 

Total

        123         144         138   
     

 

 

    

 

 

    

 

 

 

Comparison of 2016 to 2015

 

     For the Year Ended December 31,  
     2016      2015      Percent
Change
 
     (in thousands of reais, with the exception of
percentages and per-share amounts)
 

Operating revenue

        

Passenger revenue

     5,786,809         5,575,344         3.8%   

Other revenue

     883,082         682,522         29.4%   
  

 

 

    

 

 

    

 

 

 

Total revenue

     6,669,891         6,257,866         6.6%   

Operating expenses

        

Aircraft fuel

     (1,560,223)         (1,917,606)         (18.6)%   

Salaries, wages and benefits

     (1,091,871)         (1,042,119)         4.8%   

Aircraft and other rent

     (1,160,912)         (1,171,325)         (0.9)%   

Landing fees

     (442,692)         (382,610)         15.7%   

Traffic and customer servicing

     (327,289)         (307,926)         6.3%   

Sales and marketing

     (276,203)         (258,214)         7.0%   

Maintenance materials and repairs

     (708,739)         (643,897)         10.1%   

Depreciation and amortization

     (301,201)         (217,983)         38.2%   

Other operating expenses, net

     (456,475)         (483,773)         (5.6)%   
  

 

 

    

 

 

    

 

 

 
     (6,325,605)         (6,425,453)         (1.6)%   
  

 

 

    

 

 

    

 

 

 

Operating income (loss)

     344,286         (167,587)         (305.4)%   

Financial result

        

Financial income

     51,067         43,178         18.3%   

Financial expense

     (731,200)         (685,919)         6.6%   

Derivative financial instruments, net

     10,800         (82,792)         (113.0)%   

Foreign currency exchange, net

     179,668         (184,305)         (197.5)%   
  

 

 

    

 

 

    

 

 

 
     (489,665)         (909,838)         (46.2)%   

Result from related party transactions, net

     163,045                 100%   
  

 

 

    

 

 

    

 

 

 

Net income (loss) before income tax and social contribution

     17,666         (1,077,425)         (101.6)%   

Current income tax and social contribution

     8,731         (1,366)         (739.2)%   

Deferred income tax and social contribution

     (152,711)         3,886         (4,029.8)%   
  

 

 

    

 

 

    

 

 

 

Net loss for the year

     (126,314)         (1,074,905)         (88.2)%   
  

 

 

    

 

 

    

 

 

 

Basic and diluted net (loss) per common share(1)

     (0.01)         (0.14)      

Basic and diluted net (loss) per preferred share(1)

     (1.10)         (10.84)      

 

(1) Reflects a conversion ratio of 75.0 common shares to 1.0 preferred share on a theoretical, fully converted basis, pursuant to the mechanisms set forth in our by-laws.

 

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Operating income (loss)

Despite the Brazilian crisis, in 2016 our financial performance improved significantly compared to 2015, which we believe is a strong indicator of the resilience of our business model and our ability to operate under challenging macroeconomic conditions. Our operating income totaled R$344.3 million in 2016, representing an operating margin of 5.2%, compared to an operating loss of R$167.6 million in 2015. Net loss totaled R$126.3 million in 2016 compared to a net loss of R$1,074.9 million in 2015.

As a measure of our equity valuation, in 2016, our Adjusted EBITDAR also increased 47.9% from R$1,221.7 million in 2015 to R$1,806.4 million in 2016, representing a margin of 19.5% and 27.1%, respectively. See, “Summary Financial and Operating Data—Statements of Operations Data–Adjusted EBITDAR Reconciliation Table.” This increase was mainly due to (i) a 9.2% increase in RASK during the period, (ii) lower fuel expenses driven by a 11.1% average reduction of the WTI, and (iii) higher ancillary revenue, mostly derived from revenues earned from upgrades on our international flights, starting in October 2015, and the sublease of 15 aircraft to TAP, see “Business—Strategic Partnerships, Alliances and Commercial Agreements—TAP.”

To better respond to the Brazilian crisis that began in 2014 and to simplify our fleet, we removed 34 aircraft from our fleet in 2016 consisting of 15 aircraft that were subleased to TAP, and 19 aircraft that were redelivered or sold. As a result of this significant fleet reduction, we incurred R$209.5 million in maintenance costs, aircraft rent and other expenses during 2016, partially offset by a R$111.9 million gain related to the sale of 13 aircraft and one engine.

The table below sets forth the breakdown of our operating revenue and expenses on a per ASK basis for the periods indicated:

 

     For the Year Ended
December 31,
 
     2016      2015      Percent
Change
 
     (per ASK in R$cents)  

Operating revenue

        

Passenger revenue

     25.30         23.80         6.3%   

Other revenue

     3.86         2.91         32.5%   
  

 

 

    

 

 

    

 

 

 

Total operating revenue

     29.17         26.72         9.2%   
  

 

 

    

 

 

    

 

 

 

Operating expenses

        

Aircraft fuel

     6.82         8.19         (16.7)%   

Salaries, wages and benefits

     4.77         4.45         7.3%   

Aircraft and other rent

     5.08         5.00         1.5%   

Landing fees

     1.94         1.63         18.5%   

Traffic and customer servicing

     1.43         1.31         8.9%   

Sales and marketing

     1.21         1.10         9.6%   

Maintenance materials and repairs

     3.10         2.75         12.7%   

Depreciation and amortization

     1.32         0.93         41.5%   

Other operating expenses, net

     2.00         2.07         (3.4)%   
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     27.66         27.43         0.8%   
  

 

 

    

 

 

    

 

 

 

Operating Revenue

Operating revenue increased 6.6%, or R$412.0 million, from R$6,257.9 million in 2015 to R$6,669.9 million in 2016, reflecting (i) a 3.8% increase in passenger revenue and (ii) a 29.4% increase in other revenue.

 

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Passenger Revenue

The R$211.5 million, or 3.8% increase in passenger revenue in 2016 compared to 2015 was mainly attributable to a 6.3% increase in PRASK, reflecting a 8.6% increase in average fare, partially offset by a 2.4% reduction in capacity, as measured by ASKs over the period. International passenger revenue represented 10.1% of passenger revenue in 2016 compared to 6.8% in 2015 due to an increase in the number and frequency of our international flights over the period.

Other Revenue

The R$200.6 million, or 29.4% increase in other revenue was mainly due to (i) R$77.0 million related to the sublease of 15 aircraft to TAP, see “Business—Strategic Partnerships, Alliances and Commercial Agreements—TAP”, (ii) the creation of online booking fees starting in mid-2015 resulting in R$24.4 million of additional gross revenue, (iii) a 4.7% increase in passenger related ancillary gross revenue, from R$509.9 million in 2015 to R$534.0 million in 2016, mostly due to the launch in October 2015 of a new business and economy class interior for our international flights, (iv) a R$25.3 million increase in cargo gross revenue, and (v) a R$18.3 million increase in gross revenue from charter flights, mostly due to the Rio Olympics. Other revenue per passenger increased 35.4% from R$31.3 per passenger in 2015 to R$42.4 per passenger in 2016 for the reasons described above.

The table below presents our passenger revenue and selected operating data for the periods indicated:

 

     For the Year Ended
December 31,
        
     Unaudited     

 

 
     2016      2015      Percent Change  

Passenger revenue (in millions of reais)

     5,787         5,575         3.8%   

Available seat kilometers (ASKs) (millions)

     22,869         23,423         (2.4)%   

Load factor (%)

     79.7%         79.6%         0.1%   

Passenger revenue per ASK (cents)

     25.30         23.80         6.3%   

Operating revenue per ASK (cents)

     29.17         26.72         9.2%   

Yield (cents)

     31.73         29.92         6.1%   

Number of departures

     261,611         280,832         (6.8)%   

Block hours

     403,888         435,683         (7.3)%   

Average fare (in reais)

     277.92         255.81         8.6%   

Stage length (kilometers)

     848         830         2.2%   

Passengers

     20,822,146         21,794,939         (4.5)%   

Operating Expenses

Operating expenses decreased 1.6%, or R$99.9 million, from R$6,425.5 million in 2015 to R$6,325.6 million in 2016 mainly due to (i) a decrease of 18.6%, or R$357.4 million, in aircraft fuel expenses mainly due to a decrease in the average WTI prices over the period, (ii) a decrease in the number of aircraft in our fleet from 144 operating aircraft as of December 31, 2015 to 123 as of December 31, 2016, (iii) a slight decrease in rent expenses and (iv) a 2.4% reduction in ASKs. This reduction was partly offset by (i) the 4.7% average depreciation of the real against the U.S. dollar, which impacted U.S. dollar denominated expenses, (ii) an increase in landing fees expenses of R$60.1 million, (iii) a R$64.8 million increase in maintenance expenses and (iv) a R$83.2 million increase in depreciation and amortization.

 

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Aircraft fuel. Aircraft fuel expenses decreased 18.6%, or R$357.4 million, in 2016 compared to 2015, mainly due to (i) a 16.3% decrease in jet fuel prices from an average of R$2.11 per liter in 2015 to an average of R$1.77 per liter in 2016, and (ii) a 2.8% decrease in liters consumed resulting from a 2.4% reduction in ASKs. On a per ASK basis, aircraft fuel decreased 16.7%, mostly due to the reasons described above.

Salaries, wages and benefits. Salaries, wages and benefits increased 4.8%, or R$49.8 million, in 2016 compared to 2015, due to an effective scheduled salary increase of 8.9% as a result of collective bargaining agreements with labor unions applicable to all airline employees in Brazil in 2016, partially offset by a 2.1% decrease in the number of crewmembers from 10,533 as of December 31, 2015 to 10,311 as of December 31, 2016. Of the 10,311 employees, a total of 160 enrolled to a leave of absence program, launched by Azul in early 2016 as a response to the Brazilian crisis, which consists in offering employees the opportunity to sign-up for an unpaid leave from a period of six months to up to 24 months and return after this period maintaining the status of employee. On a per ASK basis, salaries, wages and benefits increased 7.3%, mostly due to the reasons described above and a 2.4% reduction in ASKs.

Aircraft and other rent. Aircraft and other rent, which are mostly incurred in U.S. dollars, decreased 0.9%, or R$10.4 million, in 2016 compared to 2015, primarily due to (i) a decrease in the number of aircraft under operating leases from 106 as of December 31, 2015 to 100 as of December 31, 2016 and (ii) the reversal of a provision for return of aircraft and engines in the amount of R$57.7 million related to a change in the estimate of redelivery costs based on more precise information, (see Note 18 of our audited consolidated financial statements), partially offset by the 4.7% average depreciation of the real against the U.S. dollar in 2016 compared to 2015. Aircraft and other rent per ASK increased 1.5%, mostly due to a 2.4% reduction in ASKs.

Landing fees. Landing fees increased 15.7%, or R$60.1 million, in 2016 compared to 2015 primarily due to a 72%, or R$42.0 million, increase in navigation fees starting in October 2015 as a result of fee adjustments implemented by DECEA, (ii) a 10.7% inflation rate in 2015, resulting in higher landing fees in 2016, and (iii) the 4.7% average depreciation of the real against the U.S. dollar, increasing landing fees related to international flights partially offset by a 6.8% decrease in the number of departures. Landing fees per ASK increased 18.5%, mostly due to the reasons described above and a 2.4% reduction in ASKs.

Traffic and customer servicing. Traffic and customer servicing expenses increased 6.3%, or R$19.4 million, in 2016 compared to 2015 primarily due to (i) a 7.9% scheduled salary increase applicable to ground handling and catering contracts, and (ii) the 4.7% average depreciation of the real against the U.S. dollar, which impacted our ground handling and passenger expenses related to international flights, partially offset by a 6.8% decrease in the number of departures combined with a 4.5% decrease in the number of passengers. On a per ASK basis, traffic and customer servicing expense increased 8.9%, mostly due to the reasons described above and a 2.4% reduction in ASKs.

 

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Sales and marketing. Sales and marketing expenses increased 7.0%, or R$18.0 million, in 2016 compared to 2015, primarily due to a 6.6% increase in operating revenue and a corresponding increase in travel agency and credit card fees to reduce commissions. Sales and marketing as a percentage of revenues remained stable at 4.1% during 2016 compared to 2015. On a per ASK basis, sales and marketing expenses increased 9.6%, mostly due to the reasons described above and a 2.4% reduction in ASKs.

Maintenance, materials and repairs. Maintenance, materials and repairs increased 10.1%, or R$64.8 million, in 2016 compared to 2015 primarily due to (i) the 4.7% average depreciation of the real against the U.S. dollar, which increased amounts due under third-party contracts denominated in U.S. dollars by R$26.5 million, and (ii) a maintenance expense increase of R$38.3 million related to aircraft redeliveries in 2016. On a per ASK basis, maintenance, materials and repairs increased 12.7%, mostly due to the reasons described above and a 2.4% reduction in ASKs.

Depreciation and amortization. Depreciation and amortization increased 38.2%, or R$83.2 million, in 2016 compared to 2015 primarily reflecting the depreciation resulting from the acquisition of seven E-Jets under debt financing during 2015, and the conversion of six aircraft under operating leases into finance leases during 2016. Depreciation and amortization per ASK increased 41.5%, mostly due to the reasons described above and a 2.4% reduction in ASKs.

Other operating expenses, net. Other operating expenses, net decreased 5.6%, or R$27.3 million, in 2016 compared to 2015 primarily due to (i) a R$36.6 million increase in gains in 2016 compared to 2015 related to the sale and sale leaseback transactions of 13 aircraft and one engine in 2016 compared to the sale of six aircraft in 2015, (ii) a decrease in expenses in 2016 compared to 2015 related to passenger accommodation and meals of R$19.6 million, and (iii) a 2.4% reduction in ASKs. This decrease was partially offset by a 28.1% increase, or R$31.9 million, in IT expenses related to GDS expenses, which are indexed to the U.S. dollar, as a result of our international partnerships. Other operating expenses per ASK decreased 3.4%, mostly due to the reasons described above and a 2.4% reduction in ASKs.

Financial Result

Financial income. Financial income increased 18.3%, or R$7.9 million, in 2016 compared to 2015, mostly due to an increase in cash and cash equivalents, short-term and long-term investments, and restricted investments (current and non-current) from R$757.8 million as of December 31, 2015 to R$1,795.6 million, as of December 31, 2016 reflecting mainly the US$450 million in proceeds received from Hainan.

Financial expenses. Financial expenses increased 6.6%, or R$45.3 million, in 2016 compared to 2015 mostly due to (i) the 4.7% average depreciation of the real against the U.S. dollar, as 53.1%, or R$2,143.7 million, of our current and non-current loans and financing was denominated in U.S. dollars as of December 31, 2016 compared to 54.5%, or R$2,619.9 million, as of December 31, 2015 and (ii) IOF/Exchange Tax of R$5.4 million related to US$450 million in proceeds received from Hainan, see “Business—Strategic Partnerships, Alliances and Commercial Agreement—Hainan”. These increases were partially offset by a 16.1% reduction in current and non-current loans and financing from R$4,810.9 million as of December 31, 2015 to R$4,034.5 million as of December 31, 2016.

 

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Derivative financial instruments, net. We recorded a gain of R$10.8 million in derivative financial instruments, net, in 2016 compared to a loss of R$82.8 million in 2015, mainly resulting from (i) U.S. dollar derivative instruments used to hedge our foreign exchange exposure resulting from U.S. dollar denominated financial expenses and (ii) heating oil derivative instruments used to hedge our fuel exposure.

Foreign currency exchange, net. The net translation gain on our assets and liabilities when remeasured into reais amounted to a gain of R$179.7 million in 2016 compared to a loss of R$184.3 million in 2015, due to the 16.5% appreciation of the Brazilian real as of December 31, 2016, compared to December 31, 2015. This line item reflects the portion of our assets and liabilities denominated in U.S. dollars, primarily our aircraft financing facilities and the currency exchange movements that occur on a period-to-period basis, and has limited impact on our cash position.

Result from related party transactions, net. In 2016, we recorded a net gain of R$163.0 million from related party transactions, mostly due to a fair value adjustment gain of R$443.4 million related to our investment in TAP bonds, partially offset by a (i) R$151.4 million expense for the derivative financial instrument liability related to the fair value of HNA’s purchase option (corresponding to €30.0 million) to purchase up to 33% of the economic benefits of the TAP bonds and (ii) a R$126.0 million loss provision as a result of seven of the fifteen aircraft sublease contracts to TAP being subleased at an amount lower than the original contractual amount, reflecting market conditions at the time of the sublease, with such loss provision corresponding to this loss over the total term of the sublease contracts discounted to its net present value amount, see “Business—Strategic Partnerships, Alliances and Commercial Agreement—TAP” and Note 11(e) to our audited consolidated financial statements.

Current income tax and social contribution. We recorded an income tax and social contributions gain of R$8.7 million in 2016 mostly due to exchange differences in foreign subsidiaries. In 2015, we recorded an income tax and social contribution expense of R$1.4 million mostly due to a taxable profit reported by one of our foreign subsidiaries.

Deferred income tax and social contribution. In 2016, expenses related to deferred income tax and social contributions totaled R$152.7 million compared to a gain of R$3.9 million in 2015, mostly due to higher deferred tax liabilities as a result of temporary differences between accounting and tax carrying values. As of December 31, 2016, we had income tax loss carryforwards of R$563.6 million and social contribution negative tax base carryforwards of R$202.9 million compared to R$410.7 million of income tax loss carryforwards and R$147.9 million of social contribution negative tax base carryforwards as of December 31, 2015. See Note 15(b) to our audited consolidated financial statements.

 

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Comparison of 2015 to 2014

 

     For the Year Ended December 31,  
     2015     2014     Percent Change  
    

(in thousands of reais, with the exception

of percentages and per-share amounts)

 

Operating revenue

      

Passenger revenue

     5,575,344        5,129,613        8.7%   

Other revenue

     682,522        673,440        1.3%   
  

 

 

   

 

 

   

 

 

 

Total revenue

     6,257,866        5,803,053        7.8%   

Operating expenses

      

Aircraft fuel

     (1,917,606     (1,955,036     (1.9)%   

Salaries, wages and benefits

     (1,042,119     (991,449     5.1%   

Aircraft and other rent

     (1,171,325     (689,055     70.0%   

Landing fees

     (382,610     (314,402     21.7%   

Traffic and customer servicing

     (307,926     (240,783     27.9%   

Sales and marketing

     (258,214     (239,359     7.9%   

Maintenance materials and repairs

     (643,897     (353,339     82.2%   

Depreciation and amortization

     (217,983     (197,755     10.2%   

Other operating expenses, net

     (483,773     (420,949     14.9%   
  

 

 

   

 

 

   

 

 

 
     (6,425,453     (5,402,127     18.9%   
  

 

 

   

 

 

   

 

 

 

Operating (loss) income

     (167,587     400,926        —     

Financial result

      

Financial income

     43,178        41,518        4.0%   

Financial expense

     (685,919     (460,049     49.1%   

Derivative financial instruments, net

     (82,792     4,245        —     

Foreign currency exchange, net

     (184,305     (74,104     148.3%   
  

 

 

   

 

 

   

 

 

 
     (909,838     (488,390     86.3%   
  

 

 

   

 

 

   

 

 

 

Net loss before income tax and social contribution

     (1,077,425     (87,464     1,131.8%   

Income tax and social contribution

     (1,366     (4,368     (68.7)%   

Deferred income tax and social contribution

     3,886        26,792        (85.5)%   
  

 

 

   

 

 

   

 

 

 

Net loss for the year

     (1,074,905     (65,040     1,552.7%   
  

 

 

   

 

 

   

 

 

 

Basic and diluted loss per common share(1):

     (0.14     (0.01  

Basic and diluted loss per preferred share(1):

     (10.84     (0.69  

 

(1) Reflects a conversion ratio of 75.0 common shares to 1.0 preferred share on a theoretical, fully converted basis, pursuant to the mechanisms set forth in our by-laws.

Operating income (loss)

Our 2015 results of operations were negatively impacted by (i) 3.8% contraction of GDP in Brazil in 2015, the most significant recession in Brazil in 25 years, resulting in lower demand from corporate and leisure travelers, who we believe demonstrated greater price sensitivity, (ii) the 41.8% devaluation of the real which affected primarily our aircraft rent, fuel, and maintenance expenses, which are indexed to the U.S. dollar, and (iii) expenses of R$176.9 million related to the redelivery of 20 aircraft as part of our fleet standardization process following the TRIP acquisition.

 

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The adverse macroeconomic conditions in Brazil, particularly the sharp depreciation of the real as well as interest rate increases, also negatively impacted our financial expenses, which increased from R$460.0 million in 2014 to R$685.9 million in 2015. The depreciation of the real also had a negative impact on the foreign exchange remeasurement of our U.S. dollar denominated assets and liabilities into reais, resulting in a foreign currency exchange expense of R$184.3 million in 2015 compared to an expense of R$74.1 million in 2014.

As a result of the above and those other factors explained below, we recorded a net loss of R$1,074.9 million in 2015 compared to a net loss of R$65.0 million in 2014. The table below sets forth the breakdown of our operating revenue and expenses on a per ASK basis for the periods indicated:

 

     For the Year Ended December 31,         
     2015      2014      Percent Change  
     (per ASK in R$ cents)  

Operating revenue

        

Passenger revenue

     23.80         25.98         (8.4)%   

Other revenue

     2.91         3.41         (14.6)%   
  

 

 

    

 

 

    

 

 

 

Total operating revenue

     26.72         29.39         (9.1)%   
  

 

 

    

 

 

    

 

 

 

Operating expenses

        

Aircraft fuel

     8.19         9.90         (17.3)%   

Salaries, wages and benefits

     4.45         5.02         (11.4)%   

Aircraft and other rent

     5.00         3.49         43.3%   

Landing fees

     1.63         1.59         2.6%   

Traffic and customer servicing

     1.31         1.22         7.8%   

Sales and marketing

     1.10         1.21         (9.1)%   

Maintenance materials and repairs

     2.75         1.79         53.6%   

Depreciation and amortization

     0.93         1.00         (7.1)%   

Other operating expenses, net

     2.07         2.13         (3.1)%   
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     27.43         27.36         0.3%   
  

 

 

    

 

 

    

 

 

 

Operating Revenue

Operating revenue increased 7.8%, or R$454.8 million, from R$5,803.1 million in 2014 to R$6,257.9 million in 2015, reflecting a 8.7% increase in passenger revenue and to a lesser extent, a slight increase in other revenue.

Passenger Revenue

The R$445.7 million, or 8.7% increase in passenger revenue in 2015 compared to 2014 was mainly attributable to (i) the launch of flights to Fort Lauderdale and Orlando, starting in December 2014 from which we derived R$407.8 million in gross revenue in 2015, leading to a 14.4% increase in total capacity, as measured by ASKs, compared to 2014 and (ii) a 3.8% growth in domestic capacity, as measured by ASKs. This growth was partially offset by an 8.4% PRASK reduction mostly due to a weaker demand environment and the increase in stage length associated with the launch of our international flights in December 2014. Considering only our domestic flights, PRASK decreased 1.7% in 2015 compared to 2014 mostly due to lower yields driven by lower passenger demand as a result of the Brazilian recession.

 

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Other Revenue

The R$9.1 million, or 1.3% increase in other revenue was mainly due to a 7.2% increase in passenger related ancillary revenue mostly related to our international flights, partially offset by lower charter flights revenue, which was higher in 2014 due to the World Cup. Other revenue per passenger decreased 5.1% from R$33.0 in 2014 to R$31.3 in 2015 as the number of passengers we carried increased more than our other revenue over the period.

The table below presents our passenger revenue and selected operating data for the periods indicated:

 

     For the Year Ended December 31,         
     Unaudited         
     2015      2014      Percent Change  

Passenger revenue (in millions of reais)

     5,575         5,130         8.7%   

Available seat kilometers (ASKs) (millions)

     23,423         19,747         18.6%   

Load factor (%)

     79.6%         79.4%         0.3%   

Passenger revenue per ASK (cents)

     23.80         25.98         (8.4)%   

Operating revenue per ASK (cents)

     26.72         29.39         (9.1)%   

Yield (cents)

     29.92         32.73         (8.6)%   

Number of departures

     280,832         283,755         (1.0)%   

Block hours

     435,683         422,873         3.0%   

Average fare (in reais)

     255.81         251.33         1.8%   

Stage length (kilometers)

     830         727         14.2%   

Passengers

     21,794,939         20,409,931         6.8%   

Operating Expenses

Operating expenses increased 18.9%, or R$1,023.4 million, from R$5,402.1 million in 2014 to R$6,425.5 million in 2015 mainly due to (i) the 41.8% average depreciation of the real against the U.S. dollar, which affected primarily our aircraft rent expenses, fuel, and maintenance expenses, (ii) expenses of R$176.9 million related to the redelivery process of 20 aircraft in connection with the TRIP acquisition, and (ii) the addition of 11 aircraft under operating leases and seven aircraft under finance leases in 2015.

Aircraft fuel. Aircraft fuel expenses decreased 1.9%, or R$37.4 million in 2015 compared to 2014, mainly due to the 14.6% decrease in the price of jet fuel, from an average of R$2.48 per liter in 2014 to an average of R$2.11 per liter in 2015, which was mostly offset by the 41.8% depreciation of the real and, to a lesser extent, a 3.0% increase in block hours, mostly due to our operation of international flights in 2015. On a per ASK basis, aircraft fuel decreased 17.3%, mostly due to the reasons described above coupled with an 18.6% increase in ASKs.

Salaries, wages and benefits. Salaries, wages and benefits increased 5.1%, or R$50.7 million, in 2015 compared to 2014 mostly due to a 7.0% scheduled increase in salaries as a result of collective bargaining agreements with labor unions applicable to all airline employees in Brazil in 2015. On a per ASK basis, salaries, wages and benefits decreased 11.4% as a result of the 18.6% increase in ASKs.

Aircraft and other rent. Aircraft and other rent, which are mostly incurred in U.S. dollars, increased 70.0%, or R$482.3 million, in 2015 compared to 2014, primarily due to (i) the 41.8% average depreciation of the real against the U.S. dollar during 2015 compared to 2014, (ii) the introduction of 11 new ATRs under operating leases to our fleet in 2015, partially offset by the redelivery of 13 ATRs formerly owned by TRIP, and (iii) the introduction of seven A330s starting in the second half of 2014. Aircraft and other rent per ASK increased 43.3% in 2015 compared to 2014, mostly due to the reasons described above, partially offset by the 18.6% increase in ASKs.

 

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Landing fees. Landing fees increased 21.7%, or R$68.2 million, in 2015 compared to 2014 primarily due to an increase in navigation fee expenses of R$45.7 million related to the launch of our international flights in December 2014. Landing fees per ASK increased 2.6% mainly due to the increase in fees, mostly due to the reasons described above, partially offset by the 18.6% increase in ASKs.

Traffic and customer servicing. Traffic and customer servicing expenses increased 27.9%, or R$67.1 million, in 2015 compared 2014 primarily due to (i) an increase of 65.9% related to catering expenses per passenger, from R$2.26 in 2014 to R$3.74 in 2015, mostly due to the launch of our international flights in December 2014, and (ii) an increase of 21.5% in ground handling expenses per departure, from R$599.0 in 2014 to R$728.0 in 2015, related to the launch of our international flights. On a per ASK basis, traffic and customer servicing expense increased 7.8%, mostly due to the reasons described above, partially offset by the 18.6% increase in ASKs.

Sales and marketing. Sales and marketing expenses increased 7.9%, or R$18.9 million, in 2015 compared to 2014, primarily due to (i) an increase in credit card processing fee expenses and commissions for travel agencies as a result of a 7.8% increase in operating revenue over the period, and (ii) the introduction of international sales, which have higher commissions than domestic sales. Sales and marketing as a percentage of revenues remained flat at 4.1% in 2015. On a per ASK basis, sales and marketing expenses decreased 9.1%, mostly due to the reasons described above, partially offset by the 18.6% increase in ASKs.

Maintenance, materials and repairs. Maintenance, materials and repairs increased 82.2%, or R$290.6 million, in 2015 compared 2014 primarily due to (i) the 41.8% average depreciation of the real, which increased amounts due under third-party contracts denominated in U.S. dollars, and (ii) redelivery expenses totaling R$104.8 million related to maintenance expenses on 20 aircraft which had to be serviced to comply with contractual obligations. On a per ASK basis, maintenance, materials and repairs increased 53.6%, mostly due to the reasons described above, partially offset by the 18.6% increase in ASKs.

Depreciation and amortization. Depreciation and amortization increased 10.2%, or R$20.2 million, in 2015 compared to 2014 primarily due the acquisition of seven E-Jets under debt financing during 2015. Depreciation and amortization per ASK decreased 7.1%, mostly due to the reasons described above, partially offset by the 18.6% increase in ASKs.

Other operating expenses, net. Other operating expenses, net increased 14.9%, or R$62.8 million, in 2015 compared to 2014 primarily due to (i) the 41.8% average depreciation of the real, which increased expenses related to IT services, and aircraft insurance, which are priced in U.S. dollars, and (ii) the launch of international flights in December 2014 resulting in an increase in accomodation and meal expenses for crewmembers of R$19.3 million. This increase was partially offset by a gain of R$75.3 million related a sale-leaseback transaction of five E-175s which were formerly owned by TRIP. Other operating expenses per ASK decreased 3.1%, mostly due to the reasons described above, partially offset by the 18.6% increase in ASKs.

Financial Result

Financial income. Financial income increased 4.0%, or R$1.7 million, in 2015 compared to 2014, mostly due to higher interest rates earned on investments as a result of an increase of the average CDI Rate from 10.8% in 2014 to 13.4% in 2015, partially offset by a lower balance of cash, short-term investments and restricted investments (current and non-current) of R$757.8 million as of December 31, 2015 compared to R$956.3 million as of December 31, 2014.

 

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Financial expenses. Financial expenses increased 49.1%, or R$225.9 million, in 2015 compared to 2014 mostly due to (i) the 41.8% average depreciation of the real against the U.S. dollar, as 54.5%, or R$2,619.9 million, of our total loans and financing was denominated in U.S. dollars as of December 31, 2015 compared to 38.9%, or R$1,268.0 million, as of December 31, 2014, (ii) a 47.6% increase in total loans and financing from R$3,259.2 million outstanding as of December 31, 2014 to R$4,810.9 million outstanding as of December 31, 2015, and (iii) an increase of the average CDI Rate from 10.8% in 2014 to 13.4% in 2015. As of December 31, 2015, 31.0%, or R$2,137.9 million, of our loans and financing was indexed to the CDI Rate compared to 37.5%, or R$1,223.7 million, as of December 31, 2014.

Derivative financial instruments, net. Our derivative financial instrument results varied from a gain of R$4.2 million in 2014 to a loss of R$82.8 million in 2015, mainly resulting from U.S. dollar derivative instruments used to hedge our foreign exchange exposure resulting from U.S. dollar denominated financial expenses.

Foreign currency exchange, net. The net translation loss on our assets and liabilities when remeasured into reais amounted for a loss of R$184.3 million in 2015 and R$74.1 million in 2014. This line item reflects the portion of our assets and liabilities denominated in U.S. dollars, primarily our aircraft financing facilities which increased due to the expansion of our fleet and the currency exchange movements that occur on a period-to-period basis, and has limited impact on our cash position.

Income tax and social contribution. For the year ended December 31, 2015, expenses related to income tax and social contributions totaled R$1.4 million compared to expenses of R$4.4 million in the prior year, due to the fact that we reported a lower taxable profit by one of our foreign subsidiaries in 2015.

Deferred income tax and social contribution. For the year ended December 31, 2015, gains related to deferred income tax and social contributions totaled R$3.9 million compared to a gain of R$26.8 million in the prior year, mostly due to lower deferred tax liabilities as a result of temporary differences between accounting and tax carrying values. As of December 31, 2015, we had income tax loss carryforwards of R$410.7 million and social contribution negative tax base carryforwards of R$147.9 million compared to R$220.2 million of income tax loss carryforwards and R$79.3 million of social contribution negative tax base carryforwards as of December 31, 2014. See Note 15(b) to our audited consolidated financial statements.

 

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Quarterly Financial and Operating Data (Unaudited)

Statement of Operations Data

 

     For the three months ended  
     March 31,
2015
    June 30,
2015
    September
30, 2015
    December
31, 2015
    March 31,
2016
    June 30,
2016
    September
30, 2016
    December
31, 2016
 
    

Unaudited

(in thousands of reais, except percentages)

 

Operating revenue

                

Passenger revenue

     1,391,769        1,238,878        1,463,180        1,481,517        1,477,835        1,238,245        1,501,326        1,569,403   

Other revenue

     164,687        158,799        168,391        190,645        190,693        205,704        235,495        251,190   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     1,556,456        1,397,677        1,631,571        1,672,162        1,668,528        1,443,949        1,736,821        1,820,593   

Operating expenses

                

Aircraft fuel

     (498,906     (438,872     (454,831     (524,997     (402,434     (332,942     (404,631     (420,216

Salaries, wages and benefits

     (264,725     (262,592     (265,322     (249,480     (272,457     (262,371     (267,256     (289,787

Aircraft and other rent

     (239,804     (273,768     (313,859     (343,895     (338,154     (259,353     (281,542     (281,863

Landing fees

     (94,759     (89,429     (86,504     (111,918     (120,164     (102,301     (112,531     (107,695

Traffic and customer servicing

     (76,568     (75,103     (76,548     (79,706     (84,278     (74,510     (82,143     (86,358

Sales and marketing

     (62,114     (57,407     (66,939     (71,754     (59,798     (71,639     (66,774     (77,993

Maintenance materials and repairs

     (123,388     (131,173     (194,283     (195,054     (189,797     (155,930     (181,331     (181,680

Depreciation and amortization

     (49,385     (51,615     (57,241     (59,742     (68,811     (76,611     (80,465     (75,315

Other operating expenses, net

     (126,717     (54,467     (143,934     (158,654     (125,678     (106,975     (94,106     (129,716
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (1,536,366     (1,434,426     (1,659,461     (1,795,200     (1,661,571     (1,442,632     (1,570,779     (1,650,623

Operating income (loss)

     20,090        (36,749     (27,890     (123,038 )      6,957        1,317        166,042        169,970   

Financial result

                

Financial income

     11,922        8,565        14,375        8,316        7,604        7,229        18,829        17,405   

Financial expense

     (116,795     (181,815     (199,468     (187,841     (215,312     (176,004     (200,513     (139,371

Derivative financial instruments, net

     74,645        (65,706     119,772        (211,504     (2,799     7,100        4,133        2,366   

Foreign currency exchange, net

     (81,762     8,096        (157,687     47,048        135,511        85,656        (11,393     (30,106
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (111,990     (230,860     (223,008     (343,981     (74,996     (76,019     (188,944     (149,706

Result from related party transactions, net

                                 570        32,618        37,834        92,023   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income before income tax and social contribution

     (91,900     (267,609     (250,898     (467,019     (67,469     (42,084     14,932        112,287   

Income tax and social contribution

                          (1,366     (61            (257     9,049   

Deferred income tax and social contribution

     708        1,964        606        606        607        (122,620     329        (31,027
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income for the period

     (91,192 )      (265,645 )      (250,292 )      (467,779 )      (66,923 )      (164,704 )      15,004        90,309   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other financial data (unaudited):

                

Operating margin

     1.3%        (2.6%     (1.7%     (7.4%     0.4%        0.1%        9.6%        9.3%   

 

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Operating Data

 

     For the three months ended  
     March 31,      June 30,      September 30,      December 31,      March 31,      June 30,      September 30,      December 31,  
     2015      2015      2015      2015      2016      2016      2016      2016  
     Unaudited  

Operating Statistics:

                       

Operating aircraft at end of period

     138         139         134         144         130         121         119         123   

Number of departures

     72,318         67,393         69,764         71,357         68,165         61,342         65,337         66,767   

Revenue passenger kilometers (RPKs) (millions)

     4,822         4,343         4,777         4,694         4,857         3,989         4,616         4,773   

Available seat kilometers (ASKs) (millions)

     5,986         5,446         5,935         6,057         6,219         5,051         5,696         5,903   

Load Factor (%)

     80.6%         79.8%         80.5%         77.5%         78.1%         79.0%         81.0%         80.9%   

Passenger revenue per ASK (real cents) (PRASK)

     23.25         22.75         24.65         24.46         23.70         24.34         26.36         26.59   

Operating revenue per ASK (real cents) (RASK)

     26.00         25.66         27.49         27.61         26.75         28.59         30.49         30.84   

Yield (real cents)

     28.86         28.52         30.63         31.56         30.34         30.82         32.53         32.88   

Trip cost

     21,245         21,284         23,787         25,158         24,376         23,518         24,041         24,722   

Average fare (R$)

     250.8         238.9         258.6         274.3         280.7         259.3         286.3         283.3   

CASK (real cents)

     25.67         26.34         27.96         29.64         26.64         27.43         27.58         27.96   

CASK (ex-fuel) (real cents)

     17.33         18.28         20.30         20.97         20.19         20.84         20.47         20.84   

Average fuel cost per liter (R$)

     2.1         2.1         2.0         2.23         1.7         1.7         1.8         1.85   

 

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Liquidity and Capital Resources

General

Our short-term liquidity requirements relate to the payment of operating costs, including of jet fuel, salaries and operating leases, payment obligations under our loans and financings (including finance leases, aircraft debt-financing and debentures) and the funding of working capital requirements. Our medium- and long-term liquidity requirements include equity payments for aircraft that we choose to finance through finance leases and debt-financing, the working capital required to start up new routes and new destinations, and payment obligations under our borrowings and financings.

For our short-term liquidity needs, we rely primarily on cash provided by operations and cash reserves. For our medium- and long-term liquidity needs, we rely primarily on cash provided by operations, cash reserves, working capital loans and bank credit lines including, but not limited to, bank loans, debentures and promissory notes.

In order to manage our liquidity, we review our cash and cash equivalents, short-term investments, and trade and other receivables on an ongoing basis. Trade and other receivables include credit card sales and accounts receivables from travel agencies and cargo transportation. Our accounts receivables are affected by the timing of our receipt of credit card revenues and travel agency invoicing. One general characteristic of the retail sector in Brazil and the aviation sector in particular is the payment for goods or services in installments via a credit card. Our customers may pay for their purchases in up to ten installments without interest or up to 12 installments with 3% interest per month. This is similar to the payment options offered by other airlines in Brazil. Once the transaction is approved by the credit card processor, we are no longer exposed to cardholder credit risk and the payment is guaranteed by the credit card issuing bank in case of default by the cardholder. Since the risk of non-payment is low, banks are willing to advance these receivables, which are paid the same day they are requested. As a result, we believe our ability to advance receivables at any time significantly increases our liquidity position.

As of December 31, 2016 our total cash position consisting of cash and cash equivalents, short term and long term investments, current and non-current restricted investments, totaled R$1,795.6 million, compared to R$757.8 million as of December 31, 2015.

We believe that, after completion of this global offering, we will be able to access equity and debt capital markets if and when necessary.

The table below presents our cash flow from operating, investing and financing activities, as well as the amount of our cash and cash equivalents for the periods indicated:

 

     For the Year Ended December 31,  
     2016