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

None

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

None

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

 

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

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

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

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

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

Note: Not required for registrant.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

Item 17 ¨    Item 18 x . 

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

Yes ¨    No x 

 

 

INDEX TO FINANCIAL STATEMENTS

 

PART I

INTRODUCTION

Unless otherwise indicated, all references herein to (1) “BRF – Brasil Foods” or “BRF” are references to BRF – Brasil Foods S.A., a corporation organized under the laws of the Federative Republic of Brazil (“Brazil”), and its consolidated subsidiaries, (2) “Sadia” are references to Sadia S.A., a corporation organized under the laws of Brazil, and its consolidated subsidiaries, (3) the “Company,” “we,” “us,” or “our” or “our company” are references to BRF – Brasil Foods, and (4) “common shares” are references to the Company’s authorized and outstanding common stock, designated ordinary shares ( ações ordinárias ), each without par value. All references herein to the “ real ,” “ reais ” or “R$” are to the Brazilian real, the official currency of Brazil. All references to “U.S. dollars,” “dollars” or “U.S.$” are to United States dollars.

Overview

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

Ø   Meat products:

 

·       frozen whole and cut chickens;

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

·       processed food products, such as the following:

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

·          specialty meats, such as sausages, ham products, bologna, frankfurters, salami, bacon and other smoked products;

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

Ø   Dairy products:

 

·          milk (UHT and pasteurized);  

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

Ø   Other processed products:

 

·          frozen prepared entrees, such as lasagna and pizzas, as well as other frozen foods, including vegetables, cheese breads and pies;

·          juices, soy milk and soy juices; 

·          margarine;  

Ø   Other: 

 

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

 

In the year ended December 31, 2010, we generated 30.4% of our net sales from poultry, 10.6% from pork and beef, 37.2% from processed meat products, 10.2% from dairy products, 9.3% from other processed products and 2.3% from other products.

In the domestic market, which accounted for 59.6% of our total net sales in the year ended December 31, 2010, we operate under such brand names as Perdigão, Sadia, Chester, Batavo, Elegê, Rezende, Confiança, Wilson, Fiesta, Miss Daisy, Qualy, Doriana and Becel  (through a strategic joint venture with Unilever) and Turma da Mônica (under a license), which are among the most recognized names in Brazil. In export markets, which account for the remaining 40.4% of our total net sales, the leading brands are Perdix, Sadia, Hilal, Halal, Corcovado, Batavo, Fazenda, Borella and Confidence .  

We are a leading producer in Brazil of specialty meats (market share of approximately 54.6% from January to December 2010), frozen processed meats (market share of approximately 69.2% from December 2009 to November 2010), dairy processed products (market share of approximately 11.2% from December 2009 to November 2010), pizzas (market share of approximately 78.3% from January 2010 to December 2010), pastas (market share of approximately 82.5% from December 2009 to November 2010) and margarines (market share of approximately 62.1% from January to December 2010), in each case based on sales volume, according to A.C. Nielsen do Brasil S.A., or “A.C. Nielsen.”  We also sell our frozen poultry, pork and beef products in the domestic market. We are able to reach substantially all of the Brazilian population through a nationwide network of 40 distribution centers. As of December 31, 2010, we operated 42 meat processing plants (of which we owned 36; the others are owned by third parties but process meat for us), 25 hatcheries (of which we owned 23), 23 animal feed mills, 14 dairy processing plants (of which we own nine, one of which is under construction and five are owned by third parties), two margarine processing plants (one of which is held through a joint venture with Unilever), 13 milk collecting centers, one soybean processing plant and one pizza, pasta, dessert and industrialized processing plant.

We are the largest Brazilian exporter of poultry products and are among the largest such exporters in the world, according to the Brazilian Secretariat for External Commerce ( Secretariado de Comércio Exterior , or “SECEX”), an agency of the Brazilian Ministry of Development, Industry and External Commerce ( Ministério do Desenvolvimento, Indústria e Comércio Exterior ). We are also the leading Brazilian exporter of pork products, based on export sales volumes in 2009, according to Brazilian Pork Industry and Exporter Association (Associação Brasileira da Indústria Produtora e Exportadora de Carne Suína), or “ABIPECS.”

In the milk and dairy product industry, we are a leader in sales of UHT milk in Brazil, with a 14.8% market share, based on volumes of sales from January 2010 to December 2010, according to A.C. Nielsen. As of December 31, 2010, we had a 6.2% market share of the Brazilian production of powdered milk, according to the U.S. Department of Agriculture, or “USDA.”

We export primarily to distributors, the institutional market (which includes restaurants and food service chains) and food processing companies. In 2010, our exports accounted for 40.4% of our total net sales. We export to more than 5,000 clients, with customers in Europe accounting for 19% of our export net sales in 2010; the Far East, 20.9%; Eurasia (including Russia), 11.3%; the Middle East, 31.9% and the Americas, Africa and other regions, 16.9%.

Business Combination with Sadia

On May 19, 2009, we signed a merger agreement with Sadia. Effective September 22, 2009, Sadia became our wholly-owned subsidiary and we changed our name to BRF — Brasil Foods S.A.  However, the business combination remains subject to review by the antitrust authorities in Brazil. On July 8, 2009, we entered into an agreement with the Brazilian antitrust authorities under which we agreed to ensure the reversibility of the business combination until a final decision is made by these authorities. The agreement, among other things, prevents our company and Sadia from integrating their administrative, production and commercial operations or exchanging certain competitive information. In addition, the business activities and structures of each company must be maintained. On September 18, 2009, the Brazilian antitrust authorities authorized the coordination of the companies’ activities directed towards the export market for in natura meat. On January 20, 2010, the Brazilian antitrust authorities authorized our company and Sadia to jointly negotiate and acquire raw materials and services (such as grains, packaging material and in natura beef), but not purchases of poultry or hogs. However, for our other activities, we continue to be subject to our reversibility agreement during the review period by the Brazilian antitrust authorities. The Brazilian antitrust authorities may decide to impose significant conditions or performance commitments on the combined company, including commitments to divest from certain businesses, risks and product lines, trademarks or production facilities.

 

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

Our Industry

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

Domestic Market

Brazil is the fifth largest country in the world, both in terms of land mass and population. As of April 2010, Brazil had an estimated population of 193.2 million people, according to data from the Brazilian Institute of Geography and Statistics ( Instituto Brasileiro de Geografia e Estatística ), or “IBGE.”  According to IBGE, Brazil had a gross domestic product, or “GDP,” of R$3.7 trillion for 2010, representing an increase of 15.4% over a GDP of R$3.2 trillion for 2009, in each case in nominal terms, and GDP per capita increased 6.5% in 2010 to R$19,016. Fiscal and monetary policies, such as reductions of taxes and interest rates, helped to mitigate the impact of the international crisis on the Brazilian economy. Following the third quarter of 2009, businesses began hiring again, which raised consumer confidence levels, increasing consumption of durables and non-durable products. The Central Bank of Brazil ( Banco Central do Brasil ), or the “Central Bank,” estimates that the Brazilian GDP in 2011 will increase 4.5% compared to 2010. The inflation rate, as measured by the National Extended Consumer Price Index ( Índice Nacional de Preços ao Consumidor Amplo ), or “IPCA,” published by the IBGE, was 4.3% in 2009 and 5.9% in 2010, continuing a trend of moderate inflation rates when compared with Brazil’s historical high rates of inflation.

Brazil is a large consumer of meat, with per capita meat consumption of 91.8 kilograms in 2010, according to the USDA. However, demand for poultry, pork and beef products in the domestic market is directly affected by economic conditions in Brazil. The overall trend towards improved economic conditions in Brazil in recent years has generally supported increased demand for processed food products, as well as traditional fresh and frozen poultry and pork products.

According to the USDA, Brazil is the world’s sixth largest producer and consumer of milk, with 30.2 million tons of milk produced in 2010.

Export Markets

Following the global economic crisis in 2008 and 2009, global trade in poultry, pork and beef products improved considerably in 2010. As employment indicators improve, consumer confidence levels increase which, in turn, stimulates consumption of goods. Sales of food products have usually recovered in the past after a period of recession, which explains the improvement in performance of global trade in meat in 2010.

Brazilian exports of chicken in 2010 were 5.1% higher than in 2009, totaling 3.8 million tons in 2010, according to ABEF. The increase was largely due to higher sales to Saudi Arabia, China, Egypt and Japan.  By contrast, data from the Brazilian Beef Exporters Association ( Associação Brasileira de Produtores e Exportadores de Frango ), or “ABIEC,” shows that the volume of beef exports decreased 1% to 1.245 million tons in 2010 from 1.230 million tons in 2009.  In terms of net sales, chicken and beef exports increased 17% and 16%, respectively, in 2010. By contrast, the volume of pork exports did not perform as well in 2010 and decreased 11% in comparison to 2009, according to ABIPECS. Brazil exported 540,000 tons of pork in 2010 and 607,000 tons in 2009. Average prices of pork rose 23% in 2010, resulting in a 9.3% increase in net sales in 2010 relative to 2009.

Despite the decrease in the export of beef and pork in 2010, we believe that sales of poultry, pork and beef products will continue to increase over the next several years. The increase in feed prices since July 2010, and the depreciation of the U.S. dollar against certain foreign currencies caused pressure in the meat industry margins. However, employment recovery around the world has allowed companies to increase prices as consumer optimism has increased. 

 

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

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

Forward-Looking Statements

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

ITEM 1.             IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2.             OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3.             KEY INFORMATION

A.   Selected Financial Data

We have changed our consolidated financial reporting from accounting principles generally accepted in Brazil (“Brazilian GAAP”) to International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). We adopted IFRS for the fiscal year ended December 31, 2010 and retrospectively applied IFRS to the fiscal year ended December 31, 2009 for comparative purposes. The transition date for our adoption of IFRS was January 1, 2009, the date on which the opening balance sheets were prepared in accordance with these new accounting practices. IFRS differs in certain significant respects from the accounting principles generally accepted in the United States, or “U.S. GAAP.”

 

 

As a result, we present below certain selected financial data derived from our consolidated financial statements as of and for the years ended December 31, 2010 and 2009, included herein, prepared in accordance with IFRS.

 

Our results of operations for 2010 include the results of operations of Sadia for the full year.  However, our results of operations for 2009 include the results of operations of Sadia since July 8, 2009 and, therefore, are not fully comparable to our results of operations for the year ended December 31, 2010. Sadia’s results of operations were fully consolidated as from July 8, 2009, when the common shareholders of BRF (then Perdigão S.A.), Sadia and HFF, a holding company formed by the controlling shareholders of Sadia for the purposes of the acquisition, approved our business combination with Sadia. For more information on the business combination with Sadia and our other acquisitions in 2009, see note 7.1 to our consolidated financial statements.

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

 

_____________________

 

 (1)  Earnings per share or American Depositary Receipt, or “ADR,” is computed under IFRS based on weighted average shares or ADRs, as the case may be, outstanding over the period. Each ADR evidences one American Depositary Share, or “ADS,” and each ADS represents one common share of our company.

 (2)  Includes common shares represented by ADSs, which are evidenced by ADRs.

 (3)  All historical periods are presented reflecting the one-for-one share split that became effective on March 31, 2010. 

 (4)  Dividends are calculated based on net income determined in accordance with IFRS and adjusted in accordance with the Brazilian Corporation Law (Law No. 6,404/76, as amended).

 

 

 

 

 

 

 

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, and, since then, the U.S. dollar- real  exchange rate has fluctuated considerably.

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

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

 

____________

 

Source: Central Bank.

 

 

 

B.   Capitalization and Indebtedness

Not applicable.

C.   Reasons for the Offer and Use of Proceeds

Not applicable.

D.   Risk Factors

Risks Relating to Our Business and Industry

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

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

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

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

In 2010, the average corn price on the CBOT was 14.7% higher than the average corn price in 2009. However, the price of corn on the CBOT in December 2010 was 71% higher than the price of corn in June 2010, largely as a result of supply and demand volatility in the market. Soybean prices also increased by 2.4% in 2010 compared to 2009 and 38.8% in December 2010 compared to June 2010. In 2010, we found it necessary to increase our selling prices of international products in order to mitigate the impact of the increase in the costs of our raw materials.

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

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

 

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

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

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

Deterioration of general economic conditions could negatively impact our business.

Our business may be adversely affected by changes in Brazilian and global economic conditions. In 2008 and 2009, our business was materially affected by the global economic crisis, which resulted in increased volatility in our markets and contributed to the net losses recorded in the fourth quarter of 2008 and in the first half of 2009. For instance, the global economic crisis led to an increase in raw material prices, such as corn and soybeans, which we could not pass on to our customers. In addition, there was a sharp decrease in demand in 2009, which forced us to cut 20% of our meat production for export in the first quarter of 2009. Although Brazilian and global economic conditions improved in 2010, we are still subject to the risk of economic volatility, which could have a material adverse effect on our business and results of operations.

In addition, any future deterioration in economic conditions in our principal export markets, including the Middle East, Europe or the Far East, could adversely affect demand for our products and our results of operations.  For example, although we do not currently believe that the recent upheaval in several countries in the Middle East or the recent earthquake in Japan will materially adversely affect our results of operations, we export to many of the affected countries, and any significant deterioration in the economies of those countries could lead to decreased demand for our products and could adversely affect our results of operations.

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

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

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

 

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

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

As of July 4, 2010, more than 18,311 deaths worldwide had been recorded since the outbreak of A(H1N1) influenza in Mexico, and on June 11, 2009, the WHO declared a flu alert level six, signaling a “global pandemic.” Many countries, including Russia and China, prohibited imports of pork from countries reporting a significant number of cases (Mexico, United States and Canada), but those countries later reopened their markets to producers from Mexico, the United States and Canada.

On August 10, 2010, the WHO terminated the level six influenza pandemic alert and shifted its focus to a post-pandemic period. During this period, localized outbreaks of different magnitudes may show significant levels of A(H1N1) transmission. Any further outbreak of A(H1N1) influenza could lead to the imposition of costly preventive controls on pork imports in our export  markets and could have a negative impact on the consumption of pork in those markets or in Brazil. In addition, any future significant outbreak of A(H1N1) influenza in Brazil could lead to pressure to destroy our hogs, even though no link between the influenza cases and pork consumption has been shown. Any such destruction of our hogs would result in decreased sales of pork, prevent recovery of costs incurred in raising or purchasing our hogs, and result in additional expense for the disposal of destroyed hogs. Accordingly, any spread of A(H1N1) influenza, or increasing concerns about this disease, may have a material and adverse effect on our company.

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

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

From January 1, 2003 to March 2, 2011, there have been over 526 confirmed human cases of avian influenza and over 311 deaths, according to the WHO. Various countries in Asia, the Middle East and Africa reported human cases in the past five years and as recently as 2011, and several countries in Europe reported cases of avian influenza in birds. For example, Indonesia became the focus of international attention when the largest cluster of human H5N1 virus cases so far was identified. The H5N1 virus is considered firmly entrenched in poultry throughout much of Indonesia, and this widespread presence has resulted in a significant number of human cases. In 2010, 48 cases were reported worldwide, with 24 deaths, according to the WHO. 

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

 

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

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

Because of the growing market share of Brazilian poultry, pork and beef products in the international markets, Brazilian exporters are increasingly being affected by measures taken by importing countries to protect local producers. The competitiveness of Brazilian companies has led certain countries to establish trade barriers to limit the access of Brazilian companies to their markets. Some countries, such as Russia, impose quotas on Brazilian pork and poultry products, and delays in allocating these quotas or changes in laws or policies regarding these quotas can adversely affect our exports. For example, Ukraine restricted pork imports for the retail market, on which higher taxes were levied for a period through December 2008. In March 2009, Ukraine initiated an anti-dumping investigation regarding imports of halves and quarters of poultry, as well as legs and cuts of poultry, in each case originating in the United States and Brazil. We were asked to answer a questionnaire from the Ministry of Economy of the Ukraine in connection with the investigation, and we complied with that request. The investigation is ongoing, and we cannot predict whether the investigation will have any consequences for our company. 

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

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

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

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

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

 

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

Export sales account for a significant portion of our net sales, representing 40.4% of our total net sales in 2010 and 41.1% of our total net sales in 2009. Our major export markets include the European Union, the Middle East (particularly Saudi Arabia) and the Far East (particularly Japan and Russia), where we are subject to many of the same risks described below in relation to Brazil. Our future financial performance will depend, to a significant extent, on economic, political and social conditions in our main export markets.

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

•         exchange rate fluctuations;

•         deterioration in international economic conditions;

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

•         strikes or other events affecting ports and other transport facilities;

•         compliance with differing foreign legal and regulatory regimes; and

•         sabotage affecting our products.

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

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

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

Environmental laws and regulations require increasing expenditures for compliance.

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

 

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

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

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

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

 

In recent years, the size of our acquisitions has increased significantly, which has increased the magnitude of the challenges described above. In 2008, we completed three acquisitions for an aggregate purchase price of R$1,754.4 million, consisting primarily of our acquisitions of Eleva (complementing our dairy product and meat businesses), Plusfood (providing meat processing capabilities in Europe) and Cotochés (adding to the scope of our dairy products business), compared to four acquisitions for an aggregate purchase price of R$261.0 million in 2007. In 2009, we completed a much larger business combination with Sadia, which poses specific risks and challenges discussed under  “Item 3. Key Information—D. Risks Factors—Risks Related to Our Business and Industry—We may not realize the expected benefits of our business combination with Sadia, in the timeframe anticipated or at all, because of integration or other challenges.”

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

Currently, five pension funds (the “Pension Funds”) hold a significant percentage of our common shares and, acting together pursuant to a shareholders’ voting agreement, have the ability to significantly influence our decisions. The pension funds owned 28.0% of our total capital as of December 31, 2010. They are parties to a shareholders’ voting agreement that sets forth voting arrangements with respect to, among other matters, (1) the election of officers and members of our board of directors and of the fiscal council and (2) the matters set forth in Article 136 of the Brazilian Corporation Law, including decisions relating to dividends, corporate restructurings, our corporate purpose and other matters.

As a result, these shareholders have, and will continue to have, the power to significantly influence the outcome of important corporate decisions or matters submitted to a vote of our shareholders. The interests of these shareholders may conflict with, or differ from, the interests of other holders of our common shares. Some of our major shareholders are also shareholders of Sadia. See “Item 3. Key Information—D. Risks Factors—Risks Related to Our Business and Industry—Our business combination with Sadia is subject to antitrust approvals, and any antitrust approval could be conditioned on divestment of a portion of our business.”

 

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

We are defendants in civil, labor and tax proceedings and are also subject to consent agreements ( termo de ajustamento de conduta ). Under IFRS, we classify the risk of adverse results in these proceedings as “remote,” “possible” or “probable.” We disclose the aggregate amounts of these proceedings that we have judged possible or probable, to the extent the amounts are known or reasonably estimable, and we record provisions only for losses that we consider probable. These disclosures for 2010 are included in “Item 8. Financial Information—Legal Proceedings” and note 26.2 to our consolidated financial statements.

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

Unfavorable decisions in our legal proceedings may, therefore, reduce our liquidity and adversely affect our business, financial condition and results of operations.

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

It is not possible to predict whether additional suits will be filed in connection with such derivative losses or other matters or what the outcome of any such litigation will be. Although Sadia is contesting the current lawsuits vigorously, it is possible that there could be unfavorable outcomes in these or other proceedings. Adverse results in proceedings involving Sadia and/or the incurrence of significant litigation expenses could be material to our consolidated business, operations, financial position, profitability or cash flows. Since Sadia is now our wholly-owned subsidiary, we will be subject to any adverse outcomes arising out of proceedings involving Sadia. Any such adverse results could therefore be material to our business, operations, financial position, profitability or cash flows.

In addition, certain directors and former officers of Sadia are subject to investigations by the CVM relating to potential liability arising out of our business combination with Sadia. Three of such individuals serve as members or alternate members of our board of directors. While neither BRF or Sadia is subject to such investigations, there are no guarantees that we will not be implicated in the future. See “Item 8.—Financial Information—Consolidated Statements and Other Financial Information—Legal Proceedings.”

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

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

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

 

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

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

In addition, even where we incur losses that are ultimately covered by insurance, we may incur expenses to shift production to other facilities, for example, that may not be fully covered by insurance.  For example, in early March 2011, a fire affected part of the installations of our Nova Mutum, Mato Grosso unit.  Although the facility is covered by fire insurance and we believe the unit’s production will be temporarily absorbed by other BRF plants in such a way as not to compromise supplies to clients and consumers, we cannot guarantee that all of our direct and indirect costs will be covered by our insurance.  Any similar event at other facilities in the future could adversely affect our revenues, expenses and our business.

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

Although we have completed our business combination with Sadia and Sadia is now our wholly-owned subsidiary, the business combination remains subject to approval by the Brazilian antitrust authorities. Brazilian antitrust law does not prevent parties from s igning an agreement or closing a transaction on a provisional basis before the Brazilian antitrust authorities have rendered a final decision. In accordance with Brazilian law, we and Sadia submitted a summary of the terms and conditions of the business combination and other information about each company to the Brazilian Conselho Administrativo de Defesa Econômica (the Brazilian government agency with antitrust decision making authority, or “CADE”) on June 8, 2009. After an analysis by the Economic Policy Bureau of the Ministry of the Treasury ( Secretaria de Acompanhamento Econômico , or “SEAE”) and the Economic Law Office of the Ministry of Justice ( Secretaria de Direito Econômico ), the CADE will determine whether the business combination negatively impacts consumer conditions in the relevant markets in which we and Sadia compete or whether they would negatively affect consumers. On July 7, 2009, we entered into an agreement ( Acordo de Preservação da Reversibilidade da Operação ) with the CADE, under which we agreed to ensure the reversibility of the business combination until a final decision is made by such authorities. The agreement, among other things, prevents our company and Sadia from integrating their administrative, production and commercial operations.

On June 29, 2010, the SEAE published its report on the business combination and recommended to the CADE that the transaction be approved with certain restrictions.  The SEAE’s report found significant concentration with a probability of negative competitive effects for certain of the activities of our combined company in our domestic market, including in the slaughter of poultry in the State of Mato Grosso, the slaughter of turkey in the State of Paraná, the sale of fresh ( in natura ) turkey and the sale of a number of processed products, including lasagnas, frozen pizzas, hamburgers, salamis and margarine.  The SEAE recommended that the CADE adopt one of two alternatives:

 

(1)      the license, for at least five years, of one of our major brands ( Sadia or Perdigão ) and the sale of the related assets of production associated with the participation in the market for the products sold under the applicable brand; or

(2)      the sale of the brands Batavo, Rezende , Confiança, Wilson and Escolha Saudável , as well as the margarine brands Doriana, Claybom and  Delicata , and the related assets of production associated with the participation in the market for the products sold under those brands.

 

The assets of production to be sold in each case would include manufacturing units (with the related personnel and equipment), slaughterhouses of poultry and pork, and the portfolio of contracts with integrated outgrowers of poultry and hogs.  In addition, in each case, the SEAE recommended the sale of our chicken slaughterhouses in the State of Mato Grosso, our turkey slaughterhouses in the State of Paraná, including the related portfolios of integrated outgrowers of chicken and turkey.

 

 

• devising a coherent marketing and branding strategy in our domestic market and our export markets that takes into account the relative strengths of BRF’s and Sadia’s marketing and brands in each of those markets and across their many product lines;
• integrating two of the largest customer distribution networks in Brazil, as well as distribution networks in BRF’s and Sadia’s export markets;
• integrating the extensive production facilities of BRF and Sadia in several Brazilian states;
• the potential loss of key customers of BRF or Sadia, or both;
• the potential loss of key officers of BRF or Sadia, or both;
• distraction of management from our ongoing operations;
• aligning the standards, processes, procedures and controls of BRF and Sadia in the operations of the combined companies; and
• increasing the scope, geographic diversity and complexity of our operations.

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• requiring that a substantial portion of our cash flows from operations be used for the payment of principal and interest on our debt, reducing the funds available for our operations or other capital needs;
• limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate because our available cash flow after paying principal and interest on our debt might not be sufficient to make the capital and other expenditures necessary to address these changes;
• increasing our vulnerability to general adverse economic and industry conditions because, during periods in which we experience lower earnings and cash flows, we would be required to devote a proportionally greater amount of our cash flows to paying principal and interest on debt;
• limiting our ability to obtain additional financing in the future to fund working capital, capital expenditures, acquisitions and general corporate requirements;
• making it difficult for us to refinance our indebtedness or to refinance such indebtedness on terms favorable to us, including with respect to existing accounts receivable securitizations;
• placing us at a competitive disadvantage compared to competitors that are relatively less leveraged and that may be better positioned to withstand economic downturns; and
• exposing our current and future borrowings made at floating interest rates to increases in interest rates.

 

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

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

•         borrow money;

•         make investments;

•         sell assets, including capital stock of subsidiaries;

•         guarantee indebtedness;

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

•         enter into transactions with affiliates;

•         create or assume liens; and

•         engage in mergers or consolidations.

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

Risks Relating to Brazil

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

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

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

•         exchange rate movements;

•         exchange control policies;

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

•         inflation; 

 

•         tax policies;

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

•         interest rates;

•         energy shortages;

•         liquidity of domestic capital and lending markets;

•         changes in environmental regulation; and

•         social and political instability.

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

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

Brazil experienced high rates of inflation in the past. According to the General Market Price Index ( Índice Geral de Preços do Mercado ) or “IGP-M,” a general price inflation index, the inflation rates in Brazil were 3.8% in 2006, 7.7% in 2007, 9.8% in 2008, (1.7)% in 2009 and 11.3% in 2010. In addition, according to the IPCA, published by the IBGE, the Brazilian consumer price inflation rates were 3.1% in 2006, 4.5% in 2007, 5.8% in 2008, 4.3% in 2009 and 5.9% in 2010.  Increases in certain commodity prices and other factors could cause consumer inflation to deviate from the Brazilian Central Bank’s target for 2011.  See “Item 5. Operating and Financial Review and Prospects—A. Operating and Financial Review and Prospects—Principal Factors Affecting Our Results of Operations—Brazilian and Global Economic Conditions” and “—Effects of Exchange Rate Variations and Inflation.”

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

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

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

The Brazilian currency has been devalued frequently over the past four decades. Throughout this period, the Brazilian government has implemented various economic plans and exchange rate policies, including sudden devaluations, periodic mini-devaluations (during which the frequency of adjustments has ranged from daily to monthly), exchange controls, dual exchange rate markets and a floating exchange rate system. From time to time, there have been significant fluctuations in the exchange rate between the Brazilian currency and the U.S. dollar and other currencies. In 2006 and 2007 the real  appreciated 9.5% and 16.3%, respectively, against the U.S. dollar. In 2008, the real  depreciated 31.9% against the U.S. dollar. In 2009 and 2010 the real  appreciated 25.5% and 4.3%, respectively, against the U.S. dollar.

 

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

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

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

We had total foreign currency-denominated debt obligations in an aggregate amount of R$3,986.9 million at December 31, 2010, representing 55% of our total consolidated indebtedness at that date. A significant portion of our consolidated debt is denominated in foreign currencies because export credit facilities available in foreign currencies often have attractive financing conditions and costs compared to other financing sources.

Foreign-currency denominated credit facilities also expose us to a greater degree of foreign exchange risk. We manage a portion of our exchange rate risk through foreign currency swaps and investments, and cash flows from export sales are in U.S. dollars and other foreign currencies, but our foreign currency debt obligations are not completely hedged. At December 31, 2010, our short-term consolidated exchange rate exposure was R$691.3 million of the amount described above. A significant devaluation of the real  in relation to the U.S. dollar or other currencies could increase the debt service requirements of our foreign currency-denominated obligations.

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

The Central Bank establishes the basic interest rate target for the Brazilian financial system by reference to the level of economic growth of the Brazilian economy, the level of inflation and other economic indicators. The basic interest rate increased in 2003 until June 2003 when the Central Bank began to decrease it, reaching 11.25% in April 2008. In 2008, the Central Bank reversed the trend, increasing the basic interest rate to 13.75%. In 2009, the Central Bank decreased the rate to 8.75% and in 2010 it increased the basic interest rate to 10.75%.

At December 31, 2010, approximately 45% of our total liabilities from indebtedness and derivative instruments of R$7,202.9 million was either (1) denominated in (or swapped into) reais  and bears interest based on Brazilian floating interest rates, such as the Long-Term Interest Rate ( Taxa de Juros de Longo Prazo ), or “TJLP,” the interest rate used in our financing agreements with Brazilian National Bank for Economic and Social Development ( Banco Nacional de Desenvolvimento Econômico e Social — BNDES), or “BNDES,” and the Interbank Deposit Certificate Rate ( Certificado de Depósito  Interbancário), or “CDI” rate, an interbank certificate of deposit rate that applies to our foreign currency swaps and some of our other real -denominated indebtedness, or (2) U.S. dollar-denominated and bears interest based on LIBOR. Any increase in the CDI, TJLP or LIBOR rates may have an adverse impact on our financial expenses and our results of operations. 

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

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

 

Risks Relating to Our Common Shares and the ADRs

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

 

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

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

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

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

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

The Brazilian securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States. The BM&F Bovespa - Securities, Commodities & Futures Exchange, or the “São Paulo Stock Exchange,” had a total market capitalization of R$2,569.41 billion, or U.S.$1,542.08 billion, at December 31, 2010 and an average daily trading volume of R$6.5 billion in 2010. By contrast, the New York Stock Exchange had a market capitalization of U.S.$16.5 trillion at December 31, 2010 (U.S. domestic listed companies) and an average daily trading volume of U.S.$71.2 billion in 2010. The Brazilian securities markets are also characterized by considerable share concentration.

The ten largest companies in terms of market capitalization represented approximately 43.42% of the aggregate market capitalization of the São Paulo Stock Exchange at December 31, 2010. In addition, the ten most widely traded stocks in terms of trading volume accounted for approximately 49.8% of all shares traded on the São Paulo Stock Exchange in 2010. These market characteristics may substantially limit the ability of holders of the ADRs to sell common shares underlying ADSs evidenced by ADRs at a price and at a time when they wish to do so and, as a result, could negatively impact the market prices of these securities.

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

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

 

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

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

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

Based on our financial statements, relevant market and shareholder data, and the projected composition of our income and valuation of our assets, including goodwill, we do not believe that we were a passive foreign investment company, or “PFIC,” for U.S. federal income tax purposes for 2010, and we do not expect to be a PFIC for 2011 or in the future, although we can provide no assurances in this regard. If we become a PFIC, U.S. holders of our common shares or ADRs may become subject to increased tax liabilities under U.S. tax laws and regulations and will become subject to burdensome reporting requirements. The determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and assets from time to time. Specifically, for any taxable year we will be classified as a PFIC for U.S. tax purposes if either (i) 75% or more of our gross income in that taxable year is passive income or (ii) the average percentage of our assets (which includes cash) by value in that taxable year which produce or are held for the production of passive income is at least 50%. The calculation of the value of our assets will be based, in part, on the quarterly market value of our common shares and ADRs, which is subject to change. See “Item 10. Additional Information––E. Taxation––U.S. Federal Income Tax Considerations––Passive Foreign Investment Company.”

ITEM 4.             INFORMATION ON THE COMPANY

A.   History and Development of the Company.

Corporate History

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

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

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

·		PREVI - Caixa de Previdência dos Funcionários do Banco do Brasil, or “PREVI,” the pension fund of employees of Banco do Brasil S.A.;
·		SISTEL - Fundação Telebrás de Seguridade Social, or “SISTEL,” the pension fund of employees of Telecomunicações Brasileiras S.A.-Telebrás;

 

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

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

On March 6, 2006, PREVI, SISTEL, PETROS, Real Grandeza, FAPEs, PREVI-BANERJ and VALIA (the “Pension Funds”) entered into a shareholders’ voting agreement, effective April 12, 2006, related to the common shares they held, directly or indirectly, which represented 49.0% of our common shares. We no longer have outstanding preferred shares following our April 2006 share reclassification. As of December 31, 2010, the Pension Funds, directly or indirectly, held 28.1% of our common shares.

Corporate Structure

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

 

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

 

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

 

Our principal executive offices are located at Rua Hungria, 1400, Jd. Europa, 01455-000, São Paulo, SP, Brazil, and our telephone number at this address is +55-11-2322-5052/5050/5061. Our internet address is www.brasilfoods.com/ir. The information on our website is not incorporated by reference into this Annual Report on Form 20-F.

Recent Acquisitions and Investments

Business Combination with Sadia

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

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

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

 

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

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

·          HFF became a wholly-owned subsidiary of BRF.

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

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

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

The business combination remains subject to review by the antitrust authorities in Brazil. On July 8, 2009, we entered into an agreement with the Brazilian antitrust authorities under which we agreed to ensure the reversibility of the business combination until a final decision is made by the antitrust authorities. The agreement, among other things, prevents our company and Sadia from integrating their administrative, production and commercial operations or exchanging certain competitive information. In addition, separate business activities and structures for each company must be maintained. On September 16, 2009, the Brazilian antitrust authorities authorized the coordination of the companies’ activities directed towards the export market for in natura meats. On January 20, 2010, the Brazilian antitrust authorities authorized our company and Sadia to jointly negotiate and acquire raw materials and services (such as grains, packaging material and in natura beef), but not purchases of poultry or hogs. Our other activities continue to be subject to our reversibility agreement during the review period by the Brazilian antitrust authorities. The Brazilian antitrust authorities may decide to impose significant conditions or performance commitments on the combined company, including commitments to divest from certain businesses, risks and product lines, trademarks or production facilities.

On June 29, 2010, the SEAE published its report on the business combination and recommended to the CADE that the transaction be approved with certain restrictions.  The SEAE’s report found significant concentration with a probability of negative competitive effects for certain of the activities of our combined company in our domestic market, including in the slaughter of poultry in the State of Mato Grosso, the slaughter of turkey in the State of Paraná, the sale of fresh ( in natura ) turkey and the sale of a number of processed products, including lasagnas, frozen pizzas, hamburgers, salamis and margarine.  The SEAE recommended that the CADE adopt one of two alternatives:

 

·          the license, for at least five years, of one of our major brands ( Sadia or Perdigão ) and the sale of the related assets of production associated with the participation in the market for the products sold under the applicable brand; or

·          the sale of the brands Batavo, Rezende , Confiança, Wilson and Escolha Saudável and the related assets of production associated with the participation in the market for the products sold under those brands.

 

The assets of production to be sold in each case would include manufacturing units (with the related personnel and equipment), slaughterhouses of poultry and pork, and the portfolio of contracts with integrated outgrowers of poultry and hogs.  In addition, in each case, the SEAE recommended the sale of our chicken slaughterhouses in the State of Mato Grosso, our turkey slaughterhouses in the State of Paraná, including the related portfolios of integrated outgrowers of chicken and turkey.

 

 

We have conveyed our belief that there are sufficient technical arguments that can be made to the CADE to demonstrate the merger’s pro-competitive nature and that it will reinforce Brazil’s penetration and competitiveness in the overseas markets. Although we believe that the CADE will approve the transaction, we cannot guarantee that they will do so.

 

If the business combination is approved, it will be retroactive to the date on which the transaction closed; however, if the business combination is not approved, it would be unwound retroactively to the closing date. As a condition to approving the transaction, CADE may require us to implement one of the alternatives recommended by the SEAE, or it could impose other significant conditions or performance commitments on the combined company, including commitments to divest from other businesses, risks and product lines, trademarks or production facilities. We believe that either of the alternatives recommended by the SEAE would have a material adverse effect on our business, results of operations and prospects, and any other conditions imposed by the CADE could also materially adversely affect our business, results of operations and prospects.

Construction Projects

The most significant investment of Sadia in the period between 2007 and 2009 was the agroindustrial site of Lucas do Rio Verde in the State of Mato Grosso. This project contemplated the construction of one poultry slaughtering unit, one pork slaughtering unit and one processing unit. The total estimated investment amounted to approximately R$869.7 million, most of which came from Sadia and the remaining from a group of outgrowers. The outgrowers were indirectly financed by BNDES to build the pork and poultry farms that feed the agroindustrial plant. Construction started in the second half of 2006, and the plant start-up occurred in the second half of 2008 with the slaughtering of poultry and the production of processed products. It is estimated that this project will be fully operational by the end of 2011. The project contemplates that 190 broiler modules (which together produce 500,000 day-old chicks per day) and 115 hog modules (which together produce 5,000 piglets per day) will be equipped with advanced technology to ensure animal wellness, higher productivity and, therefore, better competitiveness. Currently, the plant operates at 67% of its full capacity utilization. As of December 31, 2010, the total investment in the Lucas do Rio Verde project was R$861.3 million.

In addition to starting up its largest plant in Brazil in Lucas do Rio Verde in the State of Mato Grosso, Sadia is building its first plant in the northeast region, located in Vitória de Santo Antão in the State of Pernambuco. As of December 31, 2010, the total investment in this plant was R$264.6 million, and it was completed in 2010.

Capital Expenditures

In 2010, we recorded total investments of R$1.1 billion in order to support our organic growth, including total capital expenditures of R$697.8 million and expenditures of R$376.1 million for the replenishment of breeder stock. Capital expenditures in 2010 were largely dedicated to productivity and improvements as well as the continuing expansion of our industrial plant capacity, including the agroundustrial complexes of Lucas do Rio Verde and Vitória do Santo Antão. 

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

 

 

Major capital expenditures in 2010 and 2009 included the following:

Bom Conselho Agroindustrial Complex . In 2009, we invested a total of R$73.0 million in this agroindustrial complex, located in the state of Pernambuco.  This complex serves as a processing unit for our dairy products. We expect that construction of this complex will be completed at the end of 2011.

Três de Maio Agroindustrial Complex . In 2009, we invested a total of R$27.9 million in this agroindustrial complex, located in Rio Grande do Sul.  This complex serves as a processing unit for our dairy products. Construction of this complex was completed in 2009.

Lucas do Rio Verde and Vitória de Santo Antão . In 2010 and 2009, we invested a total of R$38.8 million and R$44.1 million, respectively, in the construction of these agroindustrial complexes.  Lucas do Rio Verde is located in the midwest State of Mato Grosso and Vitória de Santo Antão is  located in the State of Pernambuco in the northeast of Brazil. Vitória de Santo Antão is already in operation, and Lucas do Rio Verde is expected to be completed at the end of 2011.

Cooperativa Coopercampos.   We are currently negotiating a services agreement with Cooperativa Coopercampos from Santa Catarina under which the cooperative will provide us with additional hog slaughter capacity at a plant that it is being constructed in Campos Novos in the state of Santa Catarina.  It is expected that Cooperativa Coopercampos will invest a total of R$145 million in the plant, and, over time, we expect to support their investment by making advanced payments for services rendered, which will be secured by fixed assets. Once it is operational, the plant is expected to have a hog slaughtering capacity of 7,000 heads per day which will help us meet the needs of our export markets.

Information Technology .  In 2010, we began to install an integrated system platform to help us with synergies as a result of our business combination with Sadia. The fully integrated system is still subject to approval of the business combination by the Brazilian antitrust authorities. The project, which will take approximately 18 months to complete, will involve approximately 200 people working in the following four stages: (1) upgrading the SAP system to increase processing capacity; (2) developing the initial platform; (3) developing the HR SAP system; and (4) rolling out the SAP APO – Advance Planning Optimization. This investment is recorded as an intangible asset and is not reflected in the table above.

Internationalization Project. We are developing a long-term internationalization project focused on increasing our presence in countries where we can distribute our products profitably.

 

In 2011, we expect to make capital expenditures of approximately R$1,200 million to R$1,400 million (and an additional estimated R$400 million in expenditures on biological assets). We expect to focus our capital expenditures on finishing projects that are currently in progress and focusing on organic growth and maximizing synergies and integration of the two companies.

Competitive Strengths

We believe our major competitive strengths are as follows:

•     Leading Brazilian Food Company with Strong Brands and Global Market Presence. We are one of Brazil’s largest food industry companies, with a size and scale that enable us to compete in Brazil and globally. We believe that our leading position allows us to take advantage of market opportunities by enabling us to expand our business and increase our share of international markets.  In 2010, we slaughtered approximately 1.6 billion chickens and other poultry and 10.6 million hogs and cattle. We sold nearly 5.7 million tons of poultry, pork, beef, milk and processed food products, including dairy products in the same period. Our own and licensed brands are highly recognized in Brazil, and our export brands are well established in those markets.

 

 

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

 

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

 

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

 

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

 

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

 

Business Strategy

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

 

•     Strengthen Our Global Distribution Network .  We continue to develop our distribution capabilities outside Brazil to enable us to improve our services to existing customers and to expand our foreign customer base. In 2011, we expect to continue executing a long-term international distribution strategy in order to increase our brand awareness globally and expand into countries where we believe we can distribute our products profitably. We are focusing on expanding our distribution network in Europe and in the Middle East so as to broaden our coverage and to support more targeted marketing efforts in these key regions. We are also considering processing some products abroad to allow us to deliver those products directly to customers in those markets. We may consider selective acquisitions as one way to achieve this goal. For example, in early December 2007, we entered into a purchase agreement with the Dutch holding company Cebeco for the acquisition of Plusfood. Plusfood has two industrial plants in Europe for the manufacture of poultry- and beef-based processed food products, with an installed manufacturing capacity of approximately 40,000 tons per year of finished products.

 

•     Further Develop Our Domestic and International Customer Base .  We seek to continue to strengthen our domestic and international customer base through superior service and quality as well as increased product offerings. We believe that there are considerable opportunities to increase penetration of export markets, particularly as we broaden our product lines to include beef products, milk and dairy products and additional processed food products. We are also positioning our company to enter new export markets when existing trade barriers are relaxed or eliminated. Our objective is to pursue balanced growth of our domestic and export businesses. Domestic market sales represented 59.6% of our total net sales, while export market sales represented 40.4% in 2010.

 

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

 

•     Diversify Our Product Lines, Focusing on Value-Added Processed Food Products .  We intend to continue diversifying our product lines, focusing on processed food products whose prices tend to fluctuate less than our unprocessed poultry and pork cuts and that can be targeted to specific markets. Recent acquisitions include Batávia (milk and dairy products), a beef slaughterhouse, Sino dos Alpes (a specialty meats producer), Paraíso Agroindustrial (which owns a poultry slaughterhouse and animal feed mill) and the Doriana, Delicata and Claybom margarine brands, from Unilever, as well as the assets used in manufacturing them, among others. In 2008, we announced the construction of a dairy and processed products plant in Bom Conselho, in the State of Pernambuco (which started operating in 2009), and the purchase of control of Eleva, in order to include products like powdered milk and cheese in our portfolio and increase our market share in milk and dairy products. In addition, we acquired Cotochés in the State of Minas Gerais. In 2009, we signed a merger agreement with Sadia, pursuant to which Sadia became our wholly-owned subsidiary effective September 22, 2009. At the time, Sadia was one of the largest exporters of poultry products. We may pursue other selective acquisitions and/or build new industrial plants to support these strategic goals.

 

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

 

 

•     Synergies .  Our acquisitions in recent years, including the incorporation of Eleva and our business combination with Sadia, have created synergies. The business combination with Sadia expanded our businesses in both the Brazilian and international markets. We believe that we will achieve commercial, operational, financial and production synergies in both the medium and long term. We believe our business combination with Sadia in 2009 aligns with our strategies for both the domestic and export markets. The business combination brought us a diverse range of processed food, meat and dairy products and customer relationships in both our domestic and export markets that can be integrated with our own operations. Sadia has distribution networks in Europe, the Middle East and elsewhere around the world, which are consistent with our strategy of focusing on expanding our distribution network in those markets.

 

B.   Business Overview

Products

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

Our portfolio strategy is focused on creating new, convenient, practical and healthy products for our consumers based on their needs. We achieve that goal through a strong innovation chain, which provides us with increasing value-added items and differentiates us from our competitors, strengthening our brands.

In 2009, we acquired Sadia, which became one of our wholly-owned subsidiaries. The results of Sadia were fully incorporated into ours as from July 8, 2009. To facilitate the comparison of our volume production in 2010 relative to 2009, we present below certain sales volume data for 2009 on a combined basis to give effect to the acquisition of Sadia as if it had occurred on January 1, 2009. The combined presentation of sales volume is only for illustrative purposes and is not in accordance with IFRS.

During 2010 we launched 333 new products, including Meu Menu (“My Menu”) portfolio, which is targeted at single people.

Poultry

We produce frozen whole and cut poultries, partridges and quail. We sold 1,895 thousand tons of frozen chicken and other poultry products in 2010, compared to 1,745 thousand tons in 2009 on a combined basis. Most of our poultry sales are to our export markets.

Pork and Beef

We produce frozen pork and beef cuts, such as loins and ribs, and whole carcasses. As part of our strategy to diversify our product lines, we introduced beef cuts in December 2005 and intend to increase our sales of beef, particularly to export customers who already purchase poultry or pork from us. We sold 427 thousand tons of pork and beef cuts in 2010, compared to 413 thousand tons of pork and beef cuts in 2009 on a combined basis. Most of our sales of pork cuts are to our export markets. We are developing our export customer base for beef cuts, and we expect that most of our sales of beef cuts will ultimately be in our export markets. We raise hogs but do not raise cattle at our facilities.

Milk

We entered the dairy business in the second quarter of 2006 through our acquisition of a controlling interest in Batávia. In 2008, we expanded our presence in this market through the acquisition of Eleva. We produce pasteurized and UHT milk, which we sell in our domestic market. We sold 873 thousand tons of pasteurized and UHT milk in 2010 and 795 thousand tons in 2009, most of it in the domestic market. Our combined sales volumes for 2009 were equal to our historical sales volumes of milk because Sadia did not historically sell milk and other dairy products.

 

Processed Food Products

We produce processed foods, such as marinated, frozen chicken, Chester® rooster and turkey meat, specialty meats, frozen processed foods, frozen prepared entrees, dairy products, portioned products and sliced products. Part of our strategy is to develop additional processed food products in these and other categories because these products tend to be less price-sensitive than our frozen poultry and pork products. We sold 2,472 thousand tons of processed foods in 2010, compared to 2,341 thousand tons in 2009 on a combined basis. Most of our sales of processed foods are to our domestic market. We believe that there are opportunities to market value-added products like these to targeted regions and other market segments in Brazil as well as to expand our sales in the export market.

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

Specialty Meats

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

Frozen Processed Meats

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

Marinated Poultry

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

Dairy Products

In the second quarter of 2006, we entered the dairy products business through our acquisition of a controlling interest in Batávia. In early December 2007, we acquired the remaining 49% interest in Batávia. In 2008, we expanded our presence in this market through the acquisition of Eleva. We produce and sell a wide range of dairy-based and dairy processed products, ranging from flavored milks, yogurts, fruit juices, soybean-based drinks, cheeses and desserts.

We sold 205 thousand tons of dairy processed products in 2010 in comparison with 210 thousand tons in 2009.

Frozen Prepared Entrees

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

 

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

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

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

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

Margarine

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

We began to sell margarine as part of our strategy to diversify our product lines and to take advantage of our distribution network for refrigerated products.

Other

We produce animal feed mainly to feed poultry and hogs raised by us. However, we also sell a small portion of our animal feed production to our integrated outgrowers or to unaffiliated customers.

We produce a limited range of soy-based products, including soy meal and refined soy flour. We also produced soybean oil until July 2005, when we sold our soybean oil plant, located in the city of Marau in Rio Grande do Sul state, to Bunge Alimentos because we determined that soybean oil was neither a core business product nor a business scope product to our company.

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

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

Poultry

Brazil is the third largest producer, and the leading exporter, of poultry in the world, according to tonnage data compiled by the USDA as of October 2010. Brazil’s production, consumption and export volumes for poultry have increased significantly over the past several years, and Brazil was the number one global poultry exporter in 2009. This development can be explained by the production shift of large Brazilian companies’ exports, as well as by the competitiveness of Brazilian poultry. Sanitary problems in the main producing countries, such as the Bovine Spongiform Encephalophy (“BSE”) cases in Europe, avian influenza problems in Thailand and both BSE and avian influenza cases in the United States, have changed the world poultry trade dynamics. The reduced competition from major exporting countries affected by sanitary issues and the competitive cost of Brazilian poultry favors Brazil as the most competitive exporter of quality poultry cuts. Additionally, several new markets in Eastern Europe, Africa and the Middle East have opened to Brazilian chicken, and the number of markets to which Brazil has access was approximately 140 in 2009. The USDA projects an increase in global production, exports and consumption volumes for poultry for 2011. For Brazil, the USDA estimates volume growth of 2.9% in production, 3.0% in exports and 2.8% in consumption compared to 2010.

 

In 2010, the Middle East was the largest market for Brazilian poultry exports, mainly whole poultry, due to the effect on the local economy of higher oil prices and appreciation in real estate. In 2010, Japan was the second largest market for Brazil’s poultry exports, mostly poultry parts. Saudi Arabia, traditionally Brazil’s largest single export market for poultry, still ranks first. Saudi Arabia accounted for nearly 40% of all Brazilian poultry exports to the Middle East. Hong Kong was the third largest destination for Brazilian poultry in 2010, also mainly poultry parts.

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

_______________________

(1)   Includes chicken, special poultry and turkey .  

(2)   Based on preliminary data.

Source: USDA, October 2010.

 

 

Pork

Brazil is the fourth largest producer and exporter, and the fifth largest consumer, of pork in the world, according to tonnage data compiled by the USDA. Brazil’s production and consumption of pork has increased over the past five years, with the exception of 2008, when domestic prices were more attractive than export prices, leading producers to sell more of their products in the domestic market. Pork exports, after increasing in 2009, fell in 2010, from 707 to 625 thousand tons. The USDA projects an increase in global production and consumption of pork in 2011 and an increase of approximately of 2.4% in Brazil’s pork exports for the year.

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

Russia remains Brazil’s major destination as demand growth exceeds Russian meat producers’ ability to respond. Brazil has been affected less than its competitors by the sharp rise in the price of soy meal and corn because its large processing companies have built large new facilities in the Midwest where soy and corn are more cost competitive than in traditional meat-producing states in the southern part of Brazil. Hong Kong is the second largest market for Brazilian pork exports with a 18.5% market share by volume, followed by Ukraine, the third largest market for Brazilian pork exports, with 7.4% of market share by volume.

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

 

 

 

 

Beef

We began to produce beef cuts in the fourth quarter of 2005 for sale in our export markets and in the Brazilian market. Brazil is the largest exporter, the second largest producer and the third largest consumer of beef in the world, according to tonnage data compiled by the USDA. The USDA projects a small decrease in global production and consumption and an increase in exports of beef in 2011. A reduced world production is due, in part, to a reduction in the number of cows slaughtered in 2010 in Argentina and the United States. In Argentina, the low prices in the domestic market led to decreased production. In the United States, the reduction was mainly due to higher grain prices and, therefore, smaller margins. Imports are growing mainly in the developing countries, where economic activity is recovering at a faster pace in comparison to the United States and the European Union’s 27 economies.

 

 

Production Process

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

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

Meat Production Chain

 

Poultry

At the beginning of the poultry production cycle, we purchase breeder chicks in the form of eggs from Cobb of Brazil, an affiliate of Cobb Vantress, Hybrid, Aviagen do Brasil and sometimes from Agrogen. We send these eggs to our grandparent stock farms, where the chicks are hatched and raised, constituting our grandparent breeding stock. The eggs produced by our grandparent breeding stock are then hatched, and our parent breeding stock is produced. In 2010, we maintained an average parent breeding stock of approximately 18.7 million breeders that produce hatchable eggs. We also buy a small percentage of our parent stock from another supplier. The parents produce the hatchable eggs that result in day-old chicks that are ultimately used in our poultry products. We produced 1,694 million day-old chicks, including chickens, Chester ® roosters, turkeys, partridge and quail in 2010. We hatch these eggs in our 25 hatcheries.

 

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

At December 31, 2010, we had a fully automated slaughtering capacity of 31.2 million heads of poultry per week.

Pork

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

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

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

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

At December 31, 2010, we had a pork slaughtering capacity of 194,400 heads per week.

Beef

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

Under limited circumstances, we may contract for our own cattle confinement or enter into a partnership for that purpose.

At December 31, 2010, we had a beef slaughtering capacity of 1,797 heads per week.

 

Processed Foods

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

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

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

Dairy Products

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

 

Dairy Products Production Chain

           Through the acquisition of Batávia and Eleva, we produce dairy products in 15 plants. We receive milk from a network of over 11,000 milk producers in more than 553 cities. The milk is purchased mainly from local producers and supplemental purchases are made on the spot market, depending on market price conditions and demand levels. In the event that there is a lack of fresh milk in the market, we are capable of using powdered milk for part of our supply needs.

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

Feed

We produce most of the feed consumed at the farms operated by our integrated poultry and hog outgrowers. We provide feed to most of our integrated poultry and hog outgrowers as part of our partnership arrangements with them. We also sell animal feed to local hog producers at market rates.

We own 23 feed production plants. The basic raw materials used in animal feed production are corn and soy meal mixed with preservatives and micronutrients.  In 2010, we also purchased corn from rural producers and small merchants, through cooperatives and from trading companies such as Coamo, Bunge, Cargill, ADM and others. The corn is grown primarily in the states of Santa Catarina, Paraná, Rio Grande do Sul and the central-west region of Brazil. We buy soy meal from major producers such as Coamo, Bunge and Cargill, primarily pursuant to long-term contracts.

The prices of corn, soybeans and soy meal fluctuate significantly. See “Item 5. Operating and Financial Review and Prospects—A. Operating and Financial Review and Prospects—Principal Factors Affecting our Results of Operations—Commodity Prices.”  

 

Other Raw Materials

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

Suppliers

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

Brazilian Domestic Market

Brazil is the fifth largest country in the world, both in terms of land mass and population. As of April 2010, Brazil had an estimated population of 193.2 million people, according to data from the IBGE. According to IBGE, Brazil had a GDP of R$3.7 trillion for 2010, representing an increase of 15.4% over GDP of R$3.2 trillion for 2009, in each case in nominal terms. GDP per capita increased 6.5% in 2010 to R$19,016. The Brazilian government implemented fiscal and monetary policies, such as tax and interest rate reductions, designed to mitigate the impact of the international crisis on the Brazilian economy. Since the third quarter of 2009, increased hiring in the industry and services sectors has raised consumer confidence and led to increased sales of durable and non-durable products. The Central Bank forecasts that the Brazilian GDP in 2011 will increase 4.5% compared to 2010. The inflation rate, as measured by the IPCA, published by the IBGE, was 4.3% in 2009 and 5.9% in 2010, continuing a trend of moderate inflation rates when compared with Brazil’s historical experience of high rates of inflation.

Brazil is a large consumer of meat, with estimated per capita meat consumption of 91.8 kilograms in 2010, according to the USDA. Poultry and beef are a major food staple and protein source in the Brazilian domestic market. Pork is also an important protein source in the country, although Brazilians consume considerably more beef and poultry than pork.

Demand for poultry, pork and beef products is directly affected by economic conditions in Brazil. In the fourth quarter of 2008, the worsening of the global economic and financial crisis began to affect general demand for our products in the Brazilian market. These negative trends began to affect domestic consumer confidence in the fourth quarter of 2008 and continued to do so in 2009.  In 2010, the effectiveness of Brazilian government stimulus programs and other factors led to a an increase in consumption and consumer confidence. In addition, the overall trend toward improved economic conditions in recent years has generally supported increased demand for processed food products, as well as traditional fresh and frozen poultry and pork products. For information about certain expected macroeconomic trends for 2011, see “Item 5. Operating Financial Review and Prospects—D. Trend Information.”  

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

Among processed foods products, specialty meats and frozen processed meats have experienced considerable growth in recent years. Based upon information compiled by A.C. Nielsen, the specialty meats market in Brazil accounted for net sales of R$18,000 million in 2010, representing a 22% increase over R$14,700 million in 2009. Based upon information compiled by A.C. Nielsen, the frozen processed meats market represented net sales of approximately R$2,800 million in Brazil in 2010, a 15% increase over R$2,300 million in net sales in 2009. The processed foods sector is more concentrated in terms of the number of players. Consumption of processed products is influenced by several factors, including the increase in consumer income and marketing efforts with a view to meeting consumer demand for more value-added products. We believe that processed food products represent an opportunity for further growth in coming years.

 

In 2010, according to A.C. Nielsen, the Brazilian market for dairy processed products totaled approximately R$4,400 million, an increase of 10%, from R$4,000 million in 2009. Brazil is one of the world’s largest consumers of dairy products. The size of the Brazilian margarine market was approximately R$2,300 million in 2010, according to A.C. Nielsen.

Export Markets

In 2010, Brazil’s volume of poultry exports was 5.1% higher than in 2009. This improved performance can be explained mainly by the higher sales to Saudi Arabia, China, Egypt and Japan.

In 2011, first quarter exports of poultry meat may be affected by the disaster in Japan, which led to many port closures.

In the milk and dairy products industry, Brazil has been exporting various products, especially powdered milk, since 2000, as an alternative to the domestic market, and the sales volume of powdered milk increased from only 229 tons in 2000 to 54 thousand tons in 2010, according to SECEX.

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

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

Global trade in poultry products has been negatively affected by the spread of highly pathogenic avian influenza (H5N1 virus), particularly in Asia but also in Europe and Africa. Since the beginning of 2003, there have been 526 confirmed human cases of avian influenza and 311 deaths, according to the WHO. Human cases were reported in various countries in Asia, the Middle East and Africa,   and several countries in Europe reported cases of avian influenza in birds. Avian influenza has not yet been detected in Brazil or elsewhere in the Americas. A similar virus strain has been detected in North America, with low pathology. If this animal disease is detected in Brazil, or if it begins to be transmitted from human to human, global demand for poultry products is likely to decline for a period whose length cannot be predicted.

Similarly, global trade in pork products was negatively affected in 2009 by the spread of A(H1N1) influenza, also called “swine flu,” in many countries. As of July 4, 2010, more than 18,311 deaths worldwide had been recorded since the outbreak of A(H1N1) influenza in Mexico, and on June 11, 2009, the WHO declared a flu alert level six, signaling a “global pandemic.” Many countries, including Russia and China,  prohibited imports of pork from countries reporting a significant number of cases (Mexico, United States and Canada), but those countries later reopened their markets to producers from Mexico, the United States and Canada.

On August 10, 2010, the WHO terminated the level six influenza pandemic alert and shifted its focus to a post-pandemic period. During this period, localized outbreaks of different magnitudes may show significant levels of A(H1N1) transmission. Any further outbreak of A(H1N1) influenza could lead to the imposition of costly preventive controls on pork imports in our export markets and could have a negative impact on the consumption of pork in those markets or in Brazil. In addition, any future significant outbreak of A(H1N1) influenza in Brazil could lead to pressure to destroy our hogs, even if no link between the influenza cases and pork consumption is shown. Any such destruction of our hogs would result in decreased sales of pork, prevent recovery of costs incurred in raising or purchasing our hogs, and result in additional expense for the disposal of destroyed hogs. Accordingly, any spread of A(H1N1) influenza, or increasing concerns about this disease, may have a material and adverse effect on our company.

 

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

Sales

We sell our products both in the domestic Brazilian market and export markets around the world. Net sales to the Brazilian market, including most of our processed foods, accounted for 59.6% of our net sales in 2010 and 58.9% in 2009. Net sales to export markets, including most of our frozen whole and cut chickens and other poultry and frozen pork cuts and, more recently, beef cuts, accounted for 40.4% and 41.1% of our net sales in 2010 and 2009, respectively.

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

 

Overall Comparison of the Company’s Net Sales for the Years Ended December 31, 2010 and 2009

Domestic Market

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

None of our customers accounted for more than 5% of our total net sales in 2010. One of our strategies is to continue to expand our food service client base, which already includes Burger King, McDonalds and the Brazilian fast food chains Giraffas and Habib’s, while continuing to provide quality products and services to supermarket and other customers. Other institutional buyers include hotels, hospitals and businesses.

 

Our domestic distribution network uses 40 distribution centers in 14 Brazilian states and the Federal District. Refrigerated trucks transport our products from our processing plants to the distribution centers and from the centers to our customers. We have 50 cross docking points in several areas of the country that enable us to unload products from large refrigerated trucks onto smaller trucks or vans for transportation to our customers. We own 27 of our distribution centers and lease the remaining 13 centers, which are listed below under “—Property, Plant and Equipment.” We do not own the vehicles used to transport our products, and we contract with several carriers to provide this service for us on an exclusive basis.

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

Export Markets

We export our products to Europe, the Far East, Eurasia, the Middle East, Africa, the Americas and other countries. The graphs below set forth a breakdown of our export net sales by region. 

For illustrative purposes, the graph for 2009 presents net export sales data as if the Sadia acquisition had occurred on January 1, 2009, combining results of operation of Sadia with our company as of that date.

 

Competition

Domestic Market

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

In the specialty meat market, we (excluding Sadia) had a 25.5% market share by sales volume in 2010, Sadia had 28.9%, and Aurora and Marfig (including Seara) had market shares of 8.0% and 7.6%, respectively, according to A.C. Nielsen. The specialty meat market accounted for estimated revenues of approximately R$18.0 billion in Brazil in 2010, compared to R$14.7 billion in 2009, an increase of 22%. The four largest players accounted for 70.1% of the market in 2010, while the remainder of the market represents several small players. This market has undergone recent consolidation due to the competitiveness of the largest players, such as the acquisition of Seara by Marfrig in 2009. 

In the frozen processed meat market (which includes hamburgers, steaks, breaded meat kibes and meatballs), we (excluding Sadia) had a 31.1% market share by sales volume from December 2009 through November 2010; Sadia had a market share of 37.8% according to A.C. Nielsen. Seara was acquired by Marfrig in 2009, and its market share in the same period was 6.6%. Since 1995, the market has had average annual growth of 13.5% in terms of sales volume. The frozen processed meat market accounted for estimated revenues of approximately R$2.8 billion in Brazil in 2010, compared to R$2.4 billion in 2009, an increase of 15.3%.

 

The graph below shows the approximate percentage of our market share for 2010 in the main categories in which we compete. The percentages are based on data for twelve-month periods that vary according to the category but include most of 2010 in each case.

Source: A.C. Nielsen

In the frozen pasta market (which includes lasagnas and other products), we (excluding Sadia) had a 32.1% market share by sales volume in December 2009 through November 2010, while Sadia had a market share of 50.4%, according to A.C. Nielsen. The frozen pasta market accounted for estimated revenues of approximately R$647 million in 2010, compared to R$515 million in 2009, an increase of 26%. The frozen pasta market grew at an annual average rate of 16.2% from 2004 to 2010, in terms of sales volume.

In the frozen pizza market, we (excluding Sadia) had a 34.5% market share by sales volume from January through December 2010, while Sadia had a market share of 35.8% according to A.C. Nielsen. The frozen pizza market accounted for estimated revenues of R$551 million in 2010, compared to R$482 million in 2009, an increase of 14%. The frozen pizza market grew at an annual average rate of 13% from 2000 to 2010 in terms of sales volume.

In the dairy products market, we had a 11.2% market share by sales volume from December 2009 through November 2010, while Danone, Nestlé and Paulista had market shares of 20.4%, 15.2% and 6.7%, respectively, according to A.C. Nielsen. The dairy products market accounted for estimated revenues of approximately R$4.4 billion in Brazil in 2010, compared to R$4.0 billion in 2009, an increase of 9.9%. Since 2003, this market has had annual average growth of 6.5% in terms of sales volumes.

In the margarine market, we (excluding Sadia) had a 15.4% market share by sales volume from December 2009 through November 2010, Sadia had 46.8%, and Bunge had a market share of 27.1%, according to A.C. Nielsen. The margarine market accounted for estimated revenues of approximately R$2.3 billion in Brazil in 2010, according to A.C. Nielsen. In terms of sales volumes, this market grew 1.2% in 2010 compared with the same period in 2009.

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

In the domestic market, we compete primarily based on brand recognition, distribution capabilities, selling prices, quality and service to our customers. Since the market for processed food products is still growing in Brazil, we believe that the medium and long-term prospects for this segment are positive based on the trend over the preceding years.

Export Markets

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

 

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

The table below sets forth the main Brazilian exporters’ market share of poultry markets in 2009, by total sales volumes. ABEF, the association that consolidates the data of the companies’ export of poultry, has not yet released updated statistics for 2010. ABIPECS, the association that consolidates companies’ pork export data, no longer compiles this data.

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Source: ABEF  

(1) Market share data of Brasil Foods and Sadia is reported separately by ABEF.

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Source: ABIPECS

(1) Market share data of Brasil Foods and Sadia is reported separately by ABEF.

 

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

Distribution of Products

Domestic Market

We have focused on our logistical operations and seek to improve efficiency and reduce distribution costs by building distribution centers to cover long distances through our cross-docking facilities. We reach approximately 98% of the Brazilian territory through a nationwide distribution network. As of December 31, 2010, we operated 40 distribution centers and 42 cross-docking points.

Shipment of Products

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

 

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

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

Export Markets

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

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

Far East . In Japan, our biggest market in the Far East, we sell primarily to trading companies, which resell our products to Japanese distributors. We primarily supply special cuts of chicken, including boneless legs and wing cuts, produced specifically for the Japanese market, which has helped us foster customer loyalty. We also believe that our quality standards and product range have made us one of the preferred suppliers of chicken products in the Japanese market. We do not currently believe that the recent earthquake in Japan will materially adversely affect our results of operations; however, any significant deterioration in the Japanese economy could lead to decreased demand for our products in Japan and could adversely affect our results of operations. In addition to Japan, we sell a significant amount of products in Hong Kong and Singapore, where we believe our brands are well recognized. Our most popular products in these latter markets include chicken wings and feet.

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

 

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

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

Intellectual Property

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

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

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

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

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

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

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

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

 

Regulation

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

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

Marketing

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

In the domestic market, we have historically marketed our products primarily under the Perdigão  brand, which we believe is associated with quality and innovative products. We also use a secondary brand, Batavo, which is especially recognized in the State of Paraná. Although we previously used the Batavo  brand under license, we acquired a controlling interest in the brand through the Batávia acquisition. We also have well known brands for specific products, such as our Chester ® roosters, one of the most popular brands for premium poultry products in Brazil. In addition, we offer a popular Turma da Mônica line of processed foods for children. We have a licensing agreement to use the name and image of Mônica, a well known cartoon character in Brazil, and we use this brand for a wide variety of products, including our Turma da Mônica brand margarine for kids. Batávia also uses the Parmalat brand for processed refrigerated dairy products, such as yogurt. Upon the acquisition of Batávia, we entered into a license agreement with Parmalat S.p.A. to use the Parmalat  brand for processed dairy products and other products for a period of three years until the end of 2009, renewable for subsequent one-year periods, if there is no communication otherwise.  This license agreement with expire on April 25, 2011. In 2007, we acquired from Unilever the margarine brands Doriana, Delicata and Claybom , and also established a joint venture with Unilever to use the margarine brand Becel .  

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

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

For more information, see “—B. Business Overview—Intellectual Property.”

 

 

C.   Organizational Structure

See “—A. History and Development of the Company––Corporate Structure.”

D.   Property, Plant and Equipment

Production

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

We also operate 35 grain purchasing branches, through which we purchase corn needed for our animal feed production.

The table below sets forth our production facilities.

 

 

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

In early March 2011, a fire affected part of the installations of the Nova Mutum, Mato Grosso unit. The fire was of minor proportions, and the unit’s production will be temporarily absorbed by other BRF plants in such as a way as not to compromise supplies to clients and consumers. The Nova Mutum facility is covered by fire insurance. The Nova Mutum unit slaughters 230 thousand head of chicken/day, and its output (whole chicken and chicken cuts) is destined for the domestic and export market.

Distribution

We operate 40 distribution centers throughout Brazil, as set forth in the table below.

 

We operate 42 cross-docking points in Brazil, in the locations set forth in the table below.