Table of Contents

i  

Presentation of Financial and Other Data

The consolidated financial statements included in this annual report have been prepared in accordance with International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB), in reais. 

We have translated some of the real  amounts contained in this annual report into U.S. dollars.  The rate used to translate such amounts in respect of the year ended December 31, 2010 was R$1.6662 to US$1.00, which was the commercial rate for the purchase of U.S. dollars in effect on December 31, 2010, as reported by the Central Bank.  The U.S. dollar equivalent information presented in this annual report is provided solely for the convenience of investors and should not be construed as implying that the real  amounts represent, or could have been or could be converted into, U.S. dollars at the above rate.  See “Exchange Rates” for more detailed information regarding the Brazilian foreign exchange system and historical data on the exchange rate of the real  against the into U.S. dollars.

In this annual report, we use the terms “the Registrant” to refer to Gol Linhas Aéreas Inteligentes S.A., and “Gol”, “Company”, “we,” “us” and “our” to refer to the Registrant and its consolidated subsidiaries together, except where the context requires otherwise.  The term VRG refers to VRG Linhas Aéreas S.A., a wholly owned subsidiary of the Registrant.  References to “preferred shares” and “ADSs” refer to non-voting preferred shares of the Registrant and American depositary shares representing those preferred shares, respectively, except where the context requires otherwise.

The phrase “Brazilian government” refers to the federal government of the Federative Republic of Brazil, and the term “Central Bank” refers to the Banco Central do Brasil, or the Central Bank.  The term “Brazil” refers to the Federative Republic of Brazil.  The terms “U.S. dollar” and “U.S. dollars” and the symbol “US$” refer to the legal currency of the United States.  The terms “real” and “reais” and the symbol “R$” refer to the legal currency of Brazil.  “IFRS” refers to the international financial reporting standards issued by the International Accounting Standards Board, or IASB.  “U.S. GAAP” refers to generally accepted accounting principles in the United States, and “Brazilian GAAP” refers to generally accepted accounting principles in Brazil, which are accounting principles derived from Law No. 6,404 of December 15, 1976, as amended, or the Brazilian corporation law and the pronouncements, guidance, and interpretations issued by the Committee of Accounting Standards (Comitê de Pronunciamentos Contábeis), or the CPC, approved by the rules of the CVM.

We make statements in this annual report about our competitive position and market share in, and the market size of, the Brazilian and international airline industry.  We have made these statements on the basis of statistics and other information from third party sources, governmental agencies or industry or general publications that we believe are reliable.  Although we have no reason to believe any of this information or these reports are inaccurate in any material respect, we have not verified the competitive position, market share and market size or market growth data provided by third parties or by industry or general publications.  All industry and market data contained in this annual report is based upon the latest publicly available information as of the date of this annual report.

Certain figures included in this annual report have been rounded.  Accordingly, figures shown as totals in certain tables may not be an arithmetic sum of the figures that precede them.

This annual report contains terms relating to operating performance in the airline industry that are defined as follows:

·         “Revenue passengers” represents the total number of paying passengers flown on all flight segments.

·         “Revenue passenger kilometers” represents the numbers of kilometers flown by revenue passengers.

·         “Available seat kilometers” represents the aircraft seating capacity multiplied by the number of kilometers the seats are flown.

·         “Load factor” represents the percentage of aircraft seating capacity that is actually utilized (calculated by dividing revenue passenger kilometers by available seat kilometers).

·         “Breakeven load factor” is the passenger load factor that will result in passenger revenues being equal to operating expenses.

·         “Aircraft utilization” represents the average number of block hours operated per day per aircraft for the total aircraft fleet.

·         “Block hours” refers to the elapsed time between an aircraft’s leaving an airport gate and arriving at an airport gate.

·         “Yield per passenger kilometer” represents the average amount one passenger pays to fly one kilometer.

·         “Passenger revenue per available seat kilometer” represents passenger revenue divided by available seat kilometers.

·         “Operating revenue per available seat kilometer” represents operating revenues divided by available seat kilometers.

·         “Average stage length” represents the average number of kilometers flown per flight leg.

·         “Operating expense per available seat kilometer” represents operating expenses divided by available seat kilometers.

Cautionary Statements about Forward-Looking Statements

This annual report includes forward-looking statements, principally under the captions “Risk Factors,” “Operating and Financial Review and Prospects” and “Business Overview.”  We have based these forward-looking statements largely on our current beliefs, expectations and projections about future events and financial trends affecting our business.  Many important factors, in addition to those discussed elsewhere in this annual report, could cause our actual results to differ substantially from those anticipated in our forward-looking statements, including, among other things:

·         general economic, political and business conditions in Brazil and in other South American and Caribbean markets we serve;

·         the effects of global financial markets and economic crises;

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

·         our level of fixed obligations;

·         our capital expenditure plans;

·         our ability to obtain financing on acceptable terms;

·         inflation and fluctuations in the exchange rate of the real; 

·         existing and future governmental regulations, including air traffic capacity controls;

·         increases in fuel costs, maintenance costs and insurance premiums;

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

·         cyclical and seasonal fluctuations in our operating results;

·         defects or mechanical problems with our aircraft;

·         our ability to successfully implement our strategy;

·         developments in the Brazilian civil aviation infrastructure, including air traffic control, airspace and airport infrastructure, and

·         the risk factors discussed under “Risk Factors.”

The words “believe,” “may,” “will,” “aim,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar words are intended to identify forward-looking statements.  Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities, and the effects of future regulation and the effects of competition.  Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update publicly or to revise any forward-looking statements after we distribute this annual report because of new information, future events or other factors.  In light of the risks and uncertainties described above, the forward-looking events and circumstances discussed in this annual report might not occur and are not guarantees of future performance.

PART I

ITEM 1.  Identity of Directors, Senior Management and Advisors

Not applicable.

ITEM 2.  Offer Statistics and Expected Timetable

Not applicable.

ITEM 3.  Key Information

A.      Selected Financial Data

We changed our financial reporting from U.S. GAAP to IFRS, beginning with the financial statements as of and for the year ended December 31, 2008.  We present in this section the following summary financial data:

·         Summary financial and operating data derived from our audited financial statements included herein and prepared in accordance with IFRS as of and for the years ended December 31, 2010, 2009 and 2008;

·         Summary financial and operating data derived from out audited financial statements not included herein and prepared in accordance with IFRS as of and for the year ended December 31, 2007; and

·         Summary financial data derived from our audited financial statements not included herein and prepared in accordance with U.S. GAAP as of and for the year ended December 31, 2006.

The summary financial data prepared in accordance with IFRS and U.S. GAAP is not comparable.

The following tables present summary historical consolidated financial and operating data for us for each of the periods indicated.  Solely for the convenience of the reader, real  amounts as of and for the year ended December 31, 2010 have been translated into U.S. dollars at the commercial market rate in effect on December 31, 2010 as reported by the Central Bank of R$1.6662 to US$1.00.

IFRS Summary Financial and Operating Data

_________

(1)   Our preferred shares are not entitled to any fixed dividend preferences, but are instead entitled to receive dividends per share in the same amount of dividends per share paid to holders of our common shares.  Consequently, our earnings (loss) per share are computed by dividing income by the weighted average number of all classes of shares outstanding during the year.

(2)   Trade and other receivables related to receivables from credit card administrators, travel agencies, installment sales from the Voe Fácil program, cargo agencies and others.  These receivables are stated at cost less allowances for doubtful receivables, which approximates their fair value given their short term nature.

(3)   Operating margin represents operating income (loss) before financial results divided by net operating revenues.

(4)   Considering sales through our website and API (application programming interface) systems.

(5)   In October 2010, ANAC changed its calculation method for monthly traffic information and republished information for periods since January 2009. All operating data for 2009 and 2010 reflects the new methodology, whereas information for 2007 and 2008 was calculated pursuant to the old methodology and may not be fully comparable. According to ANAC, the changes were designed to align data with the concepts adopted by the International Civil Aviation Organization (ICAO). The change was necessary because Brazil has joined the ICAO’s statistical program and supplies the latter’s database with several industry data. Changes in the methodology refer to the calculation of ASK (seat supply) and the classification of domestic legs in international flights, which are now considered to be part of the domestic market. ANAC has stated that it will republish information for 2008 at a later date.

U.S. GAAP Summary Financial Data*

_________

*      For a reconciliation of profit (loss) and shareholders’ equity of our audited financial statements in U.S. GAAP to our audited financial statements in IFRS at January 1, 2007 and December 31, 2007 and for the year then ended, see note 23 under the caption “Reconciliation between US GAAP and IFRS as of and for the year ended December 31, 2007” to our financial statements included in our annual report on Form 20-F for the year ended December 31, 2008, as filed on May 8, 2009.

(1)   Our preferred shares are not entitled to any fixed dividend preferences, but are instead entitled to receive dividends per share in the same amount of dividends per share paid to holders of our common shares.  Consequently, our earnings (loss) per share are computed by dividing income by the weighted average number of all classes of shares outstanding during the year.

(2)   Trade and other receivables related to receivables from credit card administrators, travel agencies, installment sales from the Voe Fácil program, cargo agencies and others.  These receivables are stated at cost less allowances for doubtful receivables, which approximates their fair value given their short term nature

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.  The Brazilian currency has during the last decades experienced frequent and substantial variations in relation to the U.S. dollar and other foreign currencies.  Between 2000 and 2002 the real depreciated  significantly against the U.S. dollar, reaching an exchange rate of R$3.53 per US$1.00 at the end of 2002. Between 2003 and mid-2008, the real  appreciated significantly against the U.S. dollar due to the stabilization of the macro-economic environment and a strong increase in foreign investment in Brazil, with the exchange rate reaching R$1.56 per US$1.00 in August 2008.  With the crisis in the global financial markets beginning in mid-2008, the real  depreciated 31.9% against the U.S. dollar over the year 2008, reaching R$2.34 per US$1.00 on December 31, 2008.  Since 2009, the real appreciated against the U.S. dollar and on December 31, 2010 the exchange rate was R$1.67 per US$1.00 and on April 4, 2011, the exchange rate was R$1.61 per US$1.00.  The Central Bank has intervened occasionally to control instability in foreign exchange rates.  We cannot predict whether the Central Bank or the Brazilian government will continue to allow the real  to float freely or will intervene in the exchange rate market through a currency band system or otherwise.  The real  may substantially depreciate or appreciate against the U.S. dollar.

The following tables present the selling rate, expressed in reais per U.S. dollar (R$/US$), for the periods indicated.

_________

Source:  Central Bank

(1) Represents the average of the exchange rates on the last day of each month during the period.

(2) Average of the lowest and highest rates in the month.

B.      Capitalization and Indebtedness

Not applicable.

C.      Reasons for the Offer and Use of Proceeds

Not applicable.

D.      Risk Factors

An investment in the ADSs or our preferred shares involves a high degree of risk.  You should carefully consider the risks described below before making an investment decision.  Our business,  financial condition and results of operations could be materially and adversely affected by any of these risks.  The trading price of the ADSs could decline due to any of these risks or other factors,  and you may lose all or part of your investment.  The risks described below are those that we currently believe may materially affect us.

Risks Relating to Brazil

The Brazilian government has exercised,  and continues to exercise,  significant influence over the Brazilian economy.  This involvement,  as well as Brazilian political and economic conditions,  could adversely affect our business and the trading price of our ADSs and our preferred shares.

The Brazilian government frequently has intervened in the Brazilian economy and occasionally makes significant changes in policy and regulations.  The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, increases in interest rates, changes in tax policies, price controls, currency devaluations, capital controls and limits on imports.  Our business, financial condition and results of operations may be adversely affected by changes in policy or regulations at the federal, state or municipal levels involving or affecting factors such as:

·         interest rates;

·         currency fluctuations;

·         inflation; 

·         liquidity of domestic capital and lending markets;

·         tax policies;

·         exchange rates and exchange controls and restrictions on remittances abroad, such as those that were briefly imposed in 1989 and early 1990; and

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

Exchange rate instability may adversely affect our financial condition and results of operations and the market price of the ADSs and our preferred shares.

The Brazilian currency has during the last decades experienced frequent and substantial variations in relation to the U.S. dollar and other foreign currencies.  Between 2000 and 2002, the real  depreciated significantly against the U.S. dollar, reaching an exchange rate of R$3.53 per US$1.00 at the end of 2002.  Between 2003 and mid-2008, the real  appreciated significantly against the U.S. dollar due to the stabilization of the macro-economic environment and a strong increase in foreign investment in Brazil, with the exchange rate reaching R$1.56 per US$1.00 in August 2008.  In the context of the crisis in the global financial markets after mid-2008, the real  depreciated against the U.S. dollar over the year 2008 and reached R$2.34 per US$1.00 at year end 2008.  Since 2009, the real appreciated against the U.S. dollar and on December 31, 2010 the exchange rate was R$1.67 per US$1.00.

Depreciation of the real  against the U.S. dollar could create inflationary pressures in Brazil and cause increases in interest rates, which could negatively affect the growth of the Brazilian economy as a whole and harm our financial condition and results of operations, may curtail access to foreign financial markets and may prompt government intervention, including recessionary governmental policies.  Depreciation of the real  against the U.S. dollar can also, as in the context of an economic slowdown, lead to decreased consumer spending, deflationary pressures and reduced growth of the economy as a whole.  On the other hand, appreciation of the real  relative to the U.S. dollar and other foreign currencies could lead to a deterioration of the Brazilian foreign exchange current accounts, as well as dampen export-driven growth.  Depending on the circumstances, either depreciation or appreciation of the real  could materially and adversely affect the growth of the Brazilian economy and our business, financial condition and results of operations.

Substantially all of our passenger revenue and cargo revenue and temporary investments are denominated in reais, and a significant part of our operating expenses, such as fuel, aircraft and engine maintenance services, aircraft rent payments and aircraft insurance, are denominated in, or linked to, U.S. dollars.  We maintain U.S. dollar-denominated deposits and maintenance reserve deposits under the terms of some of our aircraft operating leases.  For the year ended December 31, 2010, 54.7% of our operating expenses were either denominated in or linked to the U.S. dollar.  In addition, the purchase price of the Boeing 737 Next Generation aircraft for which we had 100 firm purchase orders outstanding as of December 31, 2010, the 10 purchase rights and the 40 Boeing 737 Next Generation aircraft for which we currently have purchase options are denominated in U.S. dollars.  At the end of 2010, 79.5% of our indebtedness was denominated in U.S. dollars.  While in the past we have generally adjusted our fares in response to, and to alleviate the effect of, depreciation of the real and increases in the price of jet fuel (which is priced in U.S. dollars) and have entered into hedging arrangements to protect us against the effects of such developments, there can be no assurance we will be able to continue to do so.  To the extent we are unable to adjust our fares or effectively hedge against any such developments, this may lead to a decrease in our profit margins or to operating losses caused by increases in U.S. dollar-denominated costs, increases in interest expense or exchange losses on unhedged fixed obligations and indebtedness denominated in foreign currency.  We had total U.S. dollar-denominated future operating lease payment obligations of R$2,105.7 million and R$3,123.0 million regarding other U.S. dollar-denominated liabilities and indebtedness at December 31, 2010.  We may incur substantial additional amounts of U.S. dollar-denominated operating lease or financial obligations and U.S. dollar-denominated indebtedness and be subject to fuel cost increases linked to the U.S. dollar.

Depreciation of the real  also reduces the U.S. dollar value of distributions and dividends on the ADSs and the U.S. dollar equivalent of the market price of our preferred shares and, as a result, the ADSs.

Government efforts to combat inflation may hinder the growth of the Brazilian economy and could harm our business.

Brazil has in the past experienced extremely high rates of inflation and has therefore followed monetary policies that have resulted in one of the highest real interest rates in the world.  Between 2004 and 2010, the base interest rate (SELIC) in Brazil varied between 19.25% p.a. and 8.75% p.a. Inflation and the Brazilian government’s measures to fight it, principally through the Central Bank, have had and may have significant effects on the Brazilian economy and our business.  Tight monetary policies with high interest rates may restrict Brazil’s growth and the availability of credit.  Conversely, more lenient government and Central Bank policies and interest rate decreases may trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect our business.  In addition, we may not be able to adjust the fares we charge our customers to offset the effects of inflation on our cost structure.

Developments and the perception of risk in other countries,  including the United States and emerging market countries,  may adversely affect the market price of Brazilian securities,  including the ADSs and our preferred shares.

The market value of securities of Brazilian issuers is affected by economic and market conditions in other countries, including the United States, the European Union and emerging market countries.  Although economic conditions in those countries may differ significantly from economic conditions in Brazil, investor’s reactions to developments in other countries may have an adverse effect on the market value of securities of Brazilian issuers.  Crises in the United States, the European Union or emerging market countries may diminish investor interest in securities of Brazilian issuers, including ours.  This could adversely affect the trading price of the ADSs or our preferred shares, 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.

Risks Relating to Us and the Brazilian Airline Industry

Changes to the Brazilian civil aviation regulatory framework may adversely affect our business and results of operations.

Brazilian aviation authorities monitor and influence the developments in Brazil’s airline market.  For example, the predecessor of the National Civil Aviation Agency (Agência Nacional de Aviação Civil), or ANAC, the DAC (Departamento de Aviação Civíl), had addressed overcapacity by establishing strict criteria that must be met before new routes or additional flight frequencies were awarded. ANAC (the successor of the DAC) has more recently set minimum turnaround times.  The policies of the ANAC and other aviation supervisory authorities may negatively affect our operations.

The Brazilian congress is currently discussing a draft bill that would replace the current Brazilian Aeronautical Code (Código Brasileiro de Aeronáutica).  In general, this draft bill deals with matters related to civil aviation, including airport concessions, consumer protection, limitation of airlines’ civil liability, compulsory insurance, fines and the increase of limits to foreign ownership in voting stock of Brazilian airlines from 20% to 49% or higher, provided that the country of origin of the investor permits a higher ownership threshold for Brazilian investors.  This draft bill is still under discussion in the House of Representatives and, if approved, must be submitted for approval to the Federal Senate, before being sent for presidential approval. If the Brazilian civil aviation framework changes in the future, or ANAC implements increased restrictions, our growth plans and our business and results of operations could be adversely affected.

Since 2009, the Brazilian government has been analyzing the privatization of airports or granting of rights for private concessionaries to operate currently existing airports or expansions of those airports.  In January 2011, Mrs. Dilma Roussef, the newly elected Brazilian president, announced that she intends to privatize certain Brazilian airports. Although such measures may serve as a potential positive catalyst to accelerate investments in airport infrastructure, we are unable to foresee the effects of any such measures on our business and results of operations.

In March 2011, the Civil Aviation Secretary (Secretaria de Aviação Civil), or SAC, was created to supervise civil aviation in Brazil. The Civil Aviation Secretary oversees the ANAC and INFRAERO and reports directly to the Brazilian President. We are unable to foresee how SAC will act as a regulator of Brazilian civil aviation and as its main policy agency, in the event SAC changes current policies or directs ANAC and INFRAERO to do so it may adversely affect our operations.

Changes to the Brazilian civil aviation regulatory framework may change the competitive dynamics of our industry and may adversely affect our operations, see “−We operate in a highly competitive industry.”

The airline industry is particularly sensitive to changes in economic conditions and continued negative economic conditions would likely continue to negatively impact our results of operations and our ability to obtain financing on acceptable terms.

Our operations and the airline industry in general are particularly sensitive to changes in economic conditions.  Unfavorable general economic conditions, such as higher unemployment rates, a constrained credit market and increased business operating costs, can reduce spending for both leisure and business travel.  Unfavorable economic conditions can also impact our ability to raise fares to counteract increased fuel, labor, and other costs.  Any of these factors may negatively impact our results of operations.

Unfavorable economic conditions, a significant decline in demand for air travel, or continued instability of the credit and capital markets could also result in pressure on our borrowing costs, operating results and financial condition and would affect our growth and investment plans.  These factors could also negatively affect our ability to obtain financing on acceptable terms and our liquidity generally.

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

We are dependent on improvements in the coordination and development of Brazilian airspace control and airport infrastructure, which, mainly due to the large growth in civil aviation in Brazil in recent years, require substantial improvements and government investments.  This is further emphasized by the need for additional infrastructure investments in the context of the Soccer Confederations Cup (2013) and World Cup (2014) and the Summer Olympics (2016) in Brazil.  Infraero has announced a list of investments in major Brazilian airports of approximately R$5.5 billion to be implemented between 2011 and 2014.

If the measures taken and investments made by the Brazilian government and regulatory authorities do not prove sufficient or effective, air traffic control, airspace management and sector coordination-related difficulties might reoccur or worsen, which might have a material adverse effect on our business, our results of operations and our growth strategy.

We operate in a highly competitive industry.

We face intense competition on domestic routes in Brazil from existing scheduled airlines and charter airlines and potential new entrants in our market.  In addition to competition among scheduled airline companies and charter operators, the Brazilian airline industry faces competition from ground transportation alternatives, such as interstate buses.  We may also face competition from international airlines as they introduce and expand flights between Brazil, other South American and Caribbean destinations.

Our existing competitors or potential new entrants into the markets in which we operate have in the past and may again undercut our fares, increase capacity on their routes in an effort to increase their market share or attempt to conduct low-fare or low-cost airline operations of their own, emulating our strategy.  In any such event, we cannot assure you that our level of fares or passenger traffic would not be adversely affected and would not have an adverse impact on our business and results of operations or that our competitive advantage would not be reduced.

In 2010 ANAC approved the deregulation of international airfares for flights departing from Brazil to the U.S. and Europe, gradually removing the prior minimum fares.  In addition, in 2010 the National Civil Aviation Council (Conselho de Aviação Civil), or CONAC, approved the continuity of bilateral agreements providing for open skies policies with other South American countries and a new open skies policy with the United States and began negotiations for an open skies policy with Europe, which we expect will be concluded this year.  These regulations increase competition in the market and may negatively affect our results of operation.

Until 2010, landing fees charged in Brazilian airports were standard in all airports independent of whether they were busy or not. In February 2011, in the context of measures to increase the viability of airports for privatization, the Brazilian government announced that it will increase landing fees at the busiest airports as compared to less busy airports. As a result, secondary airports may benefit in light of the differences in fees for the airlines that choose to operate in these airports. Changes in landing or other fees may provide other market players with a cost advantage and negatively affect our competitive position and results of operation.

Changes in regulation may affect the competitive scenario. We cannot foresee the effects of changes in regulation on the competitive environment on us and our industry. See “−Changes to the Brazilian civil aviation regulatory framework may adversely affect our business and results of operations” above.

In addition, as a result of the competitive environment there may be further consolidation in the Brazilian and global airline industry, whether by means of acquisitions, joint ventures, partnerships or strategic alliances.  We cannot predict the effects of further consolidation on the industry and, to the extent that we act as a consolidator, we may not be able to implement our growth strategy or make use of synergies, our costs may increase and our operational efficiency may be reduced. In the event we do not act as a consolidator our competitors may increase their scale and may have a competitive advantage over us, which would negatively affect our business and results of operations.

A failure to successfully implement our strategy would harm the market value of the ADSs and our preferred shares.

Our strategy involves capitalizing on our strong market position in Brazil and Latin America with the highest number of routes at the most important airports in Brazil, our consolidated flight network, our e-commerce platform and our Smiles  mileage program, to increase our penetration of all traveler segments.

Slots at Congonhas Airport in São Paulo, the most important airport for our operations, are fully utilized.  The Santos-Dumont airport in Rio de Janeiro, a highly utilized airport with half-hourly shuttle flights between São Paulo and Rio de Janeiro, has certain slot restrictions.  Several other Brazilian airports, for example the Brasília, Campinas, Salvador, Confins and São Paulo (Guarulhos) international airports, have limited the number of slots per day due to infrastructural limitations at these airports.  Any condition that would prevent or delay our access to airports or routes that are vital to our strategy, or our inability to maintain our existing slots, and obtain additional slots, could materially adversely affect our operations.  In addition, we cannot assure that any investments will be made by the Brazilian government in the Brazilian aviation infrastructure to permit a capacity increase at busy airports and consequently additional concessions for new slots to airlines.

Our strategy involves developing new products and businesses in order to increase our ancillary revenues and therefore our total net revenues.  Any condition that would prevent or delay our ability to develop such additional revenue sources may significantly impact our operating margins.  In addition, a large portion of such ancillary revenues relies on developing partnerships to sell products through our e-commerce platform and on our flights.  We do not have any experience in the operation of these businesses and if any of our partners fails to properly deliver products or services it offers, our brand, reputation and results of operations may be significantly adversely impacted and we may be exposed to contingencies with regard to those activities.

We have significant recurring aircraft lease costs,  and we will incur significantly more fixed costs that could hinder our ability to meet our strategic goals.

We have significant costs, relating primarily to leases for our aircraft and engines, of which leases for 22 aircraft have floating-rate rent payments based on LIBOR or U.S. interest rates.  As of December 31, 2010, we had commitments of R$16.4 billion to purchase additional Boeing 737-800 Next Generation aircraft, based on aircraft list prices, although the actual price payable by us for the aircraft will be lower due to supplier discounts.  As of December 31, 2010, we had R$3.4 billion in long-term indebtedness, excluding our perpetual bonds in the amount of R$297.9 million.  We expect that we will incur additional fixed obligations and debt as we take delivery of the new aircraft and other equipment to implement our strategy.

Having significant fixed payment obligations could:

·         limit our ability to obtain additional financing to support expansion plans and for working capital and other purposes;

·         divert substantial cash flow from our operations to service our fixed obligations under aircraft operating leases and aircraft purchase commitments;

·         if LIBOR or U.S. interest rates increase, require us to incur significantly more lease or interest expense than we currently do; and

·         limit our ability to plan for or react to changes in our business and the airline industry and to general economic conditions.

Our ability to make scheduled payments on our fixed obligations, including indebtedness we will incur, will depend on our operating performance and cash flow, which will in turn depend on prevailing economic and political conditions and financial, competitive, regulatory, business and other factors, many of which are beyond our control.  In addition, our ability to raise our fares to compensate for an increase in our fixed costs may be adversely affected by any imposition of fare control mechanisms by the Brazilian civil aviation authorities.

Agreements on a common approach between export credit agencies of the United States and the European Union on offering export credits for commercial aircraft are likely to increase our aircraft financing costs.

The Export-Import Bank of the United States (“Ex-Im Bank”) has recently agreed on a common approach with European export-credit agencies on offering export credits for commercial aircraft.  Among other things, the new Sector Understanding on Export Credits for Civil Aircraft (the “ASU”) sets forth minimum guarantee premium rates applicable to aircraft delivered on or after January 1, 2011, or under firm contracts entered into after April 30, 2007.  While subject to modification, the exposure fees paid by us on applicable aircraft are likely to increase. The amount of any such increase will depend upon the credit risk assigned to us by the participating export-agencies pursuant to the protocols of the ASU.  In addition, we will no longer be able to finance the amortization payments of loans guaranteed by Ex-Im Bank with SOAR loan facilities. These developments are likely to increase our financing costs and may negatively affect our results of operation and our credit rating, which would further negatively affect our financing costs.

We may have to use our cash resources to finance a portion of our firm purchase order aircraft.  We may not have sufficient cash resources to do so.

We currently finance our aircraft principally through operating leases.  As a result of our 100 firm purchase orders for Boeing 737-800 Next Generation aircraft outstanding as of December 31, 2010, we expect to own a larger portion of our fleet as well as continue to lease aircraft through principally long-term operating leases.  The firm purchase orders represent a significant financial commitment for us.  We have in recent years financed and intend to continue financing our new Boeing 737-800 NG aircraft with a commitment we received from the Ex-Im Bank providing guarantees covering 85% of the aggregate purchase price for the firm purchase order aircraft.  While we expect that the guaranty from the Ex-Im Bank will help us in obtaining low-cost financing for the purchase of the firm purchase order aircraft, we may be required to use our own cash resources for the remaining 15% of the aggregate purchase price for the firm purchase order aircraft. As of December 31, 2010, we had R$2.0 billion of cash, cash equivalents, short-term investments in overnight deposits and deposit certificates of highly-rated Brazilian banks and marketable securities, mainly Brazilian government bonds.  If the value or liquidity of these investments were to decrease, or we do not have sufficient cash resources, we may be required to modify our aircraft acquisition plans or to incur higher than anticipated financing costs, which would have an adverse impact on the execution of our strategy and business and could have an adverse impact on our results of operations. 

Substantial fluctuations in fuel costs or the unavailability of fuel would harm our business.

Historically, international and local fuel prices have been subject to wide price fluctuations based on geopolitical issues and supply and demand.  Fuel costs, which at times in 2007 and 2008 were at historically high levels, constitute a significant portion of our total operating expenses, accounting for 36.4% of our operating expenses for the year ended December 31, 2010.  Fuel availability is also subject to periods of market surplus and shortage and is affected by demand for both home heating oil and gasoline.  In the event of an international or local fuel supply shortage, our fuel prices may increase.  Although we enter into hedging arrangements to reduce our exposure to fuel price fluctuations and have historically passed on the majority of fuel price increases by adjusting our fare structure, the price and future availability of fuel cannot be predicted with any degree of certainty.  Our hedging activities or the extent of our ability to adjust our fares may not be sufficient to protect us from fuel price increases.

Substantially all of our fuel is supplied by one source, Petrobrás Distribuidora S.A. If Petrobrás Distribuidora is unable or unwilling to continue to supply fuel to us at the times and in the quantities that we require, our business and results of operations would be adversely affected.

Events resulting from prolonged instability in the Middle East or other oil-producing regions or the suspension of production by any significant producer, may result in substantial price increases, adverse exchange rates, or the unavailability of adequate supplies and adversely affect our profitability. In addition, the same effect may be caused by natural disasters or other large unexpected disrupting events in regions with significant consumption of other energy sources. No assurances can be given about trends in fuel prices, and average fuel prices for the 2011 fiscal year or for future years may be significantly higher than current prices.

We rely on one supplier for our aircraft and engines.

One of the key elements of our current business strategy is to save costs by operating a standardized aircraft fleet.  After extensive research and analysis, we chose the Boeing 737-700/800 Next Generation aircraft and CFM 56-7B engines from CFM International.  We expect to continue to rely on Boeing and CFM International into the foreseeable future.  If either Boeing or CFM International were unable to perform its contractual obligations, we would have to find another supplier for a similar type of aircraft or engines.

If we had to lease or purchase aircraft from another supplier, we could lose the benefits we derive from our current fleet composition.  We cannot assure you that any replacement aircraft would have the same operating advantages as the Boeing 737-700/800 Next Generation aircraft or that we could lease or purchase engines that would be as reliable and efficient as the CFM engines.  We may also incur substantial transition costs, including costs associated with retraining our employees, replacing our manuals and adapting our facilities, to the extent that such costs would not be covered by the alternate supplier.  Our operations could also be disrupted by the failure or inability of Boeing or CFM International to provide sufficient parts or related support services on a timely basis.

Our business would also be significantly harmed if a design defect or mechanical problem with the Boeing 737-700/800 Next Generation aircraft or the CFM engines used on our aircraft were discovered, causing our aircraft to be grounded while any such defect or problem is being corrected, assuming it could be corrected at all.  The use of our aircraft could be suspended or restricted by the ANAC in the event of any actual or perceived mechanical, design or other problems while the ANAC conducts an investigation.  Our business would also be significantly harmed if the public avoids flying on our aircraft due to an adverse perception of the Boeing 737-700/800 Next Generation aircraft or the CFM engines because of safety concerns or other problems, whether real or perceived, or in the event of an accident involving Boeing 737-700/800 Next Generation aircraft or the CFM engines.

When Boeing or CFM release new aircrafts or engines to replace the Boeing 737-700/800 Next Generation aircraft or the CFM engines used on our aircraft the market value of our aircrafts and engines may decrease, which would negatively affect the value of our assets and could result in us recording impairment charges.

We may be unable to maintain our company culture as our business grows.

We believe that our growth potential and the maintenance of our results-oriented corporate culture are directly linked to our capacity to attract and maintain the best professionals available in the Brazilian airline industry.  We are dedicated to providing professional, high-quality service in a positive work environment and finding innovative ways to improve our business.  We place great emphasis on the selection and training of enthusiastic employees with potential to add value to our business and who we believe fit in with and contribute to our company culture.  As we grow domestically and internationally, we may be unable to identify, hire or retain enough people who meet these criteria, or we may have trouble maintaining this company culture as we become larger.  Our company culture is crucial to our business plan, and failure to maintain that culture could adversely affect our business and results of operations.

We rely heavily on automated systems to operate our business,  and any failure of these systems could harm our business.

We depend on automated systems to operate our business, including our computerized airline ticket sales system, our telecommunication systems, our scheduling system and our website.  Our website and ticket sales system must be able to accommodate a high volume of traffic and deliver important flight information.  Substantial or repeated website, ticket sales, scheduling or telecommunication systems failures could reduce the attractiveness of our services and could cause our customers to purchase tickets from another airline.  Any disruption in these systems could result in the loss of important data, increase our expenses and generally harm our business.

We rely on maintaining a high daily aircraft utilization rate to increase our revenues and reduce our costs.  High aircraft utilization also makes us vulnerable to delays.

One of the key elements of our business strategy is to maintain a high daily aircraft utilization rate.  High daily aircraft utilization allows us to generate more revenue from our aircraft and dilute our fixed costs, and is achieved in part by operating with quick turnaround times at airports so we can fly more hours on average in a day.  Our rate of aircraft utilization could be adversely affected by a number of different factors that are beyond our control, including, among others, air traffic and airport congestion, adverse weather conditions and delays by third-party service providers relating to matters such as fueling and ground handling.

High aircraft utilization increases the risk that if an aircraft falls behind schedule during the day, it could remain behind schedule during the remainder of that day and potentially the next day, which can result in disruption in operating performance, leading to passenger dissatisfaction related to delayed or cancelled flights and missed connections, which may negatively affect our reputation, results of operation and the market price of our ADSs and preferred shares.

Temporary or permanent shortages of skilled labor, or mismanagement of our scheduling systems, could disrupt our business.

Our business depends significantly upon the availability of skilled labor, including hiring, training and retaining qualified pilots, co-pilots and other key employees. We may not be able to compete for skilled labor with airlines in other growing markets, or domestically and may be unable to hire or retain pilots and other key crew members. Training a pilot requires many years of extensive flight hours, including a significant amount of hours in flight simulators. If our pilots or key crew members leave our company we may not be able to find suitable replacements, losing our investment in training and increasing the probability of disruptions in our business caused by shortages of skilled labor.

In addition, restrictions on flight hours for our pilots and crew members or mismanagement of our scheduling  systems in light of our high daily aircraft utilization rate may cause temporary shortages of skilled labor and could disrupt our business, harm our reputation and adversely affect our results of operation.

The airline industry is dynamic and volatile and our reputation,  financial results and the market price of our ADSs and preferred shares could be harmed by events out of our control

Accidents or incidents involving our aircraft could involve significant claims by injured passengers and others, as well as significant costs related to the repair or replacement of a damaged aircraft and its temporary or permanent loss from service.  We are required by ANAC and lessors of our aircraft under our operating lease agreements to carry liability insurance.  Although we believe we currently maintain liability insurance in amounts and of the type generally consistent with industry practice, the amount of such coverage may not be adequate and we may be forced to bear substantial losses in the event of an accident.  Substantial claims resulting from an accident in excess of our related insurance coverage would harm our business and financial results.  Moreover, any aircraft accident or incident involving our aircraft, even if fully insured, or an accident or incident involving Boeing 737 Next Generation aircraft or the aircraft of any major airline could cause negative public perceptions about us or the air transport system, which would harm our business and results of operations as well as the market price of our ADSs and preferred shares.

We may also be affected by other events that affect travel behavior, such as the potential of epidemics or acts of terrorism.  These events are out of our control and may affect us even if occurring in markets where we do not operate and/or in connection with other airlines.  For example, in the second quarter of 2009, there was an outbreak of the H1N1 virus which had an adverse impact on global air travel and on our operations to and from Argentina.  In addition, in the past there have been concerns about outbreaks or potential outbreaks of other diseases, such as avian flu and Severe Acute Respiratory Syndrome, or SARS, which had an adverse impact on global air travel.  Any outbreak of a disease that affects travel behavior could have a material adverse impact on us and the trading price of shares of companies in the worldwide airline industry, including our ADRs and preferred shares.  Outbreaks of disease could also result in quarantines of our personnel or an inability to access facilities or our aircraft, which could adversely affect our operations.  The trading price of shares of companies in the worldwide airline industry are relatively volatile and investors’ perception of the market value of these shares, including our ADSs and preferred shares, may also be negatively impacted with additional volatility and decreases in the price of our ADSs and preferred shares.

Our ability to use tax loss carryforwards to offset future taxable income is subject to limitation.

As of December 31, 2010, we had reported approximately R$1.6 billion of tax loss carryforward as a result of the acquisition of VRG. Under Brazilian tax laws we may only use our tax loss carryforward to offset taxes payable up to 30% of the taxable profit for each year. Thus, despite having balance tax loss carryforward we may have to pay higher taxes in case we reach the compensation limits for any given year that we are entitled to use under Brazilian tax laws.

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

Our controlling shareholder has the power to, among other things, elect a majority of our directors and determine the outcome of any action requiring shareholder approval, including transactions with related parties, corporate reorganizations, dispositions, and the timing and payment of any future dividends, subject to minimum dividend payment requirements imposed under the Brazilian corporation law.  Although you are entitled to tag-along rights in connection with a change of control of our company and you will have specific protections in connection with transactions between our controlling shareholder and related parties, our controlling shareholder may have an interest in pursuing acquisitions, dispositions, financings or similar transactions that could conflict with your interests as a holder of the ADSs or our preferred shares.

Risks Relating to the ADSs and Our Preferred Shares

The relative volatility and illiquidity of the Brazilian securities markets may substantially limit your ability to sell the preferred shares underlying the ADSs at the price and time you desire.

Investing in securities that trade in emerging markets, such as Brazil, often involves greater risk than investing in securities of issuers in the United States, and such investments are generally considered to be more speculative in nature.  The Brazilian securities market is substantially smaller, less liquid, more concentrated and can be more volatile than major securities markets in the United States.  Accordingly, although you are entitled to withdraw the preferred shares underlying the ADSs from the depositary at any time, your ability to sell the preferred shares underlying the ADSs at a price and time at which you wish to do so may be substantially limited.  There is also significantly greater concentration in the Brazilian securities market than in major securities markets in the United States.  The ten largest companies in terms of market capitalization represented 55.3% of the aggregate market capitalization of the BM&FBOVESPA S.A. Bolsa de Valores, Mercadorias & Futuros (“BM&FBOVESPA”) as of December 31, 2010.  The top ten stocks in terms of trading volume accounted for 53.2%, 49.7% and 49.7% of all shares traded on the BM&FBOVESPA in 2008, 2009 and 2010, respectively.

Holders of the ADSs and our preferred shares may not receive any dividends.

According to our by-laws, we must pay our shareholders at least 25% of our annual net income as dividends, as determined and adjusted under Brazilian corporation law.  This adjusted income may be capitalized, used to absorb losses or otherwise appropriated as allowed under the Brazilian corporation law and may not be available to be paid as dividends.  We may not pay dividends to our shareholders in any particular fiscal year if our board of directors determines that such distributions would be inadvisable in view of our financial condition.

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

As an ADS holder, you benefit from the electronic foreign capital registration obtained by the custodian for our preferred shares underlying the ADSs in Brazil, which permits the custodian to convert dividends and other distributions with respect to the preferred shares into non-Brazilian currency and remit the proceeds abroad.  If you surrender your ADSs and withdraw preferred shares, you will be entitled to continue to rely on the custodian’s electronic foreign capital registration for only five business days from the date of withdrawal.  Thereafter, upon the disposition of or distributions relating to the preferred shares, you will not be able to remit abroad non-Brazilian currency unless you obtain your own electronic foreign capital registration.

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

Holders of ADSs may be unable to exercise preemptive rights with respect to our preferred shares.

We may not be able to offer our preferred shares to U.S. holders of ADSs pursuant to preemptive rights granted to holders of our preferred shares in connection with any future issuance of our preferred shares unless a registration statement under the Securities Act is effective with respect to such preferred shares and preemptive rights, or an exemption from the registration requirements of the Securities Act is available.  We are not obligated to file a registration statement relating to preemptive rights with respect to our preferred shares, and we cannot assure you that we will file any such registration statement.  If such a registration statement is not filed and an exemption from registration does not exist, The Bank of New York Mellon, as depositary, will attempt to sell the preemptive rights, and you will be entitled to receive the proceeds of such sale.  However, these preemptive rights will expire if the depositary does not sell them, and U.S. holders of ADSs will not realize any value from the granting of such preemptive rights.

ITEM 4.  Information on the Company

A.      History and Development of the Company

General

The Registrant was formed on March 12, 2004 as a sociedade por ações, a stock corporation duly incorporated under the laws of Brazil with unlimited duration.  The Registrant’s material assets consist of the shares of VRG, three offshore finance subsidiaries, cash and cash equivalents and short-term investments.  The Registrant owns all of VRG’s shares, except for shares held by members of VRG’s boards of directors for eligibility purposes.  Our principal executive offices are located at Praça Comandante Linneu Gomes, S/N, Portaria 3, Jardim Aeroporto, CEP:  04626-020, São Paulo, SP, Brazil, and our general telephone number is +55 11 2128-4000.  The telephone number of our investor relations department is +55 11 2128-4700.  Our website address is www.voegol.com.br.  Investor information can be found on our website www.voegol.com.br/ir. Information contained on our website is not incorporated by reference in, and shall not be considered a part of, this annual report.

Capital Expenditures

For a description of our capital expenditures, see below “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources.”

B.      Business Overview

We are one of the largest low-cost low-fare airlines in the world, according to IATA, in terms of passengers transported in 2010, and the largest low-cost low-fare airline in Latin America providing frequent service on routes connecting all of Brazil’s major cities and from Brazil to major cities in South America and select touristic destinations in the Caribbean.  With our young and standardized operating fleet of 110 Boeing 737 aircraft, we serve the most comprehensive network of any airline in the Brazilian air passenger transportation market.

Since the beginning of our operations in 2001, our affordable, reliable and simple service and our focus on markets that were either underserved or did not have a lower-fare alternative have led to a strong awareness of our brand and a rapid increase in our market share.  We were the first company to successfully introduce low-cost carrier industry practices and technologies in Latin America.  We have a diversified revenue base, with customers ranging from business passengers to leisure passengers traveling throughout Brazil and other South American and Caribbean destinations.  Our strategy is to increase the size of the market by attracting new passengers as well as to diversify our revenue portfolio through our consolidated flight network, a modern aircraft fleet, targeted marketing and our loyalty program Smiles  (one of the largest loyalty program in Latin America with more than 7.4 million members and more than 180 partners), a variety of attractive ancillary businesses such as our air cargo services (Gollog), and through a variety of payment mechanisms designed to make the purchase of our tickets easier for customers in lower income classes.  Passenger transportation revenues represented 89.9% and ancillary revenues represented 10.1% of our net revenues of R$7.0 billion in 2010.

In February, 2011, we offered approximately 900 daily flights per day to 59 destinations connecting the most important cities in Brazil as well as key destinations in Argentina, Barbados, Bolivia, Chile, Colombia, Paraguay, Uruguay and Venezuela and the Caribbean region.  We strategically focus on the Brazilian and South American markets, and will continue to carefully evaluate opportunities to continue growing by increasing the frequency of flights to our existing high-demand markets and adding new routes in these markets (for example, in the Caribbean region), all of which can be reached with our Boeing 737 Next Generation (NG) aircraft.

Our Competitive Strengths

We Have a Strong Market Position Based on Slots at the Most Important Airports in Brazil.  Since the VRG acquisition, we have been the carrier with the most flights connecting the busiest airports in Brazil:  Congonhas (São Paulo), Santos Dumont and Galeão (Rio de Janeiro), Juscelino Kubitschek (Brasília), Confins (Belo Horizonte) Salvador (Bahia), Porto Alegre (Rio Grande do Sul), Recife (Pernambuco) and Curitiba (Paraná).  Routes between these airports are among the most profitable routes in our markets, with strong yields achieved mostly from business travelers.  In Congonhas, an airport with slot restrictions, we have been the leading airline in terms of the number of departures for these routes since 2008.

We Keep Our Operating Costs Low.  Our operating expense per available seat kilometer (CASK) ex-fuel for the year ended December 31, 2010 was R$8.76 cents.  We believe that our CASK for the year ended December 31, 2010, adjusted for the average number of kilometers flown per flight, or adjusted by stage length, was over the year the lowest in the domestic market and among international low-cost carriers, based upon our analysis of data collected from publicly available information. Since 2008, we managed to reduce our CASK and CASK ex-fuel by 12.8% and 6.8%, respectively.  Our business model is based on innovation and best practices adopted to improve our operating efficiency, including:

·         Operation of a young and standardized fleet.  At December 31, 2010, our operating fleet of 110 Boeing 737 aircraft was one of Latin America’s largest and youngest fleets, with an average age of 6.5 years.  We plan to continue keeping our operating fleet exclusively comprised of Boeing 737-800 and 737-700 NG aircraft.  Having a standardized fleet reduces inventory costs, as it requires fewer spare parts, and reduces the need to train our pilots to operate different types of aircraft.  It also simplifies our maintenance and operations processes.  We had 100 firm purchase orders outstanding as of December 31, 2010, to be delivered until 2017, purchase rights for 10 additional Boeing 737 NG aircraft and purchase options for 40 additional Boeing 737 NG aircraft.  We expect to be able to further decrease the age of our fleet, and therefore increase efficiency and better control maintenance costs. We have already announced the early return of 2 Boeing 767-300 aircraft to a leading aircraft leasing company. Until we are able to return the 4 remaining aircraft we will assign them to revenue generating uses to reduce their leasing costs.

·         State of the art maintenance.  We carry out heavy maintenance on our Boeing 737 aircraft internally at our Aircraft Maintenance Center at the Tancredo Neves International Airport located in Confins, in the State of Minas Gerais. We use this facility for airframe heavy checks, line maintenance, aircraft painting and aircraft interior refurbishment.  We started the first of a two-stage expansion project in 2008, when the facility had a capacity to service 60 aircraft.  The second stage was inaugurated in March 2010 and we now have a total capacity to perform full maintenance services for more than 120 Boeing 737 aircraft per year.  With our system of phased maintenance for our Boeing NG 737-700 and 737-800 aircraft fleet, we are able to perform maintenance work every day without sacrificing aircraft revenue time, and schedule preventive maintenance with more regularity and around the utilization of our aircraft, which further dilutes fixed costs.  We are one of the few airlines in the world that takes full advantage of the Boeing 737 NG phased maintenance philosophy, supported by extensive investments we have made in human resources, material, tools and equipment. We are currently seeking ratification by the Federal Aviation Administration (FAA), the U.S. civil aviation regulatory agency, that will allow us to undertake maintenance for international airlines as well.

We Stimulate Demand for Our Service.  We believe that through our differentiated services we create demand for air travel services.  We identify and stimulate demand among both business and leisure passengers for air travel that is safe, convenient, simple and a reasonably priced alternative to traditional air, bus and car travel.  By combining low fares with simple and reliable service, we have successfully improved our brand awareness, product quality, punctuality and regularity as well as strengthened customer loyalty and are attracting new groups of air travelers in our markets.  We estimate that, on average, approximately between 5% and 10% of the customers on our flights are either first-time flyers or have not flown for more than a year.

We Have a Strong Brand Recognition.  We believe that the Gol brand has become synonymous with innovation and value in the airline industry.  Our customers identify Gol as being safe, accessible, friendly, fair, intelligent and reliable and distinguish Gol in Brazil’s domestic airline industry on the basis of its modern and simplified approach to air travel services.  Our Smiles  and Gollog  brands and our www.voegol.com website provide valuable customer recognition in various businesses and create a tool for brand diversification for us.  Our Varig brand is widely known in the Brazilian and Latin American markets in which we operate.

We have one of the Largest Loyalty Program in Latin America.  Since the VRG acquisition, we have a loyalty program (Smiles), which is available to all our passengers and which we consider a strong relationship tool.  The Smiles  loyalty program serves as a source of revenue for us, as it enables us to sell miles directly to corporate clients for marketing purposes or utilize them for co-branded credit cards.  It supports partnerships with more than 180 partners, including hotel chains, car rental companies, restaurants, insurance companies, publishers and schools and also forms the basis for partnerships with some of Brazil and South America’s largest banks and credit card companies.  The Smiles loyalty program had over 7.4 million members at December 31, 2010.    

We are one of the largest e-commerce companies in Brazil.  Our effective use of technology helps us to keep our costs low and our operations highly scalable and efficient.  We seek to keep our distribution channels streamlined and convenient so as to allow our customers to interact with us via the Internet.  In 2010, we booked 88.1% of our ticket sales through a combination of our website and application programming interface, or API, systems, 7.0% through our call center and 4.9% through Global Distribution System, or GDS. In addition, our customers can check in online and through web-enabled cell phones.  As a result of our emphasis on low-cost distribution channels, in 2010 we were one of the largest e-commerce companies in Brazil and Latin America, with R$6.4 billion in net ticket sales through the internet, more than any other airline and publicly-held e-commerce company in Brazil.  Our platform also has strong traffic statistics, with more than five million visitors per month.  We enjoy significant cost savings associated with automated ticket sales, which also makes the selection of travel options more convenient for our customers.  Our e-commerce platform is starting to allow us to cross-sell other travel-related products to our customers.

We Have Proven Management.  Our top managers have broad experience in many sectors of the Brazilian economy, including air and ground transportation, telecommunications and home appliances and consumer products.  This experience has helped us to develop the most effective elements of our low-cost model and we expect will help us to further penetrate the Brazilian middle class and to generate ancillary revenues through Voe Fácil and our e-commerce platform www.voegol.com.

We Have High Corporate Governance Standards.  Our corporate governance practices go beyond those of most issuers in the transportation industry and emerging markets issuers, with the efficient and active use of specialized committees with highly qualified professionals and senior managers that add value to decisions made in the day-to-day management of our business.  We have four independent board members, including the chairman of our board of directors.  All members of our board of directors have broad and internationally recognized skills in the areas of corporate finance, business management, banking and in the transportation industry.

We Have a Strong Liquidity and Cash Position.  We believe that a strong liquidity and cash position is key to our success.  Our strong balance sheet increases our capacity to establish partnerships, negotiate with suppliers and to mitigate impacts of financial markets volatility on our results, to strengthen our financial resilience and to ensure the execution of our growth strategy.  We have a strong balance sheet, especially our cash and cash equivalents position which as of December 31, 2010 amounted to approximately 28.3% of our trailing twelve months’ net operating revenues.  We are also committed to not having any significant financial debt coming due within any three-year horizon.  In this view we believe that a stronger balance sheet, combined with our operating cash flow generation will further improve our operating flexibility in order to allow us to rapidly respond to market changes and to explore opportunities.

Our Strategies

Our strategy is to capitalize on our competitive advantages while further strengthening our financial resilience, based on four main strategic pillars:  increase passenger revenue, expand ancillary revenues, further reduce costs and improve our financial resilience.  In order to implement our strategies we intend to:

Capitalize on Our Strong Market Position in Brazil and Latin America.  We intend to capitalize on our strong market position, with our high brand recognition, the highest number of routes and frequencies between the most important airports in Brazil, our consolidated flight network and our Smiles  loyalty program and to increase penetration across all segments of travelers.  We will focus on Brazilian operations and selected South American destinations that are, or we expect to become, profitable and fit into our flight network.  In addition, we believe that the airline industry may experience further consolidation in the future and therefore partnerships and alliances are key success factors.  In this environment we intend play a leading role and strengthen our position as a long-term player.

Improve Operating Efficiency and Financial Resilience.  Continuing to reduce our operating expense per available seat kilometer is key to increased profitability.  We aim to maintain our position as one of the lowest cost airlines in the world.  We intend to further reduce the average age of our fuel-efficient fleet, while optimizing the size of our fleet to ensure high utilization rates. In 2010, our aircraft utilization rate was 12.9 block-hours per day, compared to 11.6 hours in 2009 and 12.1 hours in 2008.

We seek to continue to reduce our operating expense per available seat kilometer by using our aircraft efficiently, concentrating on minimizing our turnaround times at airports and maintaining a high number of daily flights per aircraft.  In 2010, we invested in several initiatives to reduce our CASK as the implementation of zero based budget methodology (in which budgets are built from a zero base and not based on the previous budget), shared services center, ACARS (Aircraft Communications Addressing and Reporting System) and improvements in our online check-in systems. We will continue to utilize technological innovations wherever possible to reduce our distribution costs and improve our operating efficiency.  We expect to benefit from economies of scale and reduce our average cost per available seat kilometer as we add aircraft to an established and efficient operating infrastructure.

We have a strong balance sheet and we seek to continuously set financial targets in order to further improve our financial resilience to support our growth strategy.  We currently seek to maintain a cash position equivalent to more than 25% of our net revenues recorded in the trailing twelve-month period, to continuously improve debt ratios, deleverage our balance sheet through the generation of operating cash flow and extend our financial commitments, avoiding significant debt maturities in a three-year range.

Expand Our Customer Base.  In planning the growth of our business, we will continue to select our routes and build the frequency of our service based on the extent and type of demand in the areas we serve in Brazil and South America.  We are committed to providing air travel to a wide range of travelers.  We will continue to popularize air travel, making low-fare flights more accessible to a larger portion of the population, including all types of business travelers, including with the following measures:

·         Stimulate Demand.  Our widely available service is designed to popularize air travel and stimulate demand, particularly from fare-conscious leisure travelers and small-to mid-size business travelers who might otherwise use alternative forms of transportation or not travel at all.  The Brazilian middle class has grown significantly in the last five years.  According to Fundação Getúlio Vargas, or FGV, and the Brazilian Geographical and Statistical Institute (Instituto Brasileiro de Geografia e Estatística), or IBGE, the new Brazilian middle class with monthly income between R$1,126 and R$4,854 has grown by 30 million, from 65 million in 2003 to 95 million 2010. We will continue to provide our customers with low fare alternatives and flexible payment mechanisms, such as debit payments, credit card installment payments and monthly installment payments in the form of direct credit.  For example, our Voe Fácil (“Fly Easy”) Program, which allows qualifying customers to pay for airline tickets in up to 36 monthly installments as our Voe Gol Stores opened in March 2011 in subway and bus stations and other high traffic locations.

·         Expand our network.  We will continue to carefully evaluate opportunities to meet demand for leisure travel by offering more seats at lower fares, expanding flight frequencies on existing routes and adding additional routes that contribute to our network and for which we perceive a market demand in Brazil.  In addition, by offering flights to selected South American and Caribbean destinations with connections integrated in our network, we will create opportunities for incremental traffic, feeding our network and increasing our overall load factor and supporting our strategy of expanding our network and stimulating demand for our services.

·         Overhubbing.  We estimate that between 35% and 40% of our passengers are connecting flights and, as a result, we may expand our network by creating new direct flights between two given cities, avoiding the need to connect through a third city. This may also help us to increase our flights and the number of passengers we transport despite current limitations on slot availability in Brazil’s busiest airports.

·         Expand our partnerships.  We believe we have the best platform to expand our customer base in the markets in which we operate.  Our standardized services and lower fares attract leisure travelers from all income levels, and with the integration of the Smiles  loyalty program into our operations we intend to increase our penetration in the corporate segment.  In August 2009, we received our International Operating Safety Audit, or IOSA, airline safety registration from International Air Transport Association, or IATA, and we believe this certification, combined with the integration of the Smiles  loyalty program into our consolidated flight network, makes us the preferred Brazilian partner of major international airlines operating in the country, with which we do not compete on inter-continental routes. Under these partnerships, our customers are able to use miles accumulated under the Smiles  loyalty program to fly to destinations in North America, Europe and Asia.  We intend to strengthen our existing partnerships and build new ones with large international airlines in the form of code-share arrangements to further increase our international feeder network, load factors and profitability.  Since early 2010, we signed two important code share agreements, with Delta Air Lines in April 2010 and with Qatar Airways in January 2011.  In February 2011, we entered into a strategic MRO (maintenance, repair and operations) partnership agreement with Delta TechOps, the maintenance division of Delta Air Lines, which will provide overhaul service for approximately 50 percent of our CFM 56-7 engines, maintenance for parts and components on our fleet of Boeing 737NG aircraft, and also, consulting services related to maintenance workflow planning, materials and facility optimization and tooling support. Delta TechOps will also assist us with our efforts to secure the FAA (Federal Aviation Administration) Certification. In addition, we will assist Delta with certain line maintenance services for Delta aircraft with extended ground time in Brazil. We also seek to evaluate partnerships with financial institutions, retail chain-stores, car rental and insurance companies.  We believe that these agreements will generate passenger and ancillary revenues by feeding our route network, strengthening the Smiles  loyalty program and increasing traffic and sales through our e-commerce platform. 

Further Innovate, Establish and Increase Our Ancillary Revenue Businesses.  Our ancillary revenues are derived from our e-commerce platform www.voegol.com.br and Gollog  as well as ticket change fees, excess baggage charges and other incidental services.  We expect further growth in these businesses, which will provide us with additional revenue at low incremental cost by:

·         Continuously innovating and introducing new businesses to the Brazilian market.  We have a strong track record of innovation and introduction of new business practices in Brazil.  In June 2009, we introduced the sale of beverages and food on board (buy on board) in Brazil, providing a more flexible and robust board service, which proved extremely popular with our customers during the 2010 test phase. We plan to expand these services to more than 400 daily flights in 2011, generating ancillary revenue without increasing our cost structure or fare price. We are the first airline in Brazil to allow passengers to check-in entirely by mobile phone and the first to permit check-in on domestic flights via iPhone for passengers without checked baggage, simplifying customers’ traveling. We are continuously developing an onboard wireless entertainment system which we expect to launch in the first semester of 2011, in order to provide onboard entertainment which will be sponsored by large corporations, particularly from the media, entertainment and consumer segments.  We believe that integrating travel-related products through the combination of partnerships, the development of new products, our e-commerce platform (www.voegol.com) and Smiles, will be key to a faster increase in our ancillary revenues.  We intend to provide comfort and convenience to our clients by upgrading our current e-commerce platform into a fully-integrated portal that provides a wide range of integrated travel-related products to be charged in a single invoice.  We are constantly evaluating opportunities, such as sales of travel insurance, marketing activities and other services, which may help us to better capitalize on the large number of passengers on our flights and the high volume of customers using our website.

·         Focusing on express delivery services.  Through Gollog, our cargo transportation service, we make efficient use of extra capacity in our aircraft by carrying cargo. With a comprehensive service portfolio, express delivery accounted for approximately 20% of our cargo revenue in 2010. Our express delivery products – Gollog VOO CERTO, Gollog EXPRESS, Gollog DEZ HORAS and Gollog DOC – were developed to meet growing demand for door-to-door deliveries, defined deadlines and additional optional services. We intend to intensify our efforts in the express delivery services by further strengthening our logistics capability, mainly by expanding our ground distribution network and further intensifying our commercial efforts. In September 2010, we opened a new cargo terminal in the Congonhas airport in the city of São Paulo. The new facilities are part of our strategy of increasing Gollog’s competitiveness in addition to offering low costs and attractive prices. Gollog currently has almost 100 stores, covers more than 2,000 cities in Brazil and is already among Brazil’s leading logistics operators. 

·         Increasing market penetration.  The Voe Fácil program allows select customers to pay for airline tickets in up to 36 monthly installments, with interest.  By increasing the Voe Fácil program penetration we believe that we will be able to stimulate demand for our tickets and better utilize our yield management system by selling seats which, based on statistical analyses, we would otherwise expect to fly empty without the implementation of the program. In December 2009, we opened the first Voe Fácil store located in Largo 13 de Maio, a Brazilian middle-income shopping region through which one million persons pass every day, aiming to increase our presence among Brazil’s new middle class, offering air fares that are competitive with intercity bus fares. In March 2011, we launched three small and low cost points of sale under the Voe Gol brand in main bus and subways terminals (Itaquera, Sé and Luz) allowing customers to not only be able to buy tickets, but also to change and cancel their reservations and obtain information, all of which with full customer support.

Routes and Schedules

Our operating model is a highly integrated, multiple-hub route network that is different from the point-to-point model used by other low-cost carriers worldwide.  The high level of integration of flights at selected airports permits us to offer frequent, non-stop flights at low fares between Brazil’s most important economic centers and ample interconnections through our network linking city pairs through a combination of two or more flights with little connecting or stop-over time.  Our network also allows us to increase our load factors on our strongest city pair routes by using the airports in those cities to connect our customers to their final destinations.  This strategy increases our load factor by attracting customers traveling to secondary markets who prefer to pay lower fares even if this means making one or more stops before reaching their final destination.  Between 35% and 40% of our passengers connect or fly through one or more destinations before reaching their final travel destination.  Our operating model allows us to build our flight routes to add destinations to cities that would not, individually, be economically viable to serve in the traditional point-to-point model, but that are feasible to serve when simply added as additional points on our multiple-stop route network.  We do this by offering low-fare, early-bird, minimum stay or night (red-eye) flights to lower-traffic destinations, which can be the first or last stops on our routes, allowing us to increase our aircraft utilization and generate additional revenues.  By offering international flights to South American and Caribbean destinations, and with stops integrated in our network, we create opportunities for incremental traffic, feeding our network and increasing our overall load factor and our competitive advantage and supporting our strategy of expanding our network and stimulating demand for our services.

We have been increasing the number of flights to and through the major Brazilian airports and prudently adding more routes to Caribbean destinations, which we expect to give us additional growth opportunities in the Brazilian and international markets. In addition, we consider expanding to up to 30 potential new destinations in Latin America in regions with medium density, represented by airports with a population of up to 1 million within a 200 km radius.

As of March 2011, we offered over 900 daily flights to 59 destinations connecting the most important cities in Brazil as well as the main destinations in Argentina, Barbados, Bolivia, Chile, Paraguay, Uruguay, Colombia, Venezuela and the Caribbean Region.

Services

Passenger Transportation

We recognize that we must offer excellent services to our customers.  Since April 2009, we have offered lower priced seats to price-sensitive leisure travelers and more flexible tickets with higher Smiles  miles allocation to our corporate customers.  We pay particular attention to the details that help to make for a pleasant, complication-free flying experience, including:

·         ticketless travel;

·         convenient on-line sales, check-in, seat assignment and flight change and cancellation services;

·         online flight status service;

·         web-enabled cell phone ticket sales and check-in;

·         self check-in at kiosks at designated airports;

·         designated female lavatories;

·         friendly and efficient in-flight service;

·         modern aircraft interiors;

·         quick turnaround times at airport gates;

·         free or discounted shuttle services between airports and drop-off zones on certain routes;

·         buy on board services on certain flights;

·         Mobile check-in and boarding pass (100% paperless boarding); and

·         iPhone application for check-in, electronic boarding pass and Smiles account management.

We seek to achieve punctual operations, which are of primary importance to our customers.  According to our internal data, which are corrected for delays out of our control and pre-advised changes in flight schedules, our average punctuality rate for 2010 was 88.9%, as compared to 89.9% in 2009.

We experience greater passenger demand during the summer and winter vacation periods, in January and July, respectively, and during the last two weeks of December, during the holidays season.

Smiles Loyalty Program.

We have a loyalty program (Smiles), which we consider as a strong relationship tool and which is available to all our passengers. We intend to increase the Smiles  penetration through creating marketing initiatives and additional benefits to our customers (e.g., double miles promotions and the launch of several miles redemption options, allowing our customers to use part of their miles to complete the payment) increasing and establishing partnerships with affiliated credit cards or using services and products at partner establishments.  There are four tiers in our Smiles  program (Diamond, Gold, Silver and Blue) and qualification for a particular tier is based on the miles flown.  The Smiles  program serves as a source of revenue for us, since we can sell miles directly to corporate clients for marketing purposes or utilize them for co-branded credit cards.  It maintains partnerships with hotel chains, car rental companies, restaurants, insurance companies, publishers and schools and also maintains a partnership with some of Brazil and South America’s largest banks and credit card companies.  We expect that, through these partnerships, our customers could use their miles accumulated under the Smiles program to fly to international destinations in North America, Europe and Asia.  For example, in April 2010, we entered into a commercial cooperation agreement with Delta Air Lines, which will allow for the integration of our Smiles  and Delta Air Lines’ Skymiles programs under a code-share agreement. In 2010, we implemented the technological platform using the Oracle Siebel system which will allow us to link the loyalty programs of the companies with which we have partnerships and also optimizing control of miles issued. The Smiles program had over 7.4 million members and more than 180 partners at the end of 2010.

Ancillary Revenues and Gollog Cargo Transportation

Ancillary revenues includes revenues from our Gollog services as well as baggage excess and ticket change fees, buy on board and travel insurance revenues are an increasingly important part of our revenues.  The further development and growth of our Gollog services is part of our strategy.

We are constantly evaluating opportunities to generate additional ancillary revenues such as sales of travel insurance, marketing activities and other services which may help us to better capitalize on the large number of passengers on our flights and the high volumes of customers using our website.

We believe that integrating travel-related products in our e-commerce platform to be key to a faster increase in our ancillary revenues.  We intend to provide comfort and convenience to our clients by upgrading our current e-commerce platform into a fully-integrated portal that provides a wide range of integrated travel-related products to be charged in a single invoice.  In addition, we plan to integrate the Smiles and Gollog platforms into our air travel portal to further provide convenience and simplicity to our customers.

We make efficient use of extra capacity in the stronghold of our aircraft by carrying cargo, through our cargo transport service – Gollog.  Gollog’s success is the result of the unique service we offer to the market:  the Electronic Air Waybill that can be completed via the Internet.  The Gollog system provides online access to air waybills and allows customers to track their shipment from any computer with Internet access.  Our 59 destinations throughout Brazil, South America and the Caribbean provide access to multiple locations in the region.  With our capacity of over 900 daily flights, operated by 110 aircraft, in addition to a fleet of 360 vehicles, we can guarantee quick and reliable delivery.  Packages are shipped in the freighthold of our passenger aircraft.

Aircraft Fleet

On December 31, 2010 we had an operational fleet of 114 operational aircraft and a total fleet of 125.  We expect to have 115 aircraft in our operating fleet by the end of 2011.

The following table sets forth the composition of our fleet at the dates indicated:

(1) As of December 31, 2010. 

(2) The three Boeing 737-300s excluded from our operational fleet but still part of the total fleet are grounded and in the final stages of return. These aircraft are no longer in our total fleet for 2011.

(3) Includes new aircraft received from Boeing in stages of technical acceptance and certification and spare aircrafts for our network

(4) One aircraft is sub-leased to an American airline and another is wet-leased to a Brazilian airline for flights between Brazil and Angola.

In line with our strategy of combining the renovation of our fleet with disciplined growth in our seat supply, we concluded the following initiatives in 2010:

·         Return of eleven Boeing 737-300s (three of which are grounded and in the final stages of redelivery), all replaced with brand new 737-800 NGs, and six Boeing 737-800s.

·         Reactivation of five Boeing 767-300/200s, of which four for incorporation in the operating fleet for international long-haul charter flights and one for sub-leasing to a charter company in the United States from January 2010 to the end of January 2011.

At December 31, 2010, of our total 125 aircraft 86 were under operating leases and 39 under finance leases.

The average age of our operating aircraft at December 31, 2010 was 6.5 years.  The average daily utilization rate of our operating fleet in 2010 was 12.9 block hours (11.6 block hours in 2009).

Each Boeing 737 aircraft in our fleet is powered by two CFM International Model CFM 56-7B22 engines or two CFM International Model CFM 56-7B24 engines. All Boeing 737-800 NG Short-Field Performance are equipped with an upgrade thrust plug in each engine, which allows it to operate as a CFM 56-7B27/B3 engine with 27.000 lbs. 

The following table sets forth our year-end projected operating fleet through 2015:

* Includes SFP aircrafts (Short Field Performance)

We will revise this fleet plan according to our expectations for the growth potential in the markets in which we operate.

The Boeing 737-700 Next Generation and Boeing 737-800 Next Generation aircraft currently comprising our fleet are fuel-efficient and very reliable.  They suit our cost efficient operations well for the following reasons:

·         they have comparatively standardized maintenance routines;

·         they require just one type of standardized training for our crews;

·         they use an average of 7% less fuel than other aircraft of comparable size, according to Boeing; and

·         they have one of the lowest operating costs in their class.

In addition to being cost-efficient, the Boeing 737-700/800 Next Generation aircraft are equipped with advanced technology that promotes flight stability, providing a more comfortable flying experience for our customers.  We use a single type of aircraft to preserve the simplicity of our operations.  As a result, the introduction of any new aircraft type to our fleet will only be done if, after careful consideration, we determine that such a step will reduce our operating costs.  Most of our leased Boeing 737-800 Next Generation aircraft are equipped with blended winglets and all Boeing 737-800 Next Generation aircraft from our purchase order will be equipped with winglets, which reduce our fuel and maintenance costs.  Our experience with the new winglets has shown operating fuel consumption reductions from 3% to 5%.  In addition, the winglets improve airplane performance during take-off and landing on short runways.  The new Boeing 737-800 NG aircraft will be delivered with short-field performance (SFP) with technical modifications that we expect to significantly improve flight performance, the ability to operate non-stop flights, reduce noise during take-off and to enable us to fly with our Boeing 737-800 Next Generation aircraft to the airport of Santos Dumont in Rio de Janeiro, an important link to the most important routes in Brazil.

At the end of 2010, we leased 86 of our 125 aircraft under operating lease agreements that have an average remaining term of 85 months.  We believe that leasing our aircraft fleet under operating leases provides us with flexibility to adjust our fleet size.  We make monthly rental payments, some of which are based on floating rates.  We but are not required to make termination payments at the end of our leases.  Under our operating lease agreements, we do not have purchase options and for some of our lease agreements we are required to maintain maintenance reserve deposits and to return the aircraft and engine in the agreed condition at the end of the lease term.  Title to the aircraft remains with the lessor.  We are responsible for the maintenance, servicing, insurance, repair and overhaul of the aircraft during the term of the lease.  As of December 31, 2010, our operating leases had terms of up to 144 months from the date of delivery of the relevant aircraft.

At the end of 2010, we had 39 aircraft acquired under our firm purchase order with Boeing under finance lease arrangements that had an average remaining term of 121 months.

Sales and Distribution

Our customers can purchase tickets directly from us through a number of different channels, such as our website including our Booking Web Services (BWS), our call center, at airport ticket counters and, to a lesser extent, GDS.

Our low cost low fare business model utilizes website ticket sales as its main distribution channel especially in the local market.  For the year ended December 31, 2010, 88.1% of our passenger revenues, whether directly to the customer or through travel agents, were booked via the Internet, making us one of the worldwide industry leaders in this area.  In the same period, 7.0% of our passenger revenues were booked through call centers, airport sales counters, and our BWS and 4.9% of our total sales were made through the GDS, respectively.

Our customers can purchase tickets indirectly through travel agents, who are a widely-used travel service resource in Brazil and South America, Europe, North America and other regions.  For the year ended December 31, 2010, travel agents provide us with more than 10,000 distribution outlets throughout these regions.

GDSs allows us access to a large number of tourism professionals who are able to sell our tickets to customers throughout the globe, and enables us to enter into interline agreements with other airlines to offer more flights and connection options to our passengers and add incremental international passenger traffic, especially to our international network.

On October 21, 2009 we became an issuer of cards for Universal Air Travel Plan, or UATP, a payment network owned and operated by several foreign airlines.  UATP allows us access to a payment network with lower costs than those offered by credit cards and other means of payment.  In addition, as an UATP card issuer we are able to maintain a closer relationship with our corporate customers.

Partnerships and Alliances

Our strong market positioning enables us to successfully negotiate a number of arranged partnerships with supplementary major carriers worldwide, mostly in the form of code share agreements and interline agreements.  Strategically, the additional passenger inflows generated from those partnerships aim to improve revenues at low incremental costs.

At December 31, 2010, we had code share agreements with American Airlines, Delta Air Lines, Iberia, Air France KLM, Aero Mexico, Copa Airlines and, in January, 2011 we signed a code share agreement with Qatar Airways.  We have a frequent flyer tie between our Smiles  program and the code share partners enabling travelers to accrue and redeem miles between our Smiles and each of the partners (however, the partnerships are not integrated among themselves).  In addition, passengers are able to connect with Gol operated flights within Brazil, marketed as a code-share partner flight.  We intend to enter into similar agreements with other long haul airlines serving or intending to serve Brazil.

At December 31, 2010 we had interline agreements with 71 airlines, including Korean Airlines, Emirates Airlines, Avianca, Continental Airlines, Japan Airlines, TAP Air Portugal, and others.  An interline agreement is a commercial agreement between individual airlines to handle passengers traveling on itineraries that require multiple airlines and allow its customers to utilize a single ticket, and to check their baggage through to the customers final destination.  Interline agreements differ from code sharing agreements in that code sharing agreements usually refer to numbering a flight with the airline’s code (abbreviation) even though the flight is operated by another airline.  This provides for better marketing and customer recognition of the links between the airlines.

In February 2011, we entered into a strategic MRO (maintenance, repair and operations) partnership agreement with Delta TechOps, the maintenance division of Delta Air Lines, which will provide overhaul service for approximately 50 percent of our CFM 56-7 engines, maintenance for parts and components on our fleet of Boeing 737NG aircraft and also, consulting services related to maintenance workflow planning, materials and facility optimization and tooling support. Delta TechOps will also assist us with our efforts to secure the FAA (Federal Aviation Administration) Certification. In addition, we will assist Delta with certain line maintenance services for Delta aircraft with extended ground time in Brazil.

An important element of our business strategy is to cater to the corporate client.  To further develop our business relationship with our corporate customers, we have entered into partnerships with hotel chains, rental car service and insurance providers to offer our corporate customers the convenience of the combination of transportation and accommodation arrangements.

Pricing

Brazilian airlines are permitted to establish their own domestic fares without previous government approval. Airlines are free to offer price discounts or follow other promotion activities.  Airlines must submit, 30 days after the end of each month, a file containing fares sold and quantity of passengers for each fare amount, for all markets. This file lists regular fares and excludes all contracted, corporate and private fares. The objective is to monitor the average market prices. The procedure same applies for international fares. The only difference is that all fares sold for interline itineraries are also excluded from the file sent to ANAC.

Yield Management

Yield management involves the use of historical data and statistical forecasting models to produce knowledge about our markets and guidance on how to compete to maximize our operating revenues.  Yield management forms the backbone of our revenue generation strategy and is strongly linked to our route and schedule planning and our sales and distribution methods.  Our yield management practices enable us to react quickly in response to market changes.  For example, our yield management systems are instrumental in helping us to identify the flight times and routes for which we offer promotions.  By offering lower fares for seats that our yield management indicates would otherwise remain unsold, we capture additional revenue and also stimulate customer demand.

Maintenance

According to ANAC regulation, we are directly responsible for the execution and control of all maintenance services performed on our aircraft.  The maintenance performed on our aircraft can be divided into two general categories:  line and heavy maintenance.  Line maintenance consists of routine, scheduled maintenance checks on our aircraft, including pre-flight, daily and overnight checks and any diagnostics and routine repairs.  All of our line maintenance is performed by our own highly experienced technicians at our line maintenance service bases throughout Brazil and South America.  We believe that our practice of performing daily preventative maintenance helps to maintain a high aircraft utilization rate and reduces maintenance costs.  Heavy maintenance consists of more complex inspections and servicing of the aircraft that cannot be accomplished overnight.  Heavy maintenance checks are performed following a pre-scheduled agenda of major overhauls defined by the aircraft’s manufacturer, based on the number of hours and flights flown by the aircraft.  Our continued high aircraft utilization rate will result in shorter periods of time between heavy maintenance checks for our aircraft in comparison to carriers with lower aircraft utilization rates.  In addition, engine maintenance services are rendered in different MRO (Maintenance, Repair and Operations) facilities.  We do not believe that our high aircraft utilization rate will necessarily result in the need to make more frequent repairs to our aircraft, given the durability of the aircraft type in our fleet.  Our aircraft are covered by warranties that have an average term of three to five years.  The warranties on the aircraft we received in 2011 under our firm purchase order with Boeing will start expiring in 2015.

We internalized heavy maintenance on our Boeing 737 aircraft in our Aircraft Maintenance Center at the Tancredo Neves International Airport in Confins, in the State of Minas Gerais.  We use this facility for airframe heavy checks, line maintenance, aircraft painting and aircraft interior refurbishment.  We started the first of a two- stage expansion project in 2008, when the facility had a capacity to service 60 aircraft.  The second stage was inaugurated in March, 2010 and we now have a total capacity to perform full maintenance services for more than 120 Boeing 737 aircraft per year. 

With our system of phased maintenance for our Boeing Next Generation 737-700 and 737-800 aircraft fleet, we are able to perform maintenance work every day without sacrificing aircraft revenue time and to schedule preventive maintenance with more regularity and around the utilization of our aircraft, which helps to maintain high levels of block hours per day and reduces costs.  We are one of the few airlines in the world that takes full advantage of the Boeing 737 Next Generation phased maintenance philosophy, supported by extensive investments we made in human resources, material, tools and equipment.

We have also entered into a strategic MRO (maintenance, repair and operations) partnership agreement with Delta TechOps, the maintenance division of Delta Air Lines, in order to provide overhaul service for approximately 50 percent of our CFM 56-7 engines, maintenance for parts and components on our fleet of Boeing 737 NG aircraft and also, consulting services related to maintenance workflow planning, materials and facility optimization and tooling support. Delta TechOps will also assist us with our efforts to secure FAA (Federal Aviation Administration) Certification. In addition, we will assist Delta with certain line maintenance services for Delta aircraft with extended ground time in Brazil.

We have been certified by the ANAC under the Brazilian Aeronautical Certification Regulations to perform heavy maintenance services for third parties.  We expect to utilize this certification, a potential source for ancillary revenues, now that the construction of an additional maintenance facility has been completed.

Fuel

Our fuel costs totaled R$2,287.4 million in 2010, representing 36.4% of our operating expenses for the year.  In 2010, we purchased substantially all of our fuel from Petrobrás Distribuidora S.A., a retail subsidiary of Petrobrás, principally under an into-plane contract under which the supplier supplies fuel and also fills our aircraft tanks.  In 2010, fuel prices under our contracts were re-set every 30 days and were composed of a variable and a fixed component.  The variable component is defined by the refinery and follows international crude oil price fluctuations and the real/U.S. dollar exchange rate.  The fixed component is a spread charged by the supplier and is usually a fixed cost per liter during the term of the contract.  We currently operate a tankering program under which we fill the fuel tanks of our aircraft in regions where fuel prices are lower.  We also provide our pilots with training in fuel management techniques, such as carefully selecting flight altitudes to optimize fuel efficiency.

Fuel costs are extremely volatile, as they are subject to many global economic and geopolitical factors that we can neither control nor accurately predict.  Because international prices for jet fuel are denominated in U.S. dollars, our fuel costs, though payable in reais, are subject not only to price fluctuations but also to exchange rate fluctuations.  We maintain a fuel and foreign exchange hedging program, based upon policies which define volume, price targets and instruments for multi-year periods, under which we enter into fuel and currency hedging agreements with various counterparties providing for price protection in connection with the purchase of fuel.  Our hedging positions cover short-term periods, and are adjusted weekly or more frequently as conditions require.  Our hedging practices are executed by our internal risk management committee and overseen by the risk policies committee of our board of directors.  The risk policies committee of our board of directors meets quarterly or more often, if called, and its main responsibilities are to assess the effectiveness of our hedging policies, recommend amendments when and where appropriate and establish its views regarding fuel price trends.  We use risk management instruments that have a high correlation with the underlying assets so as to reduce our exposure.  We require that all of our risk management instruments be liquid so as to allow us to make position adjustments and have prices that are widely disclosed.  We also avoid concentration of credit and product risk.  We have not otherwise entered into arrangements to guarantee our supply of fuel and we cannot provide assurance that our hedging program is sufficient to protect us against significant increases in the price of fuel.  As of December 31, 2010, we had hedged 21% on average for our projected fuel requirements for 2011, 6% in average for our projected expenditures in foreign currency and 39% for our financial leases aircraft contracts.  The fuel and foreign exchange expenditures hedges are based on call options and the financial leases hedges are based on in futures contracts.

The following chart summarizes our fuel consumption and costs for the periods indicated:

Safety and Security

Our most important priority is the safety of our passengers and employees.  We maintain our aircraft in strict accordance with manufacturer specifications and all applicable safety regulations, and perform routine line maintenance every day.  Our pilots have extensive experience, with flight captains having more than 10,000 hours of career flight time, and we conduct ongoing courses, extensive flight simulation training and seminars addressing the latest developments in safety and security issues.  We closely follow the standards established by the Air Accident Prevention Program of the ANAC and we have installed the Flight Operations Quality Assurance System, which maximizes proactive prevention of incidents through the systematic analysis of the flight data recorder system.  All of our aircraft are also equipped with Maintenance Operations Quality Assurance, a troubleshooting program that monitors performance and aircraft engine trends.  The Brazilian civil aviation market follows the highest recognized safety standards in the world.  We are also an active member of the Flight Safety Foundation, a foundation for the exchange of information about flight safety.  In June 2009, we created the office of Safety Officer which reports directly to our board of directors and whose main goal is to oversee flight safety and report directly to our highest management level.

Environmental Sustainability

We constantly invest in becoming more environmentally sustainable and have recently implemented the following actions:

·         Expansion of our Aircraft Maintenance Center at the Tancredo Neves International Airport located in Confins, in the State of Minas Gerais (completed in March 2010):  we have reduced cost by decreasing the need to fly our aircraft overseas to be serviced and we treat all of the effluents generated in our facilities and reuse water.

·         We were the first Brazilian airline selected to join the Sustainable Aviation Fuel Users Group (SAFUG), an international aviation biofuel research group, and we participate in biofuel feasibility tests. When these fuels are approved they will substantially reduce green house gas emissions in the aviation industry. We also participate in the Brazilian Alliance for Aviation Biofuels, which aims to promote public and private initiatives that seek the development and certification of sustainable biofuels for aviation. In May 2010, in São Paulo, was formed Abraba (Aliança Brasileira de Biocombustíveis de Aviação - Brazilian Aviation Biofuels Alliance), composed of airlines and research of biofuels, biomass producers and manufacturers aircraft companies.

·         We were one of Latin America’s first airlines to present an emission control plan for the inventory of the DEHST (Deutsches Emissionshandelsregister), a German authority responsible for monitoring emissions and the clean development mechanism projects of the Kyoto Protocol. Based on this survey, we are able to record our emissions and develop plans to reduce them.

·         We have a partnership agreement with the Fuel and Carbon Services Division of GE Aviation, which envisages the creation of studies and systems to reduce fossil fuel consumption and green house gas emissions.

·         Our use of electrostatic painting has reduced aircraft weight by 300 kg and has also reduced the amount of paint used and emission of carbon dioxide.

·         To provide a reduction in fuel consumption in soil (and therefore reduced emissions of GEEs emissions), each of our flight crews follows an internal procedure for the shutdown of one engine of the aircraft during taxi.

·         The GSE sector (Ground Support Equipment) of Maintenance Line ordered 23 GPUs (Ground Power Unit and Energy Unit of Soil), responsible for converting the mechanical energy generated by a diesel engine into electrical energy used to power aircraft on ground.

·         We started using Aircraft Communications Addressing and Reporting System, or ACARS, in 2010 and we expect to have the system implanted in all our fleet by 2012.  ACARS provides real time flight data via satellite and allow us to better anticipate maintenance needs, increasing flight safety, efficiency and gains of scale.

·         We started using GPS Landing System in January 2010 and we expect to have the system implemented in all our fleet by the end of 2014.  This system reduces fuel consumption during take-off and landing, increases precision and safety.

·         Inauguration of GOL Institute, a nonprofit association, created to meet the demand for skilled labor in the aviation sector. Its goal is to promote technical education and training of professionals in the aviation industry, and contribute to the promotion of socioeconomic development in Belo Horizonte, as the Maintenance Center is the headquarters of the Institute.

·         All waste of our offices and headquarters is recycled.

Insurance

We maintain passenger liability insurance in an amount consistent with industry practice and we insure our aircraft against losses and damages on an “all risks” basis.  We are required by the ANAC to maintain insurance coverage for general liability against terrorist acts or acts of war with a minimum amount of US$800 million.  We have obtained all insurance coverage required by the terms of our leasing agreements.  We believe our insurance coverage is consistent with airline industry standards in Brazil and is appropriate to protect us from material loss in light of the activities we conduct.  No assurance can be given, however, that the amount of insurance we carry will be sufficient to protect us from material loss.

Competition

Domestic

Airlines in Brazil compete primarily on the basis of routes, fare levels, frequency of flights, capacity, airport operating rights and presence, reliability of services, brand recognition, frequent flyer programs and customer service.

Our main competitor in Brazil is TAM Linhas Aéreas S.A., or TAM, which is a full-service scheduled carrier offering flights on domestic routes and international routes.  We also face domestic competition from other domestic scheduled carriers, regional airlines and charter airlines, which mainly have regional networks.

As the growth in the Brazilian airline sector evolves, we may face increased competition from our primary competitors and charter airlines as well as other entrants into the market that reduce their fares to attract new passengers in some of our markets.

The following table sets forth the historical market shares on domestic routes, based on revenue passenger kilometers, of the significant airlines in Brazil for each of the periods indicated:

_______________

Source:  Advanced Comparative Data (Dados Comparativos Avançados) 2007—2010

(1)           In October 2010, ANAC changed its calculation method for monthly traffic information and republished information for periods since January 2009. All operating data for 2009 and 2010 reflects the new methodology, whereas information for 2007 and 2008 was calculated pursuant to the old methodology and may not be fully comparable. According to ANAC, the changes were designed to align data with the concepts adopted by the ICAO. The change was necessary because Brazil has joined the ICAO’s statistical program and supplies the latter’s database with several industry data. Changes in the methodology refer to the calculation of ASK (seat supply) and the classification of domestic legs in international flights, which are now considered to be part of the domestic market. ANAC has stated that it will republish information for 2008 at a later date.

Until 2010, landing fees charged in Brazilian airports were standard in all airports independent of whether they were busy or not. In February 2011, in the context of measures to increase the viability of airports for privatization, the Brazilian government announced that it will increase landing fees at the busiest airports as compared to less busy airports. As a result, secondary airports may benefit in light of the differences in fees for the airlines that choose to operate in these airports.

Domestically, we also face competition from ground transportation alternatives, primarily interstate bus companies.  In 2010, interstate bus companies transported over 67 million passengers, according to data from the National Ground Transportation Agency (Agência Nacional de Transportes Terrestres), and given the absence of meaningful passenger rail services in Brazil, travel by bus has traditionally been the only low-cost option for long-distance travel for a significant portion of Brazil’s population.  We believe that our low-cost business model has given us flexibility in setting our fares to stimulate demand for air travel among passengers who in the past have traveled long distances primarily by bus.  In particular, the highly competitive fares we have offered for travel on our night flights, which have often been comparable to bus fares for the same destinations, have had the effect of providing direct competition for interstate bus companies on these routes.

International

As we expand our international services in South America and the Caribbean, our pool of competitors will increase and we will face competition from Brazilian and South American airlines that are already established in the international market and that participate in strategic alliances and code sharing arrangements. In addition, non-Brazilian airlines may decide to enter or increase their schedules in the market for routes between Brazil and other South American and Caribbean countries.

Industry Overview

Since air transportation has historically been affordable only to the higher income segment of Brazil’s population, resulting in a comparatively low level of air travel, we believe that the low-cost, low-fare business model has the potential to significantly increase the use of air transportation in Brazil.  Brazil is the fifth largest domestic aviation market in the world and, according to the ANAC, there were 58.5 million domestic enplanements and 4.4 million international enplanements on Brazilian carriers in Brazil in 2010, out of a total population of approximately 190 million, according to IBGE.  In contrast, according to the U.S. Department of Transportation, the United States had 621 million domestic enplanements and 88.5 million international enplanements in 2009, out of a total population of approximately 308 million, based on the latest U.S. census estimates.

The business travel segment is the largest component of Brazilian air transportation demand and the most profitable in the market. According to company data, business travel represented more than 65% of the total demand for domestic air travel in 2010, which we believe is significantly higher than the business travel portion of domestic air travel in the global aviation sector.  According to data collected from the ANAC, flights between Rio de Janeiro and São Paulo accounted for 8.2% of all domestic passengers in 2009.  The ten busiest routes accounted for 15.6% of all domestic air passengers in 2009, while the ten busiest airports accounted for 72.6% and 68.3% of all domestic passenger traffic through INFRAERO airports in terms of arrivals and departures in 2009 and 2010, respectively.

In light of economic growth, the domestic market has significantly increased in the last years from 76 million in 2003 to more than 98 million in 2010, according to FGV and IBGE, due to increased passenger volumes and both the soccer confederations and world cup scheduled for 2013 and 2014, respectively, in Brazil and the summer Olympics scheduled for 2016 in Rio de Janeiro, the Brazilian airport infrastructure will need substantial improvements.

In 2009 the CONAC announced that it would propose to the Brazilian Government a change to the regulatory limit of foreign ownership in Brazilian airline companies from 20% to 49%.  This proposal may be accepted by the Brazilian Government and become a draft bill during 2011.

Since 2009, the Brazilian government has been analyzing the privatization of airports or granting of rights for private concessionaries to operate currently existing airports or expansions of those airports but has not yet made any formal announcements as to its decision.

Brazilian Civil Aviation Market Evolution

Since 1970, Brazil has for the most part had stable growth in revenue passenger kilometers.  From 1970 to 2009 domestic revenue passenger kilometers grew at a compound annual rate of 8.9% . In the past 9 years, the domestic market generally experienced year-over-year growth in revenue passenger kilometers except in times of significant economic or political distress, such as the petroleum crisis in the 1970s, the Brazilian sovereign debt crisis in the early 1980s and the economic and political distress in Brazil in the early 1990s.

From 2006 to 2010, the compound annual growth rate in industry passenger traffic, in terms of domestic revenue passenger kilometers, was 15.2%, versus a compound annual growth rate in available industry domestic capacity, in terms of available seat kilometers, of 16.4% . Domestic industry load factors, calculated as revenue passenger kilometers divided by available seat kilometers, have averaged 67.9% over the same period.  The table below shows the figures of domestic industry passenger traffic and available capacity for the periods indicated:

________________

Source:  ANAC, Dados Comparativos Avançados.

Note:        In October 2010, ANAC changed its calculation method for monthly traffic information and republished information for periods since January 2009. All operating data for 2009 and 2010 reflects the new methodology, whereas information for 2007 and 2008 was calculated pursuant to the old methodology and may not be fully comparable. According to ANAC, the changes were designed to align data with the concepts adopted by the ICAO. The change was necessary because Brazil has joined the ICAO’s statistical program and supplies the latter’s database with several industry data. Changes in the methodology refer to the calculation of ASK (seat supply) and the classification of domestic legs in international flights, which are now considered to be part of the domestic market. ANAC has stated that it will republish information for 2008 at a later date.

In 2009 Brazil was the fourth largest market in domestic revenue passenger kilometers and, as compared to 2008, the second fastest growing market.

Regulation of the Brazilian Civil Aviation Market

The Brazilian Aviation Authorities and Regulation Overview

Air transportation services are considered a public service and are subject to extensive regulation and monitoring by the CONAC and the ANAC.  Air transportation services are also regulated by the Brazilian Federal Constitution and the Brazilian Aeronautical Code.  The Brazilian civil air transportation system is controlled by several authorities.  The ANAC is responsible for the regulation of the airlines, the DECEA is responsible for airspace control and INFRAERO is responsible for airport administration.

The following chart illustrates the main regulatory bodies, their responsibilities and reporting lines within the Brazilian governmental structure.

In March 2011, the SAC was created to supervise civil aviation in Brazil. The Civil Aviation Secretary oversees the ANAC and INFRAERO and reports directly to the Brazilian President.

The ANAC is currently responsible for guiding, planning, stimulating and supporting the activities of public and private civil aviation companies in Brazil, and also regulates flying operations generally and economic issues affecting air transportation, including matters relating to air safety, certification and fitness, insurance, consumer protection and competitive practices.

The Department of Air Space Control (Departamento de Controle do Espaço Aéreo), or DECEA, reports indirectly to the Brazilian Minister of Defense which is responsible for planning, administrating and controlling activities related to airspace, aeronautical telecommunications and technology.  This includes approving and overseeing the implementation of equipment as well as of navigation, meteorological and radar systems.  The DECEA also controls and supervises the Brazilian Airspace Control System.

INFRAERO, a state-controlled corporation reporting to the Civil Aviation Secretary, is in charge of managing, operating and controlling federal airports, including control towers and airport safety operations.  See “Airport Infrastructure” below.

The CONAC is an advisory body of the President of Brazil and its upper level advisory board is composed of the Minister of Defense, the Minister of Foreign Affairs, the Minister of Treasury, the Minister of Development, Industry and International Trade, the Minister of Tourism, the Minister Chief of the Civil Cabinet, the Minister of Planning, Budget and Management, the Minister of Justice, the Minister of Transportation and the Commandant of the Air Force.  The CONAC has the authority to establish national civil aviation policies that may be adopted and enforced by the High Command of Aeronautics and by the ANAC.  The CONAC establishes guidelines relating to the proper representation of Brazil in conventions, treaties and other actions related to international air transportation, airport infrastructure, the granting of supplemental funds to be used for the benefit of airlines and airports based on strategic, economic or tourism-related aspects, the coordination of civil aviation, air safety, the granting of air routes and concessions, as well as permission for the provision of commercial air transportation services.

The Brazilian Aeronautical Code provides for the main rules and regulations relating to airport infrastructure and operation, flight safety and protection, airline certification, lease structuring, burdening, disposal, registration and licensing of aircraft; crew training; concessions, inspection and control of airlines; public and private air carrier services; civil liability of airlines; and penalties in case of infringements.

In February 2009, the Federal Government approved the new Civil Aviation National Policy (Política Nacional de Aviação Civil), or PNAC.  Although the PNAC does not establish any immediate measure, it contains the main guidelines for the national civil aviation system.  It encourages the Ministry of Defense, CONAC and ANAC to issue regulations on strategic matters such as safety, competition, environmental, and consumers’ issues, as well as to inspect, review and valuate the activities of all operating companies.

The Brazilian government recognized and ratified, and must comply with, the Warsaw Convention of 1929, the Chicago Convention of 1944, and the Geneva Convention of 1948, the three leading international conventions relating to worldwide commercial air transportation activities.

Route Rights

Domestic routes.  For the granting of new routes and changes to existing ones, the ANAC evaluates the actual capacity of the airport infrastructure where such route is or would be operated.  In addition, route frequencies are granted subject to the condition that they are operated on a frequent basis.  Any airline’s route frequency rights may be terminated if the airline (a) fails to begin operation of a given route for a period exceeding 15 days, (b) fails to maintain at least 75% of flights provided for in its air transportation schedule (Horário de Transporte Aéreo), or HOTRAN, for any 90-day period or (c) suspends its operation for a period exceeding 30 days.  The ANAC approval of new routes or changes to existing routes is given in the course of an administrative procedure and requires no changes to existing concession agreements.

Once routes are granted, they must be immediately reflected in the HOTRAN, which is the official schedule report of all routes that an airline can operate.  The HOTRAN provides not only for the routes but also the times of arrival at and departure from certain airports, none of which may be changed without the prior consent of the ANAC.  According to Brazilian laws and regulations, an airline cannot sell, assign or transfer its routes to another airline.

International routes.  In general, requests for new international routes, or changes to existing routes, must be filed by each interested Brazilian airline that has been previously qualified by the ANAC to provide international services, with the SRI (International Relations Superintendence of the ANAC), which, based on the provisions of the applicable bilateral agreement and general policies of the Brazilian aviation authorities, will submit a non-binding recommendation to the ANAC president, who will decide on approval of the request.  International route rights for all countries, as well as the corresponding transit rights, derive from bilateral air transport agreements negotiated between Brazil and foreign governments.  Under such agreements, each government grants to the other the right to designate one or more of its domestic airlines to operate scheduled service between certain destinations in each country.  Airlines are only entitled to apply for new international routes when they are made available under these agreements.  For the granting of new routes and changes to existing ones, the ANAC has the authority to approve Brazilian airlines to operate new routes, subject to the airline having filed studies satisfactory to the ANAC demonstrating the technical and financial viability of such routes and fulfilling certain conditions in respect of the concession for such routes.  Any airline’s international route frequency rights may be terminated if the airline fails to maintain at least 80% of flights provided for in its air transportation schedule HOTRAN for any 180-day period or suspends its operation for a period exceeding 180 days.

Slots Policy

Domestic.  Under Brazilian law, a domestic slot is a concession of the ANAC, which is reflected in the airline’s HOTRAN.  Each HOTRAN represents the authorization for an airline to depart from and arrive at specific airports within a predetermined timeframe.  Such period of time is known as an “airport slot” and provides that an airline can operate at the specific airport at the times established in the HOTRAN.  An airline must request an additional slot from the ANAC with a minimum of two months’ prior notice.

Congonhas airport in the city of São Paulo is a coordinated airport, where slots must be allocated to an airline company before it starts its operations there.  Although it is difficult to obtain a slot in Congonhas airport, on March 8, 2010 ANAC reallocated 202 Congonhas’ slots that were idle. When the capacity at the airport increases and more slots become available, 20% of those slots must be distributed to new entrants who will have a preference to their assignment.  The remaining slots will be allocated to the other airline companies, including us.  The Santos-Dumont airport in Rio de Janeiro, a highly utilized airport with half-hourly shuttle flights between São Paulo and Rio de Janeiro, is also a coordinated airport with certain slot restrictions.  Several other Brazilian airports, for example the Brasília International Airport and São Paulo International Airport in Guarulhos have limited the number of slots per day due to infrastructural limitations at these airports.

ANAC has imposed schedule restrictions to several Brazilian airports from which we operate.  Operating restrictions, including the prohibition of international flights’ operations and the prohibition of civil aircraft’s operation after 11:00 p.m. and before 6:00 a.m., were imposed for Congonhas Airport, one of the busiest Brazilian airports and the most important airport for our operations.  No assurance can be given that these or other government measures will not have a material adverse effect on our business and results of operations.

CONAC has taken measures to minimize the recent technical and operational problems in the São Paulo airports, redistributing air traffic from the Congonhas airport to the airports of Guarulhos and has mentioned its intention to adjust tariffs for the use of busy airport hubs to encourage further redistribution of air traffic.

In the last quarter of 2008, the ANAC proposed a new regulation for the allocation of slots to domestic airlines.  This regulation governs the manner of allocation of slots, by organizing rotations among the concessionaires, determining the procedures for registration, qualification, judgment and homologation of a request for slot concessions in coordinated airports.  Additionally, such regulation also establishes the rules permitting transfers of slots between concessionaires.  ANAC’s resolution has not yet been released.

Also, in 2008, the ANAC enacted a regulation providing that the minimum ground time for aircraft between landing and take-off must be 40 minutes at the International Airport of Sao Paulo in Guarulhos, the international airport of Rio de Janeiro Galeão and at the Brasília airports, and 30 minutes at all other Brazilian airports.  This regulation negatively affected our ability to increase aircraft utilization by minimizing turnaround times between flights.

Airport Infrastructure

INFRAERO, a state-controlled corporation, is in charge of managing, operating and controlling federal airports, including control towers and airport safety operations.

Smaller, regional airports may belong to states or municipalities within Brazil and, in such cases, are often managed by local governmental entities.  At most important Brazilian airports, INFRAERO performs safety and security activities, including passenger and baggage screening, cargo security measures and airport security.

The use of areas within federal airports, such as hangars and check-in counters, is subject to a concession by INFRAERO.  If there is more than one applicant for the use of a specific airport area, INFRAERO may conduct a public bidding process for the granting of the concession.

We have renewable concessions with terms varying from one to five years from INFRAERO to use and operate all of our facilities at each of the major airports that we serve.  Our concession agreements for our terminals’ passenger service facilities, which include check-in counters and ticket offices, operations support area and baggage service offices, contain provisions for periodic adjustments of the lease rates and the extension of the concession term.

Of the 67 Brazilian airports managed by INFRAERO, approximately 20 airports are receiving infrastructure investments and upgrades.  The airport upgrade plan does not require contributions or investments by the Brazilian airlines and is not expected to be accompanied by increases in landing fees or passenger taxes on air travel.

Concession for Air Transportation Services

According to the Brazilian Federal Constitution, the Brazilian government is responsible for public services related to airspace as well as airport infrastructure, and may provide these services directly or through third parties under concessions or authorizations.  According to the Brazilian Aeronautical Code and regulations issued by the CONAC, the application for a concession to operate regular air transportation services is subject to a license granted by the ANAC to operate an airline and to explore regular air transportation services.  The applicant is required by the ANAC to have met certain economic, financial, technical, operational and administrative requirements in order to be granted such license.  Additionally, a concession applicant must be an entity incorporated in Brazil, duly registered with the Brazilian Aeronautical Registry (Registro Aeronáutico Brasileiro), or RAB, must have a valid airline operating certificate (Certificado de Homologação de Empresa de Transporte Aéreo), or CHETA, and must also comply with certain ownership restrictions.  See “—Restrictions to the Ownership of Shares Issued by Concessionaires of Air Transportation Services.”  The ANAC has the authority to revoke a concession for failure by the airline to comply with the terms of the Brazilian Aeronautical Code, the complementary laws and regulations and the terms of the concession agreement.

Our concession was granted on January 2, 2001 by the High Command of Aeronautics of the Ministry of Defense.  The concession agreement can be terminated if, among other things, we fail to meet specified service levels, cease operations or declare bankruptcy.

The Brazilian Aeronautical Code and the regulations issued by the CONAC and ANAC do not expressly provide for public bidding processes and currently it is not necessary to conduct public bidding processes prior to granting of concessions for the operation of air transportation services.  Due to the intense growth of the civil aviation sector, this rule may be changed by the government, in order to allow more competition or to achieve other political purposes.

Import of Aircraft into Brazil

The import of civil or commercial aircraft into Brazil is subject to prior certification of the aircraft by ANAC.  Import authorizations usually follow the general procedures for import of goods into Brazil, after which the importer must request the registration of the aircraft with the RAB.

Registration of Aircraft

The registration of aircraft in Brazil is governed by the Brazilian Aeronautical Code, under which no aircraft is allowed to fly in Brazilian airspace, or land in or take off from Brazilian territory, without having been properly registered.  In order to be registered and continue to be registered in Brazil, an aircraft must have a certificate of registration (certificado de matrícula) and a certificate of airworthiness (certificado de aeronavegabilidade), both of which are issued by the RAB after technical inspection of the aircraft by the ANAC.  A certificate of registration attributes Brazilian nationality to the aircraft and is evidence of its enrollment with the competent aviation authority.  A certificate of airworthiness is generally valid for six years from the date of the ANAC’s inspection and authorizes the aircraft to fly in Brazilian airspace, subject to continuing compliance with certain technical requirements and conditions.  The registration of any aircraft may be cancelled if it is found that the aircraft is not in compliance with the requirements for registration and, in particular, if the aircraft has failed to comply with any applicable safety requirements specified by the ANAC or the Brazilian Aeronautical Code.

All information relating to the contractual status of an aircraft, including purchase and sale agreements, operating leases and mortgages, must be filed with the RAB in order to provide the public with an updated record of any amendments made to the aircraft certificate of registration.

Restrictions on the Ownership of Shares Issued by Concessionaires of Air Transportation Services

According to the Brazilian Aeronautical Code, in order to be eligible for a concession for operation of regular services, the entity operating the concession must have at least 80% of its voting stock held directly or indirectly by Brazilian citizens and must have certain management positions entrusted to Brazilian citizens.  The Brazilian Aeronautical Code also imposes certain restrictions on the transfer of capital stock of concessionaires of air transportation services, such as VRG, including the following:

·         the voting shares have to be nominative and non-voting shares cannot be converted into voting shares;

·         prior approval of the Brazilian aviation authorities is required for any transfer of shares, regardless of the nationality of the investor, which results in the change of the company’s corporate control, causes the assignee to hold more than 10% of the company’s capital stock or represents more than 2% of the company’s capital stock;

·         the airline must file with the ANAC, in the first month of each semester, a detailed shareholder chart including a list of shareholders, as well as a list of all share transfers effected in the preceding semester; and

·         based on its review of the airline’s shareholder chart, the ANAC has the authority to subject any further transfer of shares to its prior approval.

The Registrant holds substantially all of the shares of VRG, which are public concessionaires of air transportation services in Brazil.  Under the Brazilian Aeronautical Code, the restrictions on the transfer of shares described above apply only to companies that hold concessions to provide regular air transportation services.  Therefore, the restrictions do not apply to the Registrant.

Environmental Regulation

Brazilian airlines are subject to various federal, state and municipal laws and regulations relating to the protection of the environment, including the disposal of materials and chemical substances and aircraft noise.  These laws and regulations are enforced by various governmental authorities.  The non-compliance with such laws and regulations may subject the violator to administrative and criminal sanctions, in addition to the obligation to repair or to pay damages caused to the environment and third parties.  As far as civil liabilities are concerned, Brazilian environmental laws adopt the strict and joint liability regime.  In this regard we may be liable for violations by third parties hired to dispose of our waste. Moreover, pursuant to Brazilian environmental laws and regulations, the piercing of the corporate veil of a company may occur in order to ensure enough financial resources to the recovery of damages caused against the environment.

We adopted several Environmental Management System (EMS) procedures with our suppliers and use technical audits to enforce compliance.  We exercise caution, and may reject goods and services from companies that do not meet our environmental protection parameters unless confirmation of compliance is received.

We are monitoring and analyzing the developments regarding amendments to Kyoto protocol and emissions regulations in the United States and Europe and may in the future be obliged to acquire carbon credits for the operation of our business.  No legislation on this matter has yet been enacted in Brazil.

Pending Legislation

The Brazilian congress is currently discussing a draft bill that would replace the current Brazilian Aeronautical Code (Código Brasileiro de Aeronáutica).  In general, this draft bill deals with matters related to civil aviation, including airport concessions, consumer protection, limitation of airlines’ civil liability, compulsory insurance, fines and the increase of limits to foreign ownership in voting stock of Brazilian airlines from 20% to 49% or higher, provided that the country of origin of the investor permits a higher ownership threshold for Brazilian investors.  This draft bill is still under discussion in the House of Representatives and, if approved, must be submitted for approval to the Federal Senate, before being sent for presidential approval. If the Brazilian civil aviation framework changes in the future, or ANAC implements increased restrictions, our growth plans and our business and results of operations could be adversely affected.

Since 2009, the Brazilian government has been analyzing the privatization of airports or granting of rights for private concessionaries to operate currently existing airports or expansions of those airports.  In January 2011, Mrs. Dilma Roussef, the newly elected Brazilian president, announced that she intends to privatize certain Brazilian airports. Although such measures may serve as a potential positive catalyst to accelerate investments in airport infrastructure, we are unable to foresee the effects of any such measures on our business and results of operations.

In 2010 ANAC approved the deregulation of international airfares for flights departing from Brazil to the U.S. and Europe, gradually removing the prior minimum fares.  In addition, in 2010 the National Civil Aviation Council (Conselho de Aviação Civil), or CONAC, approved the continuity of bilateral agreements providing for open skies policies with other South American countries and a new open skies policy with the United States and began negotiations for an open skies policy with Europe, which we expect will be concluded this year.  These regulations increase competition in the market and may negatively affect our results of operation.

Currently, landing fees charged in Brazilian airports are standard in all airports independent of whether they are busy or not. In February 2011, the Brazilian government announced that it will increase landing fees at the busiest airports as compared to less busy airports. As a result secondary airports may be created with more competitive fees for the airlines that choose to operate in these airports. Changes in landing or other fees may provide other market players with a cost advantage and negatively affect our competitive position and results of operation.

Aircraft Financing by Export Credit Agencies

Ex-Im Bank has recently agreed on a common approach with European export-credit agencies on offering export credits for commercial aircraft.  Among other things, the new ASU sets forth minimum guarantee premium rates applicable to aircraft delivered on or after January 1, 2011, or under firm contracts entered into after April 30, 2007.  While subject to modification, the exposure fees paid by Gol on applicable aircraft are likely to increase. The amount of any such increase will depend upon the credit risk assigned to us by the participating export-agencies pursuant to the protocols of the ASU.  In addition, we will no longer be able to finance the amortization payments of loans guaranteed by Ex-Im Bank with SOAR loan facilities.

C.      Organizational Structure

The Registrant is a holding company, which owns directly or indirectly shares of four subsidiaries:  VRG and three offshore finance subsidiaries Gol Finance Cayman and GAC Inc., which owns Sky Finance II.  VRG is the Registrant’s operating subsidiary, under which we conduct our business.  Gol Finance, GAC Inc. and Sky Finance II are off-shore companies established for the purpose of facilitating cross-border general and aircraft financing transactions. In June 2010 we wound down one of our finance subsidiary Sky Finance, after the last repayment of all funds raised through it.

D.      Property, Plant and Equipment

Our primary corporate offices are located in two buildings in São Paulo.  Our commercial, operations, technology, finance and administrative staff is based primarily at our headquarters.  We have concessions to use other airport buildings and hangars throughout Brazil, including a part of a hangar at Congonhas airport where we perform aircraft maintenance.  As of December 31, 2010, we have 39 Boeing 737s classified as finance lease aircrafts. We own a state-of-the-art Aircraft Maintenance Center in Confins, in the State of Minas Gerais.  The certification of our aircraft maintenance center authorizes maintenance services for Boeing 737-300s and Boeing Next Generation 737-700 and 800s.  In 2008, we started a two-stage expansion project of our aircraft maintenance center, when the facility had a capacity to service 60 aircraft.  The second stage was inaugurated in March 2010 and we now have a total capacity to perform full maintenance services for more than 120 Boeing 737 aircraft per year.  With our system of phased maintenance for our Boeing NG 737-700 and 737-800 aircraft fleet, we are able to perform maintenance work every day without sacrificing aircraft revenue time, and schedule preventive maintenance with more regularity and around the utilization of our aircraft, which further dilutes fixed costs.  We use the new facility for airframe heavy checks, line maintenance, aircraft painting and aircraft interior refurbishment.  See also “Item 4—Business Overview—Aircraft” and note 14 to our financial statements as of and for the year ended December 31, 2010.

ITEM 4A.     Unresolved Staff Comments

None.

ITEM 5.  Operating and Financial Review and Prospects

You should read this discussion in conjunction with our consolidated financial statements and the related notes and the other financial information included elsewhere in this annual report.

A.      Operating Results

Revenues

We derive our revenues primarily from transporting passengers on our aircraft.  In 2010, 89.9% of our revenues were derived from passenger fares, and the remaining 10.1% of our revenues were derived from ancillary revenues principally from our cargo business, which utilizes available cargo space on our passenger flights.  Nearly all of our passenger revenue and cargo revenue is denominated in reais.  Passenger revenue, including revenue from our Smiles loyalty program, is recognized either when transportation is provided or when the ticket expires unused.  Cargo revenue is recognized when transportation is provided.  Other ancillary revenue consists primarily of ticket change fees, excess baggage charges, interest on installment sales and other incidental services.  Passenger revenues are based upon our capacity, load factor and yield.  Our capacity is measured in terms of available seat kilometers, which represents the number of seats we make available on our aircraft multiplied by the number of kilometers the seats are flown.  Load factor, or the percentage of our capacity that is actually used by paying customers, is calculated by dividing revenue passenger kilometers by available seat kilometers.  Yield is the average amount that one passenger pays to fly one kilometer.

The following table demonstrates our main operating performance indicators in 2009 and 2010.

Our revenues are net of certain taxes, including state-value added taxes, Imposto sobre Circulação de Mercadorias e Serviços, or ICMS; federal social contribution taxes, including Programa de Integração Social, or PIS; and the Contribuição Social para o Financiamento da Seguridade Social, or COFINS.  ICMS does not apply to passenger revenues.  The average rate of ICMS on cargo revenues varies by state from 4% to 12%.  As a general rule, PIS and COFINS are imposed at rates of 1.65% and 7.6%, respectively, of total revenues.

Generally, the revenues from and profitability of our flights reach their highest levels during the January (summer) and July (winter) vacation periods and in the final two weeks of December during the Christmas holiday season.  The week during which the annual Carnival celebrations take place in Brazil is generally accompanied by a decrease in load factors.  Given our high proportion of fixed costs, this seasonality is likely to cause our results of operations to vary from quarter to quarter.  We generate most of our revenue from ticket sales through our website, and we are one of the largest and leading e-commerce companies in Brazil in terms of net sales through the Internet.

The ANAC and the aviation authorities of the other countries in which we operate may influence our ability to generate revenues.  In Brazil, the ANAC approves the concession of slots, entry of new companies, launch of new routes, increases in route frequencies and lease or acquisition of new aircraft.  Our ability to grow and to increase our revenues is dependent on the receipt of approvals for new routes, increased frequencies and additional aircraft from the ANAC.

Operating Expenses

We seek to lower our operating expenses by operating a standardized fleet with a single-class of service, having one of the newest fleets in the industry, utilizing our aircraft efficiently, using and encouraging low-cost ticket sales and distribution processes. The main components of operating expenses include those related to aircraft fuel, aircraft rent, aircraft maintenance, sales and marketing, and salaries, wages and benefits provided to employees, including provisions for our profit sharing plan.

Our aircraft fuel expenses are higher than those of low-cost airlines in the United States and Europe because the Brazilian infrastructure to produce, transport and store fuel is expensive and underdeveloped, especially in the north and northeast regions of the country.  In addition, taxes applicable to the sale of jet fuel are high and are passed along to us.  Our aircraft fuel expenses are variable and fluctuate based on global oil prices.  Since global oil prices are U.S. dollar-based, our aircraft fuel costs are also linked to fluctuations in the exchange rate of the real  versus the U.S. dollar.  In 2010, fuel expenses represented 36.4% of our total operating expenses, as compared to 32.2% in 2009.  In 2008, the price of West Texas Intermediate crude oil, a benchmark widely used for crude oil prices that is measured in barrels and quoted in U.S. dollars, varied significantly, reaching an all-time high of US$145 in March, 2008 and decreasing to US$44.60 per barrel at the end of 2008.  At year end 2009 the price per barrel was US$79.36 and increasing to US$91.40 at the end of 2010.  We currently enter into short-term arrangements to hedge against increases in oil prices and foreign exchange fluctuations.

Our aircraft rent expenses are in U.S. dollars and have increased in line with the expansion of our operations.  We use short-term arrangements to hedge against exchange rate exposure related to our lease payment obligations.  In addition, leases for 22 of our aircraft are subject to floating-rate payment obligations that are based on fluctuations in international interest rates.  We currently have hedging policies in place to manage our interest rate exposure.

Our maintenance, material and repair expenses consist of light (line) and scheduled heavy (structural) maintenance of our aircraft.  Line maintenance and repair expenses are charged to operating expenses as incurred.  Structural maintenance for aircraft leased under finance leases is capitalized and amortized over the life of the maintenance cycle.  Once the maintenance is performed, accrual does not commence again until the maintenance status is reduced below the return condition.  Since the average age of our operating fleet was 6.5 years at December 31, 2010 and most of the parts on our aircraft are under multi-year warranties, our aircraft have required a low level of maintenance and therefore we have incurred low maintenance expenses.  Our aircraft are covered by warranties that have an average term of three to five years.  The warranties on the aircraft we received in 2010 under our firm purchase order with Boeing will start expiring in 2014.  Thus, with regard to the accounting for aircraft maintenance and repair costs, our current and past results of operations may not be indicative of future results.  Our Aircraft Maintenance Center in Confins, in the State of Minas Gerais is certificated for the maintenance services for Boeing 737-300s and Boeing Next Generation 737-700 and 800s.  We currently use the new facility for airframe heavy checks, line maintenance, aircraft painting and aircraft interior refurbishment.  We believe that we have an advantage compared to industry peers in maintenance, materials and repairs expenses due to the use of Boeing 737 Next Generation aircraft that allows for phased maintenance as described in this annual report, and due to the internalization of our maintenance.  We believe that this advantage will remain in the future.

Our sales and marketing expenses include commissions paid to travel agents, fees paid for our own and third-party reservation systems and agents, fees paid to credit card companies and advertising.  Our distribution costs are lower than those of other airlines in Brazil on a per available seat kilometer basis because a higher proportion of our customers purchase tickets from us directly through our website instead of through traditional distribution channels, such as ticket offices, and we have comparatively fewer sales made through higher cost global distribution systems.  We generated 88.1% of our consolidated passenger revenues through our website and API systems in the years ended December 31, 2010 and 92.4% in 2009, including internet sales through travel agents.  For these reasons, we believe that we have an advantage compared to industry peers in sales and marketing expenses and expect this advantage will remain in the future.

Salaries, wages and benefits paid to our employees include annual cost of living adjustments and provisions made for our profit sharing plan.  We have no seniority-related increases in these costs due to our salary structure.  We believe that we have an advantage compared to industry peers in salaries, wages and benefits expenses due to generally lower labor costs in Brazil as compared to other countries.  We believe that these advantages will continue to exist in the future.

Aircraft and traffic servicing expenses include ground handling and the cost of airport facilities.  Other operating expenses consist of general and administrative expenses, purchased services, equipment rentals, passenger refreshments, communication costs, supplies and professional fees.

Brazilian Economic Environment

As a company with most of its operations currently in Brazil, we are affected by general economic conditions in the country.  While our growth since 2001 has been primarily driven by our expansion into new markets and increased flight frequencies, we have also been affected by macroeconomic conditions in Brazil.  Our growth outpaced that of our primary competitors because of strong demand for our lower fare service.  In 2010, we grew 17.0% in terms of revenue passenger kilometers in the domestic market and considering both international and domestic market 19.2% . The relatively higher consolidated growth rate compared to the domestic market is due to mainly due to the continuing recovery of the Latin American economy, combined with the high demand in Southern Cone routes, especially in Argentina, Chile and Uruguay, the appreciation of the Brazilian real  against the U.S. dollar.  We believe the rate of growth in Brazil is important in determining our future growth capacity and our results of operations.

Our results of operations are affected by currency fluctuations.  The vast majority of our revenues are denominated in reais  (with a small portion of our revenues from our international flights being denominated in other currencies), but a significant part of our operating expenses are either payable in or affected by the U.S. dollar, such as our aircraft operating lease payments, related maintenance reserves and deposits, and jet fuel expenses.  Based on a statistical analysis of our first seven years of operations, we believe that our revenues are highly correlated with the real/U.S. dollar exchange rate and jet fuel prices because real  fluctuations and increases in jet fuel prices are generally incorporated into the fare structures of Brazilian airlines.  In 2010, 54.7% of our operating expenses (including aircraft fuel) are denominated in, or linked to, U.S. dollars and therefore vary with the real/U.S. dollar exchange rate.  We believe that our foreign exchange and fuel hedging programs protect us against short-term swings in the real/U.S. dollar exchange rate and jet fuel prices.  Overall, we believe that the combination of our revenue stream, with its correlation to movements in the real/U.S. dollar exchange rate, and short-term hedges on the U.S. dollar-linked portion of our expenses, will mitigate the adverse effect on our operating expenses of abrupt movements in the real/ U.S. dollar exchange rate.

Inflation has also had, and may continue to have, effects on our financial condition and results of operations.  In 2010, 45.3% of our operating expenses (excluding aircraft fuel) were denominated in reais, and the suppliers and service providers of these expense items generally attempt to increase their prices to reflect Brazilian inflation.

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

_________

Sources:  Fundação Getúlio Vargas, the Central Bank and Bloomberg

(1)   Inflation (IGP-M) is the general market price index measured by the Fundação Getúlio Vargas.

(2)   Inflation (IPCA) is a broad consumer price index measured by the Instituto Brasileiro de Geografia e Estatística.

(3)   The CDI rate is average of inter-bank overnight rates in Brazil (accumulated for period-end month, annualized).

(4)   Three-month U.S. dollar LIBOR rate as of the last date of the period.  The LIBOR rate is the London inter-bank offer rate.

(5)   Represents the average of the exchange rates on the last day of each month during the period.

Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with IFRS requires our management to adopt accounting policies and make estimates and judgments to develop amounts reported in our consolidated financial statements and related notes.  We strive to maintain a process to review the application of our accounting policies and to evaluate the appropriateness of the estimates that are required to prepare our consolidated financial statements.  We believe that our estimates and judgments are reasonable; however, actual results and the timing of recognition of such amounts could differ from those estimates.  In addition, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information.

Critical accounting policies and estimates are those that are reflective of significant judgments and uncertainties, and potentially result in materially different outcomes under different assumptions and conditions.  For a discussion of these and other accounting policies, see Note 2 to our consolidated financial statements.

Accounting for Property,  Plant and Equipment.  Property, plant and equipment, including rotable parts, are recorded at cost and are depreciated to estimated residual values over their estimated useful lives using the straight-line method.  Each component of property, plant and equipment that has a cost that is significant in relation to the overall cost of the item is depreciated separately.  Aircraft and engine spares acquired on the introduction or expansion of a fleet, as well as rotable spares purchased separately, are carried as fixed assets and generally depreciated in line with the fleet to which they relate.  Pre-delivery deposits refer to prepayments made based on the agreements entered into with Boeing Company for the purchase of Boeing 737-800 Next Generation aircraft and includes interest and finance charges incurred during the manufacture of aircraft and the leasehold improvements.

Under IAS 16 “Property, Plant and Equipment,” major engine overhauls including replacement spares and labor costs, are treated as a separate asset component with the cost capitalized and depreciated over the period to the next major overhaul.  All other replacement spares and costs relating to maintenance of fleet assets are charged to the income statement on consumption or as incurred.  Interest costs incurred and exchange differences on borrowings that fund progress payments on assets under construction, including pre-delivery deposits to acquire new aircraft, are capitalized and included as part of the cost of the assets through the earlier of the date of completion or aircraft delivery.  Exchange differences are capitalized to the extent that they are regarded as an adjustment to interest costs.

In estimating the lives and expected residual values of its aircraft, the Company primarily has relied upon actual experience with the same or similar aircraft types and recommendations from Boeing, the manufacturer of the Company’s aircraft.  Aircraft estimated useful lives are based on the number of “cycles” flown (one-take-off and landing).  The Company has made a conversion of cycles into years based on both its historical and anticipated future utilization of the aircraft.  Subsequent revisions to these estimates, which can be significant, could be caused by changes to the Company’s maintenance program, changes in utilization of the aircraft (actual cycles during a given period of time), governmental regulations related to aging aircraft, and changing market prices of new and used aircraft of the same or similar types.  The Company evaluates its estimates and assumptions each reporting period and, when warranted, adjusts these estimates and assumptions.  These adjustments are accounted for on a prospective basis through depreciation and amortization expense, as required by IFRS. 

We evaluate annually whether there is an indication that our property, plant and equipment may be impaired.  Factors that would indicate potential impairment may include, but are not limited to, significant decreases in the market value of the long-lived asset(s), a significant change in the long-lived asset’s physical condition, and operating or cash flow losses associated with the use of the long-lived assets.  We have not identified any impairments related to our existing aircraft fleet.  As of 31 December 2010 and 2009, no impairment on property, plant and equipment assets was recognized.

Lease accounting.  Aircraft lease agreements are accounted as either operating or capital leases (finance leases).  When the risks and benefits of the lease are transferred to us, as lessee, the lease is classified as capital lease.  Capital leases are accounted as an acquisition obtained through a financing, with the aircraft recorded as a fixed asset and a corresponding liability recorded as a loan.  Capital leases are recorded based on the lesser of the fair value of the aircraft or the present value of the minimum lease payments, discounted at an implicit interest rate, when it is clearly identified in the lease agreement, or market interest rate.  The aircraft is depreciated through the lesser of its useful life or the lease term.  Interest expense is recognized through the effective interest rate method, based on the implicit interest rate of the lease.  Lease agreements that do not transfer de risks and benefits to us are classified as operating leases.  Operating leases are accounted as a rent, and the lease expense is recognized when incurred through the straight line method.

Sale-lease back transactions that result in a subsequent operating lease have different accounting treatments depending on the fair value, the price and the cost of the sale.  If the fair value is less than the carrying amount of the asset, the difference is recognized as a loss immediately.  When the sale gives rise to a gain it is recognized up to the fair value, the excess is deferred and amortized throughout the term of the lease.  When the sale results in a loss and the carrying amount is not greater than fair value, the loss is deferred if compensated by future lease payments.  If the carrying amount is greater than fair value it is written down to fair value, and if there is still a loss it is deferred if compensated by future lease payments.

Lease accounting is critical for us because it requires an extensive analysis of the lease agreements in order to classify and measure the transactions in our financial statements and significantly impacts our financial position and results of operations.  Changes in the terms of our outstanding lease agreements and the terms of future lease agreements may impact the accounting for the lease transactions and our future financial position and results of operations.

Goodwill and Intangible Assets.  We have allocated goodwill and intangible assets with indefinite lives acquired through business combinations for the purposes of impairment testing to a single cash-generating unit, the operating subsidiary VRG.  Goodwill is tested for impairment annually by comparing the carrying amount to the recoverable amount of the cash-generating unit level that has been measured on the basis of its value-in-use, by applying cash flow projections in the functional currency based on the Company’s approved business plan covering a five-year period followed by the long-term growth rate of 3%.  The pre-tax discount rate applied to the cash flow projections is 20.46% . Considerable judgment is necessary to evaluate the impact of operating and macroeconomic changes to estimate future cash flows and to measure the recoverable amount.  Assumptions in the Company’s impairment evaluations are consistent with internal projections and operating plans.  Airport operating rights were acquired as part of the acquisition of VRG and were capitalized at fair value at that date and are not amortized.  Those rights are considered to have indefinite useful lives due to several factors and considerations, including requirements for necessary permits to operate within Brazil and limited slot availability in the most important airports in terms of traffic volume.  VRG tradenames were acquired as part of the VRG acquisition and were capitalized at fair value at that date.  The tradenames are considered to have an indefinite useful life (and are not amortized) due to several factors and considerations, including the brand awareness and market position, customer recognition and loyalty and the continued use of the VARIG tradenames.  The carrying values of the airport operating rights and tradenames are reviewed for impairment at each reporting date and are subject to impairment testing when events or changes in circumstances indicate that carrying values may not be recoverable.  Costs related to the purchase or development of computer software that is separable from an item of related hardware is capitalized separately and amortized over a period not exceeding five years on a straight-line basis.  The carrying value of these intangibles is reviewed for impairment if events or changes in circumstances indicate the carrying value may not be recoverable.  The Company assesses at each balance sheet date whether intangibles with indefinite useful lives are impaired using discounted cash flow analyses, which considers the creditworthiness of the issuer of the security, as further described in Note 15 to our financial statements.  As of 31 December 2010 and 2009, no impairment on goodwill and other intangible assets was recognized.

Derivative Financial Instruments.  The Company accounts for derivative financial instruments in accordance with IAS 39.  In executing the risk management program, management uses a variety of financial instruments, to protect against sharp changes in market prices and to mitigate the volatility of its expenditures related to these prices.  The Company does not hold or issue derivative financial instruments for speculative purposes.

Derivative financial instruments are initially recognized at fair value and subsequently the change in fair value is recorded in profit or loss, unless the derivative meets the strict criteria for cash flow hedge accounting.

For hedge accounting purposes, according to IAS 39, the hedge instrument is classified as a: (i) cash flow hedge when it protects against the exposure to fluctuations in cash flow that are attributable to a particular risk associated with an asset or liability recognized regarding an operation that is highly likely to occur or to an exchange rate risk for an unrecognized firm commitment, and (ii) fair value hedge when it protects from the results of a change in the fair value of a recognized liability, or a part thereof, that could be attributed to exchange risk.

At the beginning of a hedge transaction, the Company designates and formally documents the item covered by the hedge, as well as the objective of the hedge and the risk policy strategy.  Documentation includes identification of the hedge instrument, the item or transaction to be protected, the nature of the risk to be hedged and how the entity will determine the effectiveness of the hedge instrument in offsetting exposure to variations in the fair value of the item covered or the cash flows attributable to the risk covered.  The purpose is that such hedge instruments will be effective in offsetting the changes in fair value or cash flows and they are constantly appraised to determine if they really have been effective throughout the entire period for which they have been designated.

Amounts classified in equity are transferred to profit or loss each period in which the hedged transaction affects profit or loss.  If the hedged item is the cost of a non-financial asset, the amounts classified in equity are transferred to the initial carrying amount of the non-financial asset.

If the forecast transaction or the firm commitment is no longer expected to occur, amounts previously recognized in equity are transferred to profit or loss.  If the hedging instrument expires, is terminated or exercised without replacement or rollover, or if its designation as a hedge is revoked, amounts previously recognized in equity are recognized in profit or loss.

We measure quarterly the effectiveness of the hedge instruments in offsetting changes in prices.  Derivative financial instruments are effective if they offset between 80% and 125% of the changes in price of the item for which the hedge has been contracted.  Any gain or loss resulting from changes in the fair value of the derivative financial instruments during the quarter in which they are not qualified for hedge accounting, as well as the ineffective portion of the instruments designated for hedge accounting are recognized as other finance income (expenses).

At December 31, 2010 we had the following derivative financial instruments classified as cash flow hedge:  petroleum call options and foreign currency call options denominated in U.S. dollars; classified as fair value hedge: forward contracts for U.S. dollars.    

Aircraft maintenance and repair costs.  Our aircraft lease agreements specifically provide that we, as lessee, are responsible for maintenance of the leased aircraft and engines, and we must meet specified airframe and engine return conditions upon lease expiration.  Under certain of our existing lease agreements, we pay maintenance deposits to aircraft and engine lessors that are to be applied to future maintenance events.  These deposits are calculated based on a performance measure, such as flight hours or cycles, and are available for reimbursement to us upon the completion of the maintenance of the leased aircraft.  If there are sufficient funds on deposit to reimburse us for our maintenance costs, such funds are returned to us.  The maintenance deposits paid under our lease agreements do not transfer either the obligation to maintain the aircraft or the cost risk associated with the maintenance activities to the aircraft lessor.  In addition, we maintain the right to select any third-party maintenance provider or to perform such services in-house.  Therefore, we record these amounts as a deposit on our balance sheet and recognize maintenance expense when the underlying maintenance is performed, in accordance with our maintenance accounting policy.  Certain of our lease agreements provide that excess deposits at the end of the lease term are not refundable to us.  Such excess could occur if the amounts ultimately expended for the maintenance events were less than the amounts on deposit.  Any excess amounts held by the lessor or retained by the lessor upon the expiration of the lease, which are not expected to be significant, would be recognized as additional aircraft rental expense at the time it is no longer probable that such amounts will be used for maintenance for which they were deposited.  The amount of aircraft and engine maintenance deposits expected to be utilized in the next twelve months is classified in current assets.

At the inception of the leases, our initial estimates of the maintenance expenses are equal to or in excess of the amounts required to be deposited.  This demonstrates it is probable the amounts will be utilized for the maintenance for which they are to be deposited and the likelihood of an impairment of the balance is remote.  There has been no impairment of our maintenance deposits.

A summary of activity in the Aircraft and Engine Maintenance Deposits is as follows:

Our fleet plan contemplates the replacement of some operating leases with financing lease agreements, in line with our plan to further standardize our fleet with Boeing Next Generation 737-700 and 737-800 aircraft.  Due to the performance advantages of Boeing Next Generation 737-700 and 737-800 aircraft, we believe these aircraft should sustain attractive market valuations over the next years.  We therefore intend to increase the number of financing leases.  In light of this trend, our maintenance deposit accounts should decrease in the near term, subject to significant potential variations, including the actual cost of maintenance, the timing of the maintenance, aircraft cycles and potential new maintenance requirements.

Revenue Recognition. Passenger revenue is recognized either when transportation is provided or when the unused ticket expires.  Tickets sold but not yet used are recorded as advance ticket sales that represents primarily deferred revenue for tickets sold for future travel dates.

Mileage Program. Since the acquisition of VRG, the Company operates a frequent flyer program, (“Smiles  Program”) that provides travel and other awards to members based on accumulated mileage credits.  The obligations assumed under the Smiles  Program were valued at the acquisition date at estimated fair value that represents the estimated price the Company would pay to a third party to assume the obligation for miles expected to be redeemed under the Smiles  Program. The fair value of mileage credits, net of estimated non-use of miles (breakage) is determined by the weighted average according to (i) the average amount charged per seat by VRG to airlines that participate in the loyalty program divided by the amount of miles required to issue a ticket using miles and (ii) the average sale price of miles sold to airlines that participate in the loyalty program Smiles. This fair value is updated every six months.

Share-Based Payments.  The Company measures the fair value of equity-settled transactions with employees at the grant date using the Black&Scholes valuation model.  The resulting amount, as adjusted for forfeitures is charged to income over the period in which the options vest.  At each balance sheet date before vesting, the cumulative expense is calculated; representing the extent to which the vesting period has expired and management’s best estimate of the number of equity instruments that will ultimately vest.  The change in cumulative expense since the previous balance sheet date is recognized in the income statement prospectively over the remaining vesting period of the instrument.

Provisions.  For certain operating leases, the Company is contractually obligated to return aircraft in a defined condition.  The Company accrues for restitution costs related to aircraft held under operating leases at the time the asset does not meet the return condition criteria throughout the duration of the lease.  Other provisions are recorded for probable losses and are reviewed based on the development of lawsuits and the background of losses on labor and civil claims, based on the best current estimate.

Provisions are recognized when the Company has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation.  Where the Company expects some or all of a provision to be reimbursed, for example under an insurance contract, the reimbursement is recognized as a separate asset when the reimbursement is virtually certain.  The expense relating to any provision is presented in profit or loss net of any reimbursement.  If the effect of the time value of money is material, provisions are discounted using a current pre-tax rate that reflects, where appropriate, the risks specific to the liability.  Where discounting is used, the increase in the provision due to the passage of time is recognized as a finance cost.

Deferred taxes.  Deferred taxes are calculated based on tax losses, temporary differences arising on differences between tax bases and carrying amounts for financial reporting purposes of our assets and liabilities.

Even though unused tax losses and temporary differences have no expiration date in Brazil, deferred tax assets are recorded when there is evidence that future taxable profit will be available to use such tax credits.  We record our deferred tax assets based on projections for future taxable profits, which considers a number of assumptions for revenue increase, for operating costs such as jet fuel prices, leasing expenses and etc. Our business plan is revised annually in order to revaluate the amounts to be recorded as deferred tax assets.

Deferred taxes is a critical accounting policy for us because it requires a number of assumptions and is based on our best estimate of our projections related to future taxable profit.  In addition, because the preparation of our business plan is subject to a variety of market conditions, the results of our operations may vary significantly from our projections and as such, the amounts recorded as deferred tax assets may be impacted significantly in the future.

Results of Operations

Year 2010 Compared to Year 2009

Our results of operations in 2010 were affected by the following key drivers:

Strong growth in domestic market: In 2010, the improved economic scenario in Brazil and South America as a whole, especially from the consumer confidence point of view and the expansion of the country’s emerging middle class, which led to a greater number of people opting for air transport, were the main factors for the increase in domestic demand. As a result we grew 17.0% as compared to 2009 in terms of revenue passenger kilometers in the domestic market.

Implementation of new cost reduction initiatives:  We have completed our fleet renewal plan in 2010, with the return of the remaining 11 Boeing 737-300 aircraft. This will benefit future years with a reduction of approximately R$9 million per quarter of leasing expenses. We will replace more aircrafts with new Boeing 737-800 and 700s NGs aircrafts that will provide lower cost of inventories and spare parts, less fuel consumption and lower crew training costs. We also have implemented several measures for cost reduction resulting in a reduction of other operating expenses, including: the implementation of the Shared Services Center, the adoption of zero based budgeting methodology and investments linked to IT improvements of internal controls systems in order to improve operational efficiency. Our high aircraft utilization rate of 12.9 block hours per day in 2010, an increase of 10.4% compared to the 11.6 block hours per day recorded in 2009, also contributed to dilute fixed costs.

We present in the following table information regarding our results of operations in IFRS in 2010 and 2009.

We had operating income of R$697.8 million in 2010 compared to R$413.2 million in 2009.  Our operating margin was 10.0% in 2010, and 6.9% in 2009.  We reported net income in 2010 of R$214.2 million compared to R$890.8 million for 2009.  Income before income tax was R$386.5 million in 2010 compared to R$756.1 million in 2009.

Net Operating Revenues.  Net operating revenues increased 15.8% to R$6,979.5 million in 2010 as compared to 2009 as a result of the increased demand for domestic flights emerging from the Brazilian middle class due to the positive macroeconomic scenario, in addition to our: (i) dominant position and increased frequency between the Brazilian leading airports; (ii) high operating quality indices (punctuality, regularity, client service and safety); (iii) dynamic fare management, which combines the strengthening quarterly yields with stimulation demand for leisure travelers; (iv) growth of the Smiles mileage program and; (vi) focus on short-haul flights in a range of three hours or less, benefiting business travelers. Our consolidated demand increased 19,2%. Our domestic market demand increased by 17.0%, while international market demand increased 46.2% as a result of our international network expansion with the introduction of new routes in the Southern Cone and Caribbean regions and the introduction of new regional destinations in Brazil in addition to markets operated by our new regional airline partners. The higher demand was partially offset by a 0.8% decrease in yields to R$20.5 cents in 2010 from R$20.7 cents in 2009 due to a variety of factors: (i) a more stable capital markets scenario, (ii) lower selling expenses in the domestic market due to a gradual decrease during 2009 of commissions paid to travel agencies in the domestic market (valid for all players in the industry) which were fully extinguished in February 2010, (iii) the upturn in economic activity and consumer confidence, reflected in increased demand for leisure trips that consequently, generate larger forward bookings; (iv) an increase in the average stage length by 1.9% and; (v) lower U.S. dollar and WTI oil price volatility.

Our load factor increased 1.9 percentage points from 65.3% in 2009 to 67.1% in 2010, mainly due to lower increase in available seat kilometers by 14.0% compared to the increase of 17.3% in revenue passenger kilometers.

Our ancillary and other revenues decreased 2.4% from R$718.9 million in 2009 to R$701.8 million in 2010, representing 10.1% of our total net revenues, mainly due to the decrease in no-show fee and tickets rescheduling revenue and due to revenues of R$48.1 million in 2009 related to image rights and rental of our Smiles  client database as part of the co-branded credit card contract.

Operating Expenses.  Operating expenses per available seat kilometer decreased 1.8% from R$13.91 cents in 2009 to R$13.78 cents in 2010, primarily due to the (i) increased available seats kilometers by 14.0%; (ii) 10.4% increase in aircraft utilization; (iii) 1.8% extension of the average stage length, offset by an increase of 10.8% in fuel cost from R$4.53 cents to R$5.02 cents per available seat kilometers.  Operating expenses per available seat kilometer excluding fuel decreased 7.8% from R$9.41 cents to R$8.76 cents in 2010, mainly due to lower aircraft rent, maintenance, sales and marketing and other operating expenses; offset by the non-recurring costs arising from the fleet renewal carried out in 2010 to return eleven Boeing 737-300 aircraft and the maintenance expenses for reactivation of five Boeing 767, four for long-haul international charter and one for sub-leasing operations.

Our breakeven load factor increased 1.2 percentage points to 60.4% in 2010 compared to 59.2% in 2009, primarily due to (i) higher fuel cost per liter; (ii) 0.8% decline in yields and; (iii) a 3.5 percentage points increase in load factor.

The breakdown of our operating expenses on a per available seat kilometer basis for 2010 compared to 2009 is as follows.

Note: In October 2010, ANAC changed its calculation method for monthly traffic information and republished information for periods since January 2009. All operating data for 2009 and 2010 reflects the new methodology, whereas information for 2007 and 2008 was calculated pursuant to the old methodology and may not be fully comparable. According to ANAC, the changes were designed to align data with the concepts adopted by the ICAO. The change was necessary because Brazil has joined the ICAO’s statistical program and supplies the latter’s database with several industry data. Changes in the methodology refer to the calculation of ASK (seat supply) and the classification of domestic legs in international flights, which are now considered to be part of the domestic market. ANAC has stated that it will republish information for 2008 at a later date.

Salaries, wages and benefits increased 13.8%, or R$151.4 million, due to (i) a 6% partial cost of living increase on salaries effected in December 2010; (ii) higher constituted provisions for employee profit sharing based on the stock option plan and; (iii) a 4.5% increase in the number of employees from 17,963 in 2009 to 18,776 in 2010, especially in the operational, airport and call center areas, in turn fueled by the need to adjust to the growth in our operations and the growth of 15.8% in passengers transported.  Salaries, wages and benefits per available seat kilometer increased 0.8% due to the same reasons, although diluted by the increase in available seat kilometers in 2010.

Aircraft fuel expense increased 26.2%, or R$ 474.3 million, primarily due to a 22.4% increase in average oil (WTI) prices, 3.4% increase in fuel consumption due to the growth in the operations and higher number of average operating aircrafts (from 108 in 2009 to 111 in 2010). Aircraft fuel expense per available seat kilometer increased 11.7% due to the same reasons, although diluted by the increase in available seat kilometers in 2010.

Aircraft rent, which we incur in U.S. dollars, decreased 14.6%, or R$ 95.1 million, due to a 11.7% average depreciation of the U.S. dollar against real  and a 18.2% increase in the total fleet under finance leases from 33 in 2009 to 39 in 2010. Aircraft rent per available seat kilometer decreased 24.4%, due to the same reasons, although emphasized by an increase in available seat kilometers in 2010.

Sales and marketing expense increased 0.9%, or R$ 3.2 million, resulting from (i) additional advertising expenses in order to revitalize our Smiles mileage program; (ii) advertising expenses from a new institutional campaign and; (iii) higher commissions paid to credit card administrators due to the increase in direct sales, partially offset by the elimination of ticket sales commissions for travel agents as of the beginning of February, 2010.  Sales and marketing per available seat kilometer decreased 10.7% due to the increase in available seat kilometers in 2010.

Landing fees increased 6.2%, or R$19.3 million, mainly due to a 7.9% increase in departures.  Landing fees per available seat kilometer decreased 6.0% due to the increase in available seat kilometers in 2010.

Aircraft and traffic servicing expense increased 12.1%, or R$46.2 million, primarily due to an increase in the average operating fleet (from 108 in 2009 to 111 in 2010), increased handling expenses as a result of increased arrivals and departures and additional IT and consulting services related to (i) the implementation of the new budget planning method (zero base budget), (ii) the Shared Service Center aiming to improve the quality and productivity of our operations, (iii) the migration of our Smiles system from IBM to Oracle (Siebel) and (iv) the improvement of internal software (related to check-in developments, buy on board services and wireless entertainment service).  Aircraft and traffic servicing expense per available seat kilometer decreased 0.8% due to the same reasons, although diluted by the increase in available seat kilometers in 2010.

Maintenance, materials and repairs increased 1.4%, or R$5.8 million, due to increase in scheduled aircraft maintenance events during the year, reflecting the larger average operating fleet and non-recurring expenses related to the fleet renovation and standardization program, with return of eleven remaining Boeing 737-300 and reactivation of five Boeing 767 to long-haul international charters and sub-leasing operations.  Maintenance, materials and repairs per available seat kilometer decreased 10.7% primarily due to the increase in available seat kilometers in 2010.

Depreciation and amortization increased 97.1% or R$138.7 million, due primarily to (i) the higher number of aircrafts under finance leases (from 33 in 2009 to 39 in 2010); (ii) a change in 2010 in the estimate for the depreciation of maintenance costs for engines under finance leases, which now have a 5-year depreciation period, whereas the remaining items continue to depreciate over 25 years.  Depreciation and amortization per available seat kilometer increased 74.5% due to the same reasons, although diluted by the increase in available seat kilometers in 2010.

Other operating expenses (mainly comprising accommodation, crew travel and accommodation, direct passenger expenses, equipment leasing and general and administrative expenses) decreased 17.3%, or R$74.3 million, due to several factors: (i) more efficient controls over general and administrative expenses (telephone, water, gas and electricity), as well as losses of inventories, uniforms and other inputs in the operational bases, (ii) gains from the automation of our internal systems (inventories, accounts, billing, legal affairs and accounts receivable), which led to better controls over provisions and reduction in general and administrative expenses; (iii) optimization of our route network; (iv) fewer flight cancellations; and (v) greater volume of IT equipment under finance leases, reducing expenses from equipment rentals. Other operating expenses per available seat kilometer decreased 26.8% due to the same reasons, although emphasized by the increase in available seat kilometers in 2010.

Financial Income (Expense).  Financial expense in 2010 totaled R$311.3 million compared to a financial income of R$342.8 million in 2009, mainly as a result of: (i) lower non-cash foreign exchange variation gains on our assets and liabilities of R$661.7 million due to the impact of the 4.3% appreciation of the real  against the U.S. dollar during 2010 (compared to a 25.5% appreciation in 2009); (ii) higher interest expenses related to the increase in our indebtedness with the issue of senior notes in July 2010 and debentures in September, 2010; (iii) partially offset by the R$33.9 million increase of interest revenue due to the higher cash position since the end of 2009.

Income Taxes.  Our income taxes totaled R$172.3 million in 2010, compared to an income tax benefit of R$134.7 million in 2009, mainly as a result of higher current income tax in 2010 due to higher taxable income basis calculated in accordance with Brazilian corporation law (No. 6,404/76) and higher deferred income tax expense caused by: (i) temporary differences arising mainly from the exchange variation on financial leasing operations which generate deferred income tax liabilities; (ii) recognition in 2009 of deferred income tax credits resulting from tax losses generated by VRG acquisition and; (iii) tax credits from temporary differences recorded in 2009 based on expectations for future taxable income.

Year 2009 Compared to Year 2008

Our results of operations in 2009 were affected by the following key drivers:

VRG Merger:  Our corporate restructuring, which allowed us to fully integrate VRG into our operations, was concluded in the last quarter of 2008 and therefore we were operating on a fully integrated basis since January 2009.  The merger was the key driver to the cost reduction and optimization of our route network, enabling us to gather the expected synergies from the VRG acquisition in 2007 (including the revamp of our Smiles  loyalty program), benefit from our high frequency route network and generate operating profits in all quarters of 2009.

Better market positioning and focus on our competitive strengths:  since the merger of VRG into our operations, we have focused on our core competitive strengths.  We discontinued our intercontinental flights to the EU in mid-2008 and relied on our operations in Brazil and South America.  According to TMC Brasil and Favecc, the largest business travel agency associations in Brazil, our market share among business passengers increased by 6.1 and 8.3 percentage points, from 34.5% to 40.7% and from 25.7% to 33.8%, respectively.  These advantages combined with our low cost structure and dynamic yield management enabled us to also continue to offer low fares to compete against airlines and interstate buses and stimulate demand from the growing Brazilian middle class, resulting in a 6% increase in market share among first time travelers.

Positive macroeconomic scenario:  demand in the Brazilian airline industry was, during the recent global financial crisis, not as significantly affected as worldwide air travel demand and demand in other consumer based industries in Brazil or worldwide.  In 2009, volatility in the financial and oil markets was relatively low, which benefited our yield management and cost structure.  The second half of 2009 was particularly positive, principally due to improved consumer confidence levels and an ongoing change in customer behavior, shifting towards a relative increase in leisure expenditures in the disposable income share of wallet.  According to the Brazilian Ministry of Tourism, the Brazilian middle class will increase their share in the leisure segment from 35.5% between 2007 and 2009 to 58.5% between 2009 and 2011.  In light of the combination of these factors, demand grew 17.7% in 2009 in the domestic market, the vast majority of which was generated during the second half, when the industry experienced domestic growth averaging more than 30% year over year from the last quarter 2008 as compared to the last quarter 2009.  These positive factors were partially offset by a highly competitive scenario in the domestic market, principally during the months of September and October 2009.

We present in the following table information regarding our results of operations in IFRS in 2009 and 2008.

We note that in October 2010, ANAC changed its calculation method for monthly traffic information and republished information for periods since January 2009. For the purposes of the comparison between the years ended December 31, 2009 and 2008 presented below we have not reflected the new methodology, whereas information for the comparison between the years ended December 31, 2010 and 2009 presented above were calculated and presented pursuant to the new methodology. As a result these two comparisons and may not be fully comparable. According to ANAC, the changes were designed to align data with the concepts adopted by the ICAO. The change was necessary because Brazil has joined the ICAO’s statistical program and supplies the latter’s database with several industry data. Changes in the methodology refer to the calculation of ASK (seat supply) and the classification of domestic legs in international flights, which are now considered to be part of the domestic market. ANAC has stated that it will republish information for 2008 at a later date.

We had operating income of R$413.2 million in 2009 compared to operating losses of R$88.6 million in 2008.  Our operating margin was 6.9% in 2009, and a negative 1.4% in 2008.  We reported net income in 2009 of R$890.8 million compared to a net loss of R$1,239.3 million for 2008.  Income before income tax was R$756.1 million in 2009 compared to losses before income tax of R$1,195.0 million in 2008.

Net Operating Revenues.  Net operating revenues decreased 5.9% to R$6,025.4 million in 2009 as a result of our decision to discontinue intercontinental flights since the second half of 2008, focusing our operations in the domestic market, South America and deploying new routes to the Caribbean Region (Aruba and Curacao).  Consolidated demand increased 3.1% . Domestic market demand increased by 14.9%, while in the international market dropped 44.2% as a result of the discontinuation of our intercontinental flights to the EU in mid 2008 and the low demand to our routes to Argentina and Chile, due to the swine flu, especially during the second and third quarter of 2009.  The higher demand was partially offset by a 12.6% decrease in yields to R$20.34 cents in 2009 from R$23.27 cents in 2008 due to a variety of factors:  (i) more stable capital markets scenario, (ii) lower selling expenses in the domestic market due to a gradual decrease during 2009 of commissions paid to travel agencies in the domestic market (valid for all players in the industry) which were fully extinguished in February 2010, (iii) a highly competitive scenario in the domestic market, principally during the months of September and October 2009 and (iv) high demand growth from Brazilian consumers during the second half of 2009, mainly due to the positive economic scenario and improved consumer confidence.

Despite the 1.8% increase in the average number of operating aircraft from 106.4 in 2008 to 108.7 in 2009, our operating capacity decreased 2.7% in terms of available seat kilometers, from 41,107 million in 2008 to 39,998 million in 2009.  The lower capacity was mainly due to the discontinuation of the long haul flights and our focus on fine tuning our capacity to demand growth by adjusting our aircraft utilization rate, especially during the first half of 2009, when the macroeconomic environment was still not as positive as during the second half of 2009.  As a consequence, our utilization rate dropped 4.1% from 12.2 in 2008 to 11.6 in 2009.  The number of departures increased 1.9% from 268,540 in 2008 to 273,602 in 2009 driven by our strategy to focus our operations in Brazil, South America and Caribbean markets, reflecting our average stage length to decrease by 4.7% from 933 km in 2008 to 890 km in 2009.

Our load factor increased 3.7 percentage points from 61.6% in 2008 to 65.3% in 2009, mainly due a 2.7% decrease in available seat kilometers and a 3.1% increase in revenue passenger kilometers.

Our ancillary revenues are derived from the Gollog  and Voe Fácil businesses as well as ticket change fees, excess baggage charges, Smiles  co-branded credit card and other incidental services, and are an increasingly important part of our revenue composition.  Our ancillary and other revenues increased 39.3% from R$516.1 million in 2008 to R$718.9 million in 2009, representing 11.9% of our total net revenues, mainly due to one off revenues of R$48.1 million related to image rights and rental of our Smiles  client database as part of the co-branded credit card contract, higher revenues from cargo transportation and other fees related to flight rescheduling and excess baggage.

Operating Expenses.  Operating expenses per available seat kilometer decreased 11.2% to R$14.03 in 2009, primarily due to (i) a 29.2% decrease in fuel cost from R$6.40 cents in 2008 to R$4.53 cents in 2009, (ii) a more favorable macroeconomic scenario in Brazil and (iii) the better cost structure after fully integrated VRG into our operations in the last quarter of 2008.  Operating expenses per available seat kilometer excluding fuel increased by 1.2% to R$9.50 in 2009, mainly due to non-recurring expenses related to (i) the fleet renewal carried out in 2009 in order to further standardize our fleet, which, since January 2010, has been fully comprised of Boeing Next Generation aircraft Boeing 737-700, and 737-800, and (ii) non-recurring expenses related to VRG merger concentrated in the first half of 2009, and recurring expenses related to Boeing 767 aircrafts.

Our breakeven load factor decreased 1.6% percentage points to 60.8% in 2009 compared to 62.4% in 2008, primarily due the lower fuel cost per liter and lower cost structure, a 3.7 percentage points increase in load factor, partially offset by a 12.6% decline in yields.

The breakdown of our operating expenses on a per available seat kilometer basis for 2009 compared to 2008 is as follows.

Salaries, wages and benefits increased 11.9%, or R$117.2 million, due to a 8% cost of living increase on salaries effected in December 2008, a 12.9% increase in the number of employees from 15,911 in 2008 to 17,963 in 2009 (mainly due to the internalization of our call center) and a provision for our profit sharing plan of R$71 million, due to the company’s return to profitability.  Salaries, wages and benefits per available seat kilometer increased 15.2% due to the same reasons, although less diluted due to the decrease in available seat kilometers in 2009.

Aircraft fuel expense decreased 31.1%, or R$817.7 million, primarily due to a 37.9% decrease in average oil (WTI) prices, partially offset by an 8.5% average appreciation of the U.S. dollar against the real.  Aircraft fuel expense per available seat kilometer decreased 29.2% due to the same reasons, although less diluted by the decrease in available seat kilometers in 2009.

Aircraft rent, which we incur in U.S. dollars, increased 0.9%, or R$5.6 million, due to a 4.4% increase in the total fleet under operational leases from 90 in 2008 to 94 in 2009.  This tendency was partially offset by an 8.5% average appreciation of the U.S. dollar against the real.  Aircraft rent per available seat kilometer increased 3.6%, reflecting a lower expense dilution due to the lower available seat kilometers in 2009.

Sales and marketing expense decreased 38.1%, or R$224.2 million, resulting from the integration of VRG’s reservation systems that optimized selling expenses as well as the progressive decrease in travel agent commissions for domestic market sales.  Sales and marketing per available seat kilometer decreased 36.2% due to the same reasons, although diluted by the decrease in available seat kilometers in 2009.

Landing fees decreased 7.6%, or R$25.7 million, mainly due to the discontinuation of intercontinental flights in the second half of 2008 resulting in lower fares, partially offset by the 1.9% increase in the number of departures.  Landing fees per available seat kilometer increased 4.7% due to the same reasons, although less diluted by the decrease in available seat kilometers in 2009.  Aircraft and traffic servicing expense increased 9.6%, or R$40.5 million, primarily due to same reasons that impacted landing fees.  Aircraft and traffic servicing expense per available seat kilometer decreased 7.3% due to the decrease in the total capacity as a result of our decision to discontinue intercontinental flights as of July 2008.

Maintenance, materials and repairs increased 7.5%, or R$29.2 million, due to increased maintenance expenses related to the return of part the Boeing 737-300 fleet as part of the further fleet standardization and renovation plan, partially offset by a 8.8% decrease in engine overhauls from 58 in 2008 to 51 in 2009.  Maintenance, materials and repairs per available seat kilometer decreased 11.0% primarily due to the same reasons, although less diluted by the decrease in available seat kilometers in 2009.

Depreciation and amortization increased 14.2% or R$17.7 million, due primarily to the increase in fixed assets resulting from the addition of 8 aircraft as finance leases during 2009.  Depreciation and amortization per available seat kilometer increased 19.1% due to the same reasons, although less diluted by the decrease in available seat kilometers in 2009.

Other operating expenses increased 14.9%, or R$55.7 million, due to expenses of R$73.0 million related to the integration of accounting systems that provided further automation of our consolidation process and adherence to the Brazilian Federal Taxes Installment Payment Program (REFIS), to finance past due taxes in up 180 installments.  Other operating expenses per available seat kilometer decreased 18.7% due to the same reasons, although diluted by the increase in available seat kilometers in 2008.

Financial Income.  Financial income totaled R$342.8 million as of December 31, 2009, compared to a financial expense of R$1.106.4 million in 2008, mainly as a result of non-cash foreign exchange variation gain on our assets and liabilities of R$713.4 million due to the impact of the appreciation of the real  against the U.S. dollar during 2009.

Income Taxes.  We recorded an income tax benefit of R$134.7 million in 2009, compared to an expense of R$44.3 million, mainly due to the use of tax credits in the amount of R$135.3 million from tax losses generated by VRG, acquired in 2007.  This change was possible due to our positive operating profit for the last six quarters and we expect that this trend will continue in the next years

B.      Liquidity and Capital Resources

Cash Flow Analysis

Operating Activities.  Our strategy is to rely primarily on cash flows from operations to provide working capital for current and future operations.  In 2010, we generated R$723.9 million in cash from our operating activities reflecting the increase in our operating profitability. In 2009 and 2008 net cash provided by operating activities was R$457.3 million and R$151.7 million, respectively. Cash flows from operating activities for 2010 were also driven by R$214.2 million in net income, plus noncash depreciation and amortization expense of R$281.6 million, noncash interest on loans of R$297.3 million, and a R$208.5 million increase in accounts receivable. Cash flows associated with financial derivative instruments, which are also classified as operating cash flows, were net inflows of R$117.0 million in 2010. These increases were partially offset by an increase of R$146.6 million in accounts payable, an outflow of R$162.2 million in advance from customers and an increase R$124.7 million in provisions. In 2009, we generated R$457.3 million cash from our operating activities, mainly driven by our net income of R$890.8 million, and partially offset by the decrease in accounts receivable of R$182.0 million and a decrease in deposits of R$124.2 million.  The lower cash flows from operations activities in 2008, was mainly due to the net operating losses for the year.

Our operating cash flows are affected by the requirement under the terms of certain of our aircraft operating lease agreements that we establish maintenance reserve deposit accounts for our aircraft that must be funded at specified levels.  At December 31, 2010, we had R$456.7 million of deposits under our aircraft operating leases for maintenance.  Funds will be drawn from the maintenance reserve accounts to reimburse for certain structural maintenance expenditures incurred.  We believe the amounts deposited and to be deposited plus our own cash resources will be sufficient to service our future aircraft and maintenance costs for the duration of the applicable operating leases.

Investing Activities.  Net cash used in investing activities was R$279.5 million primarily due to acquisitions of property and equipment, including spare parts and aircraft modifications, investments in the expansion of Confins Maintenance Center and pre-delivery deposits for the acquisition of Boeing 737 aircrafts. During 2009, capital expenditures were R$130.5 million, due to investments in airport infrastructure and stores, especially in South American destinations, information technology, rotables and spare parts.  In 2008, capital expenditures were R$346.0 million related to acquisitions of property, plant and equipment and cash generated was R$40.6 million. 

Financing Activities.  Net cash provided by financing activities totaled R$139.9 million in 2010 and consisted primarily of capital we raised in our issuance of R$525.5 million senior notes (equivalent to US$300 million on the date of issuance) maturing in 2020, and the issuance of our 4^th series of debentures in the amount of R$600 million that we used to repay the remaining balance of R$378 million from our 3^rd series of debentures. These proceeds were partially offset by the prepayment of working capital lines and other debt maturing within 3 years range, and by the decrease in the dividends paid during the period.  Net cash provided by financing activities totaled R$769.2 million in 2009, as compared to net cash used in financing activities of R$611.3 million in 2008, mainly due to receipt of net proceeds from a follow-on offering of common and preferred shares in the amount of R$600.3 million concluded in October 2009 and receipt of net proceeds from a rights offering in the amount of R$203.5 million concluded in the second quarter of 2009.

Liquidity

In managing our liquidity, we take into account our cash and cash equivalents and short-term investments as well as our accounts receivable balances.  Our accounts receivable balance is affected by the payment terms of our credit card receivables.  Our customers can purchase seats on our flights using a credit card and pay in installments, typically creating a one-or two-month lag between the time that we pay our suppliers and expenses and the time that we receive payment for our services.  When necessary, we obtain working capital loans, which can be secured by our receivables, to finance the sale-to-cash collection cycle.

We have a strong balance sheet, especially our cash and cash equivalents position which as of December 31, 2010 was equivalent to 28.3% of our trailing twelve months’ net operating revenues and already surpasses our initial target of to at least 25% of trailing twelve months’ net operating revenues. This position also covers 5.7 times our short-term obligations, which we believe currently is an appropriate level of liquidity.  We are also committed to have no significant financial debt maturities coming due within any three-year horizon.

The following table sets forth certain key liquidity data in IFRS at the dates indicated:

At December 31, 2010, cash, short-term investments and restricted cash were R$2,013.0 million, comprised by R$1.955,9 in cash and cash equivalents balance, R$22.6 million in short-term investments representing immediate liquid financial assets and R$34.5 million in restricted cash.  The increase in total liquidity as compared to 2009 is mostly due to operating cash flow generation and the several measures in 2010 towards increasing our liquidity such as (i) our 4th debenture issuance in the amount of R$600 million, which were used to finance working capital, pay suppliers and settle the outstanding balance of our 3rd debenture issue in the amount of R$378 million; and (ii) the R$525.5 million senior notes issue (equivalent to US$300 million on the date of issuance) in July 2010, which proceeds were used to settle the working capital credit lines and other debt maturing within 3-years range.

Short-term receivables include credit card sales, the Voe Fácil installment payment program, accounts receivables from travel agencies and cargo transportation.  At the end of 2010, we had decreased the volume of short-term receivables as compared to 2009, due to increase in the volume of discounted receivables.

At December 31, 2010, we had R$308.5 million deposited with Boeing as advances for aircraft acquisitions, a decrease of 39.1% as compared to December 31, 2009, mainly due to the higher number of aircraft delivered in 2010 with the deposit returned to us and the lower number of new aircraft deliveries scheduled to be delivered from Boeing under our fleet plan in the next 18 months as compared to the same period in 2009.

As a result, our total cash deposits was R$2,605.2 million at December 31, 2010 as compared to R$2,765.5 million at December 31, 2009.

Indebtedness

The following table sets forth our loans and financings at December 31, 2010 and 2009: