Annual and Transition Report (foreign Private Issuer) (20-f)

ITEM 3.        Key Information

A.       Selected Financial Data

We present in this section the following summary financial data:

·          Summary financial information derived from our audited consolidated financial statements included herein as of December 31, 2016 and 2015 and for the years ended December 31, 2016, 2015 and 2014; and

·          Summary financial information derived from our audited consolidated financial statements not included herein as of and for the years ended December 31, 2013 and 2012.

The following tables present summary historical consolidated financial and operating data for us for each of the periods indicated.

(1)   Translated for convenience using the U.S. dollar exchange rate as reported by the Central Bank of R$3.2591 to US$1.00 as of December 31, 2016.

(2)   Adjusted to reflect the one to 35 stock split of our common shares on March 23, 2015 and that since that date our preferred shares are entitled to receive dividends per share in an amount 35 times the amount of dividends per share paid to holders of our common shares in order to account for the split of our common shares. Our preferred shares are not entitled to any fixed dividend preferences. See “Item 9. The Offer and Listing–C. Markets–Corporate Governance Practices” for further details.

(3)   Common shares multiplied by 35 to calculate earnings (loss) per share and divided by 35 to calculate weighted average number of shares, to reflect the ratio of 35 common shares for each preferred share. This is not a measure of financial performance recognized under Brazilian GAAP or IFRS, nor should it be considered as alternatives to numbers calculated per preferred share and per common share. We believe that calculations per share provide useful information as it equalizes the common share economic rights and number of shares to those of our preferred shares.

(4)   Adjusted to reflect the ratio of our ADSs to preferred shares of one ADS to five preferred shares. See “Item 12. Description of Securities other than Equity Securities–A. American Depositary Shares.”

(5)   We calculate EBITDA as net income (loss) plus financial income (expense), net, income taxes and depreciation and amortization.  EBITDA is not a measure of financial performance recognized under Brazilian GAAP or IFRS, nor should it be considered as alternatives to net income (loss) as measures of operating performance, or as alternatives to operating cash flows, or as measures of liquidity. EBITDA is not calculated using a standard methodology and may not be comparable to the definition of EBITDA or similarly titled measures used by other companies. As financial income (expenses) net, income taxes, and depreciation and amortization are not considered for calculation of EBITDA, we believe that our EBITDA provides an indication of our general economic performance, without giving effect to interest rate or exchange rate fluctuations, changes in income and social contribution tax rates, or depreciation and amortization.

(6)   EBITDA divided by net revenue.

(7)   Operating margin represents operating income (loss) before financial results and income taxes divided by operating revenue.

(8)   Total liquidity is the sum of cash and cash equivalents, restricted cash, short-term investments and trade receivables.

(9)   Source: National Civil Aviation Agency ( Agência Nacional de Aviação Civil ), or ANAC.

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

(1)   Translated for convenience using the U.S. dollar exchange rate as reported by the Central Bank of R$3.2591 to US$1.00 as of December 31, 2016.

(2)   We calculate EBITDA as net income (loss) plus financial income (expense), net, income taxes and depreciation and amortization. EBITDAR is calculated as net income (loss) plus financial income (expenses) net, income taxes, depreciation and amortization and aircraft rent expenses. EBITDA and EBITDAR are not measures of financial performance recognized under Brazilian GAAP or IFRS, nor should they be considered as alternatives to net income (loss) as measures of operating performance, or as alternatives to operating cash flows, or as measures of liquidity. EBITDA and EBITDAR are not calculated using a standard methodology and may not be comparable to the definition of EBITDA or EBITDAR or similarly titled measures used by other companies. As financial income (expenses) net, income taxes, and depreciation and amortization are not considered for calculation of EBITDA and EBITDAR, we believe that our EBITDA and EBITDAR provides an indication of our general economic performance, without giving effect to interest rate or exchange rate fluctuations, changes in income and social contribution tax rates, or depreciation and amortization. In addition, we believe EBITDAR provides a better understanding of our operating performance as it excludes aircraft rent expenses. We usually present EBITDAR because aircraft leasing represents a significant operating expense of our business, and we believe the impact of this expense should be considered in addition to the impact of depreciation and amortization. A substantial amount of aircraft is leased, representing a material cost item. EBITDAR therefore indicates the capacity to cover such costs, as well as facilitating comparisons with other companies in the sector.

Exchange Rates

Brazil’s foreign exchange system allows the purchase and sale of currency and the international transfer of reais by any person or legal entity, regardless of 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.

The Central Bank has intervened occasionally to combat 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 following tables present the selling rate, expressed in reais to the 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

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 us and the trading price of our ADSs, our preferred shares and our debt instruments.

The Brazilian federal government has frequently intervened in the Brazilian economy and occasionally has made drastic changes in policy and regulations. The Brazilian federal government’s actions to control inflation and affect other policies and regulations have involved, among other measures, increases in interest rates, changes in tax and social security policies, price controls, currency exchange and remittance controls, devaluations, capital controls and limits on imports. Our business, financial condition, results of operations and the trading price of the preferred shares and the ADSs may be adversely affected by changes in policy or regulations at the federal, state or municipal level involving or affecting factors such as:

·          interest rates;

·          currency fluctuations;

·          monetary policies;

·          inflation;

·          liquidity of capital and lending markets;

·          tax and social security policies;

·          labor regulations;

·          energy and water shortages and rationing; and

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

Uncertainty over whether the Brazilian federal government will implement changes in policy or regulation affecting these or other factors may contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets and securities issued abroad by Brazilian companies. These and other developments in the Brazilian economy and governmental policies may adversely affect us and our business and results of operations and may adversely affect the trading price of our preferred shares and ADSs.

Since 2011, Brazil’s economy has stagnated. The Gross Domestic Product, or GDP, contraction rates were (3.6)% in 2016 and (3.8)% in 2015, and GDP growth was 0.1% in 2014, 2.7% in 2013, 1.8% in 2012 and 3.9% in 2011, compared to a GDP growth of 7.5% in 2010. The Brazilian government projects the Brazilian GDP will grow by 0.5% in 2017.

Our results of operations and financial condition have been, and will continue to be, affected by the weakness of the Brazilian GDP. Developments in the Brazilian economy may affect Brazil’s growth rates and, consequently, the use of our products and services.

Political instability may adversely affect our business and results of operations and the price of our preferred shares and our debt instruments.

Brazilian markets have been experiencing heightened volatility due to the uncertainties derived from the ongoing Lava Jato investigation, which is being conducted by the Federal Prosecutors’ Office, and its impact on the Brazilian economy and political environment. Numerous members of the Brazilian government and of the legislative branch, as well as senior officers of large state-owned and private companies have been convicted of political corruption of officials accepting bribes by means of kickbacks on contracts granted by the government to several infrastructure, oil and gas and construction companies. Profits from these kickbacks financed the political campaigns of political parties that were unaccounted for or not publicly disclosed, and served to further the personal enrichment of the recipients of the bribery scheme. As a result, a number of senior politicians, including congressmen and officers of the major state-owned and private companies in Brazil, resigned or have been arrested.

The ultimate outcome of these investigations is uncertain, but they have already had an adverse impact on the image and reputation of the implicated companies, and on the general market perception of the Brazilian economy. The development of those unethical conduct cases has and may continue to adversely affect our business, financial condition and results of operations and the trading price of our preferred shares and ADSs .

In addition, the Brazilian economy continues to be subject to the effects of the impeachment of President Dilma Rousseff on August 31, 2016. Vice-President Michel Temer was sworn in as the new President of Brazil until the next presidential election in 2018, but political uncertainty has remained. We cannot predict the effects of these recent developments and the current ongoing political uncertainties on the Brazilian economy.

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

The market value of securities of Brazilian issuers is affected by economic and market conditions in other countries. Although economic conditions in those countries may differ significantly from economic conditions in Brazil, investors’ 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 our securities, and could also make it more difficult for us to gain access to the capital markets and finance our operations on acceptable terms, or at all.

Recently, the Brazilian market experienced heightened volatility due to, among other factors, uncertainty as to the implication of U.S. elections, U.S. monetary policy and Great Britain’s exit from the European Union, increased aversion to risk in emerging countries, and uncertainties regarding macroeconomic and political conditions.

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

Historically, Brazil has experienced high inflation rates. Inflation and certain actions taken by the Central Bank to curb it have had significant negative effects on the Brazilian economy. After the implementation of the Plano Real in 1994, the annual rate of inflation in Brazil decreased significantly, as measured by the National Broad Consumer Price Index ( Índice Nacional de Preços ao Consumidor Amplo ), or IPCA. Inflation measured by the IPCA index was 6.4%, 10.7% and 6.3 % in 2014, 2015 and 2016, respectively and the tendency is decreasing inflation for 2017.

Between 2004 and 2010, the base interest rate for the Brazilian banking system, varied between 19.8% and 8.6%. This rate is the Central Bank’s Special System for Settlement and Custody ( Sistema Especial de Liquidação e Custódia ) rate, or SELIC rate. On December 31, 2014, 2015 and 2016, the SELIC rate was 11.75%, 14.25% and 13.65 %, respectively.

Inflation and the Brazilian government’s measures to fight it, principally the Central Bank monetary policy, have had and may have significant effects on the Brazilian economy and us. Tight monetary policies with high interest rates have restricted and may restrict Brazil’s growth and the availability of credit. Conversely, more lenient government and Central Bank policies and interest rate decreases have triggered and may trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect us and increase our indebtedness. In addition, we may not be able to adjust the fares we charge our customers to offset the effects of inflation on our cost structure.

Any further downgrading of Brazil’s credit rating could adversely affect the trading price of our preferred shares, ADSs and notes.

Credit ratings affect investors’ perceptions of risk and, as a result, the yields required on debt issuances in the financial markets. Rating agencies regularly evaluate Brazil and its sovereign ratings, taking into account a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness and the prospect of change in these factors.

In September 2015, Standard & Poor’s lowered Brazil’s sovereign credit rating to below investment grade, from BBB-minus to BB-plus, citing, among other reasons, general instability in the Brazilian market caused by the Brazilian government’s interference in the economy and budgetary difficulties. Standard & Poor’s again downgraded Brazil’s credit rating in February 2016, from BB-plus to BB, and maintained its negative outlook on the rating, citing a worsening credit situation from the time of the September 2015 downgrade. In December 2015, Moody’s placed Brazil’s Baa3 ratings on review for a downgrade, citing negative macroeconomic trends and a deterioration of the government’s fiscal conditions. Subsequently, in February 2016, Moody’s downgraded Brazil’s ratings to below investment grade, to Ba2 with a negative outlook, citing the prospect for further deterioration in Brazil’s debt service in a negative or low growth environment, in addition to challenging political dynamics. Rating agency Fitch also downgraded Brazil’s credit rating to BB-plus with a negative outlook, citing the country’s rapidly expanding budget deficit and the worse-than-expected recession. As a result, the trading prices of debt and equity securities of Brazilian issuers were negatively affected. Continuation of the current Brazilian recession could lead to further ratings downgrades.

Any further downgrade of Brazil’s credit ratings could heighten investors’ perception of risk and, as a result, increase the cost of debt issuance and adversely affect the trading price of our securities.

Risks Relating to Us and the Brazilian Airline Industry

Exchange rate instability may materially and adversely affect us and the market price of the ADSs, our preferred shares and our debt instruments.

The Brazilian currency has, during the last decades, experienced frequent and substantial variations in relation to the U.S. dollar and other foreign currencies. For example, the real was valued at R$1.67 per US$1.00 in August 2008. Following the onset of the crisis in the global financial markets, the real depreciated 31.9% against the U.S. dollar and reached R$2.34 per US$1.00 at the end of 2008. In 2010, the real appreciated against the U.S. dollar, reaching R$1.661 per US$1.00 at the end of 2010. Since 2011, the real depreciated against the U.S. dollar, reaching R$3.905 per US$1.00 at the end of 2015 with a 47.0% devaluation in 2015. In 2016, the real appreciated against the U.S. dollar, reaching R$3.2591 per US$1. 00 at December 31, 2016. There can be no assurance that the real will not depreciate further against the U.S. dollar.

Nearly 88.7% of our passenger revenue and other revenue 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. For the year ended December 31, 2016, 47.2% of our operating expenses were either denominated in or linked to the U.S. dollar. The purchase price of Boeing 737 aircraft is denominated in U.S. dollars. At December 31, 2016, R$5,314.4 million (or 83.3%) of our indebtedness was denominated in U.S. dollars and we had a total of R$6,246.7 million in non-cancelable U.S. dollar-denominated future operating lease payments.

We are also required to maintain U.S. dollar-denominated deposits and maintenance reserve deposits under the terms of some of our aircraft operating leases. We may incur substantial additional amounts of U.S. dollar-denominated operating leases or financial obligations and U.S. dollar-denominated indebtedness and be subject to fuel cost increases linked to the U.S. dollar. 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 short-term effects of such developments, there can be no assurance we will be able to continue to do so. In addition, there is no economically viable hedging alternative for medium- and long-term depreciation of the real .

Depreciation of the real against the U.S. dollar creates inflationary pressures in Brazil and causes increases in interest rates, which negatively affects the growth of the Brazilian economy as a whole, curtails access to foreign financial markets and may prompt government intervention, including recessionary governmental policies. Depreciation of the real against the U.S. dollar has also, as in the context of an economic slowdown, led 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 us.

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.

We may not be able to maintain adequate liquidity and our cash flows from operations and financings may not be sufficient to meet our current obligations.

Our liquidity, cash flows from operations and financings have been and may be negatively affected by the exchange rate environment, fuel prices and economic conditions in Brazil on the demand for air travel. Recent cost cutting measures, such as capacity reduction and the liquidity improving measures we adopted in 2016 (see “Item, 4. Information on the Company–A. History and Development of the Company–Our Fleet Reduction and Network Redesign” and “–Improvement of our Capital Structure” ), may not be sufficient to offset these effects.

Certain of our debt agreements contain covenants that require the maintenance of specified financial ratios. Our ability to meet these financial ratios and other restrictive covenants may be affected by events beyond our control and we cannot assure that we will meet those ratios. Failure to comply with any of these covenants could result in an event of default under these agreements and others, as a result of cross default provisions. If we were unable to comply with our debt covenants, we would be forced to seek waivers. We cannot guarantee that we will be successful in meeting our covenants, and if we are unable to meet our covenants, in obtaining or renewing any waivers.

As a result of significant losses from 2011 to 2015, our financial condition, and, consequently, our ability to obtain debt and equity financing has been materially weakened.

Significant losses have materially and negatively affected our financial condition. We had net losses of R$751.5 million in 2011, R$1,513 million in 2012, R$724.6 million in 2013, R$1,117.3 million in 2014, R$4,291.2 million in 2015 and a net income of R$1,102.4 million in 2016 . The historical losses were principally due to factors we do not control, such as the effect of fluctuations in foreign exchange rates, which affects a significant part of our operating expenses and our debt service, as well as volatility in international fuel prices. Despite the net income in 2016, we had a negative equity of R$3,356.8 million as of December 31, 2016 , compared to R$4,322.4 million as of December 31, 2015.

Our indebtedness and our overall leverage during this period increased significantly, mainly due to the strong depreciation of the real against the U.S. dollar between 2012 and early 2016, while our reduced operating cash flow generation and EBITDAR in the period reduced our debt service coverage ratios and liquidity, resulting in decreases in our credit ratings. From the end of 2012 to 2016, Fitch Ratings, Moody’s and S&P lowered our credit ratings from B, B3 and B, to CC, Caa3 and CCC-, respectively. In March 2017, Fitch Ratings upgraded our Long-Term Foreign and Local Currency Issuer Default Ratings (IDH) to CCC. Credit ratings affect the cost and other terms upon which we are able to obtain funding. Credit rating agencies regularly evaluate us and their ratings of our long-term debt are based on a number of factors, including our financial strength and capacity to generate cash flows and service our financial commitments.

Our current credit ratings, negative shareholders’ equity and leverage ratio have materially reduced our ability to obtain debt and equity financing, which could make us more vulnerable to unexpected events or to the deterioration of the operating environment.

The airline industry is particularly sensitive to changes in economic conditions and continued negative economic conditions would likely continue to adversely affect us and our ability to obtain financing on acceptable terms.

Our operations and the airline industry in general are particularly sensitive to changes in economic conditions. Unfavorable economic conditions in Brazil, a constrained credit market and increased business operating costs have reduced spending on both leisure and business travel as well as cargo transportation. The slowdown in Brazilian economy and political instability has adversely affected industries with significant spending in travel, including government, oil and gas, mining and construction. In addition, reduced spending on business travel also affects the quality of demand, reducing the number of higher yield tickets we can sell, which negatively affected our results of operations in 2015 and 2016. Unfavorable economic conditions can also affect our ability to raise fares to counteract increased fuel, labor and other costs. Any of these factors may negatively affect us.

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 debt 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.

Substantial fluctuations in fuel costs would harm us.

Historically, international and local fuel prices have been subject to wide price fluctuations based on geopolitical issues and supply and demand. 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, which at times in 2007 and 2008 was at historically high levels, affects our fuel costs, and constitutes a significant portion of our total operating expenses. In 2014, the average price per barrel of West Texas Intermediate crude oil was US$93.04 and fuel costs represented 40 % of our operating expenses. Prices have decreased since 2015 and fuel costs represented 33% and 29% of our operating expenses for the years ended December 31, 2015 and 2016, respectively. The high volatility in prices led to fuel hedge losses, principally in 2015, while the recent appreciation of the real against the U.S. dollar has positively affected our fuel costs in reais . 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 availability of fuel cannot be predicted with any degree of certainty. Our hedging activities and fares adjustments may not be sufficient to protect us fully from fuel price increases.

Substantially all of our fuel is supplied by one source, Petrobras Distribuidora S.A., or Petrobras Distribuidora. If Petrobras Distribuidora is unable or unwilling to continue to supply fuel at the times and in the quantities that we require we may not be able to find a suitable replacement or to purchase fuel at the same cost, in which case we would be adversely affected. See “Item 4. Information on the Company–B. Business Overview–Airline Business–Fuel.”

Changes to the Brazilian civil aviation regulatory framework, including rules regarding slot distribution, fare restrictions and fees associated with civil aviation, may adversely affect us.

Brazilian aviation authorities monitor and influence the developments in Brazil’s airline market. For example, airport services are regulated by the National Civil Aviation Agency (Agência Nacional de Aviação Civil) , or ANAC, and in many cases still managed by by the Brazilian Airport Infrastructure Company ( Empresa Brasileira de Infraestrutura Aeroportuária ), or INFRAERO, a government-owned corporation. ANAC addressed overcapacity in the system in 2014 by establishing strict criteria that must be met before new routes or additional flight frequencies are awarded. ANAC policies as well as those of other aviation supervisory authorities have in the past negatively affected our operations and these effects may reoccur. In July 2014, ANAC published new rules governing the allocation of slots in coordinated/slotted airports, such as Congonhas and Guarulhos in São Paulo and Brasilia in Distrito Federal, which consider operational efficiency (on-time performance and regularity) as the main criteria for the allocation of slots. Under these rules on-time performance and regularity are assessed twice per year, following the IATA summer and winter calendars, between April and September and between October and March. Minimum on-time performance and regularity targets for each series of slots in a season are 80% and 90%, respectively, at Congonhas airport (São Paulo) and 75% and 80%, respectively, for all other main airports. Airlines forfeit slots used below the minimum criteria in a season. Forfeited slots are redistributed 50% to new entrants, which includes airlines that operate fewer than five slots in the affected airport in the given weekday, and 50% to all airlines operating in that airport based on their share of slots. These and other changes to the Brazilian civil aviation regulatory framework could increase our costs and change the competitive dynamics of our industry and may adversely affect our operations, see “−We operate in a highly competitive industry.”

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 us.

We are dependent on improvements in the coordination and development of Brazilian airspace control and airport infrastructure, which, mainly due to the large growth in civil aviation in Brazil in recent years, require substantial improvements and government investments.

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 us.

Slots at Congonhas airport in São Paulo, the most important airport for our operations and busiest one in Brazil, 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 also 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 (by expanding additional or developing new airports) to permit our growth.

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. As of December 31, 2016, we had commitments of R$48,032.4 million (US$14,737.9 million as of December 31, 2016) to purchase additional 120 Boeing aircraft through 2028, based on aircraft list prices, although the actual price payable by us for the aircraft should be lower due to supplier discounts. 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.

These 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 flows from our operations to service our fixed obligations under aircraft operating leases and aircraft purchase commitments;

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

·          could limit our ability to react to changes in our business, the airline industry and general economic conditions.

Our ability to make scheduled payments on our fixed obligations 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 limited by competition and regulatory factors.

We operate in a highly competitive industry.

We face intense competition on all routes we operate from existing scheduled airlines, charter airlines and potential new entrants in our market. Competition from other airlines has a relatively greater impact on us when compared to our competitors because we have a greater proportion of flights connecting Brazil’s busiest airports, where competition is more intense. In contrast, some of our competitors have a greater percentage of flights connecting less busy airports, where there is no or only reduced competition.

The Brazilian airline industry also faces competition from ground transportation alternatives, such as interstate buses. In addition, the Brazilian government and regulators could give preference to new entrants and existing competitors when granting new and current slots in Brazilian airports, to promote competition.

Existing and potential new competitors have in the past and may again undercut our fares or increase capacity on their routes in an effort to increase their market share of business traffic (high value-added customers). In any such event, we cannot assure you that our level of fares or passenger traffic would not be adversely affected.

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

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. We may not be able to successfully integrate the business and operations of companies acquired, governmental approvals may be delayed, costs of integration and fleet renovation may be greater than anticipated, synergies may not meet our expectations, our costs may increase and our operational efficiency may be reduced, all of which would negatively affect us.

Under Brazilian law, the foreign ownership limit for Brazilian airlines is 20%, but there have been repeated discussions by the Brazilian government and Congress to lift this restriction fully or partially, including most recently an announcement that the government intends to issue a new measure, subject to Congress approval, completely removing the foreign ownership limit. We cannot foresee if and how these restrictions may be changed and how any such change would affect us and the competitive environment in Brazil.

Consolidation in the airline industry and changes in international alliances will continue to affect the competitive landscape in the industry and may result in the formation of airlines and alliances with greater financial resources, more extensive global networks and lower cost structures than we can obtain.

We rely on one manufacturer for our aircraft and engines.

One of the key elements of our business strategy and a key element of the low-cost carrier business model is to reduce 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 for the foreseeable future and have made a purchase order for 120 Boeing 737 Max-7/8 aircraft (the newest generation of our current aircraft and still under development), to be delivered starting in 2018. If either Boeing or CFM International were unable to perform its contractual obligations, our operations would be materially affected.

We derive benefits from a fleet comprised of a single type of aircraft while still having the flexibility to match the capacity and range of the aircraft to the demands of each route. If we had to lease or purchase aircraft of another manufacturer, we could lose these benefits. We cannot assure you that any such replacement aircraft would have the same operating advantages as the Boeing aircraft or that we could lease or purchase engines that would be as reliable and efficient as the CFM engines. 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.

In 2012, Boeing and CFM released new aircraft and engines, the Boeing 737 Max-7/8 and LEAP-1B, to replace the Boeing 737-700/800 Next Generation. Any project delays or operational difficulties with this new aircraft and engines could create an adverse perception about our fleet, therefore adversely affecting us.

In addition, when these aircraft and engines are delivered and operational, it could cause the market value of our other aircraft and engines to decrease, which would lower the value of our assets and could result in us recording impairment charges.

We rely on complex systems and technology, and operational or security inadequacy or interruption could materially affect our ability to effectively operate our business.

In the ordinary course of business, our systems and technology will continue to require modification and refinements to address growth and changing business requirements. Modifications and refinements to our systems have been and are expected to continue to be expensive to implement and may divert management’s attention from other matters. In addition, our operations could be adversely affected, or we could face imposition of regulatory penalties, if we were unable to timely or effectively modify its systems as necessary.

We have occasionally experienced system interruptions and delays that make our websites and services unavailable or slow to respond, which could prevent us from efficiently processing customer transactions or providing services. This in turn could reduce our operating revenues and the attractiveness of our services. Our computer and communications systems and operations could be damaged or interrupted by catastrophic events such as fires, floods, earthquakes, tornadoes and hurricanes, power loss, computer and telecommunications failures, acts of war or terrorism, computer viruses, security breaches, and similar events or disruptions. Any of these events could cause system interruptions, delays, and loss of critical data, and could prevent us from processing customer transactions or providing services, which could make our business and services less attractive and subject us to liability. Any of these events could damage our reputation and be expensive to remedy.

We rely on maintaining a high daily aircraft utilization rate to increase our revenues and reduce our costs.

One of the key elements of our business strategy and an important element of the low-cost carrier business model 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.

Our reputation, operations and financial results 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 us. Moreover, any 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 us.

In addition, we can be negatively affected by other factors, such as unpredictable economic conditions, fuel costs or the outbreak of diseases.

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. After the amendments to our by-laws on March 23, 2015, our controlling shareholder may continue to direct our business and affairs even after significantly reducing its ownership interest, which is currently equivalent to 61.3% of the economic interests in us. A difference in economic exposure may intensify conflicts of interests between our controlling shareholder and you. See “Item 9. The Offer and Listing–C. Markets–Corporate Governance Practices.”

Risks Relating to the ADSs and Our Preferred Shares

The relative volatility and illiquidity of the Brazilian securities markets, and securities issued by airlines in particular, may substantially limit your ability to sell the preferred shares underlying the ADSs at the price and time you desire. Recent decreases in our market capitalization have increased volatility in the trading price of our preferred shares and ADSs.

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 54.9% of the aggregate market capitalization of the BM&FBOVESPA S.A. Bolsa de Valores, Mercadorias & Futuros, or BM&FBOVESPA, as of December 31, 2016.

In recent years our market capitalization has decreased and as a result it has increased volatility in the trading price of our preferred shares and ADSs. Any decreases in our market capitalization may further increase volatility. As a result of the decrease in the trading price of our preferred shares and ADSs in 2015 and early 2016, we increased our ratio of preferred shares per ADS to 10:1 in February 2016. Effective April 28, 2017, we reduced the ratio of preferred shares per ADS to 5:1.

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.

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 25.0% of our annual net income as dividends, as determined and adjusted under Brazilian corporation law. The adjusted net 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 will incur expenses and may 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.

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 depositary bank 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.

Mr. Oliveira is a member of our controlling shareholder group, served as our CEO from our inception to 2012 and currently serves as the chairman of Gol and Smiles. Mr. Oliveira was instrumental in structuring and completing all of the strategic events we have consummated since inception, including: AIG’s private equity investment in Gol, Gol’s simultaneous dual-listing IPO on the NYSE and BOVESPA in 2004 (after only three years of operation), Gol’s acquisitions of VRG and Webjet and the IPO of Gol’s subsidiary Smiles. In addition, Mr. Oliveira orchestrated the strategic investment in Gol by Delta, the world’s largest airline. Paulo Kakinoff took over as our CEO in 2012, and under his leadership we have become the number one airline in Brazil and the market leader in punctuality and air travel customer experience in the country. Gol is the only major Brazilian commercial airline that is majority owned by Brazilians.

Brazil is the fourth largest domestic airline market in the world, and the IATA estimates that the market will continue to grow 5.4% per year in the next two decades. In addition, the Brazilian aviation market has significant untapped potential as flights per capita totaled 0.5 per year, significantly below that of the more established markets such as Australia (2.4) or the United States (2.1). From Gol’s launch in 2001 to the economic slowdown that began in 2011, Brazil’s domestic passenger market grew 2.7 times, from 30.8 million passengers per year to 82.0 million passengers per year. At the same time, our market share in the domestic air transportation market increased from 4.6% in 2001 to 37% in 2011. We refer to this growth of the air transportation market and our increase in market share in this increased market as the “Gol effect.”

We are the fourth largest low cost carrier in the world after Southwest, Ryanair and EasyJet in terms of revenues. We believe a key component of our competitive advantage and identity as a low cost carrier is our operation of a single Boeing aircraft type, the Boeing 737-700/800, the most reliable aircraft in its class according to Boeing, which allows us to maximize aircraft utilization and dilute our fixed costs. As of December 31, 2016, we used our operating fleet of 121 aircraft to offer approximately 700 daily flights to 63 destinations connecting the most important cities in Brazil as well as key destinations in South America and the Caribbean.

Our operating model is based on a highly integrated route network that is a combination of the point-to-point, hub and spoke and multiple-stop models. We believe the use of this hybrid model increases the reach of our network while maintaining a low-cost structure and improving aircraft and crew scheduling efficiency. The high level of integration of flights at selected airports allows us to offer frequent, non-stop flights at competitive fares between Brazil’s most important cities. 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. Finally, our operating model allows us to build our flight routes to add destinations to cities that would not, individually, be feasible to serve in the traditional point-to-point model, but that can be served when simply added as additional points on our multiple-stop flight. We offer flights to 120 worldwide destinations through our strategic partnerships with our minority shareholders Delta and Air France-KLM, as well as various code share agreements with other leading airlines globally.

We are the leader in air transportation of business and leisure passengers. Business passengers are particularly attractive as they are less price sensitive, purchase tickets closer to the flight date at higher fares and often purchase other ancillary products. Our low-cost carrier business model permits effective segmentation, allowing us to attract a high share of the demand inelastic but price sensitive Brazilian business passengers as well as providing attractive fares to demand elastic and very price sensitive leisure travelers. According to the Brazilian Association of Corporate Travel ( Associação Brasileira de Agências de Viagens Corporativas ), or ABRACORP, we had a 32.3% share of business travelers in 2016. In 2016, passenger transportation revenues represented 88% and ancillary revenues represented 12% of our net revenue of R$9,867.3 million.

Our Competitive Strengths

We have the Leading Market Position in Brazil. Gol has the leading position in Brazil’s primary cities, and our route network closely mirrors the country’s GDP income distribution. Several Brazilian airports have limited their number of slots due to capacity limitations, especially the busiest airports in the country (Congonhas and Guarulhos in São Paulo and Santos Dumont in Rio de Janeiro). The strong demand for routes between these airports, combined with the seat capacity of our Boeing 737 aircraft, results in our leading domestic market share in terms of RPK.  Routes between these airports are among the most profitable routes in our markets, with high yields mostly from business travelers.  Our leading position in Brazil’s main airports permits us to add connections to additional destinations with attractive demand characteristics. The following table demonstrates our leading market share in the economically most important states and our share in terms of number of flights and domestic passengers at the busiest airports in Brazil:

1. According to ANAC information for 2016 for departures and arrivals.

2. According to the Brazilian Institute of Geography and Statistics ( Instituto Brasileiro de Geografia e Estatística ), or IBGE.

3. Gol share in total number of domestic and international flights.

We have the Leading Customer Experience and Satisfaction. We believe Gol provides the best overall experience to its customers, provided by the best on-time performance, best customer services, largest pitch, on-board Wi-Fi and ancillary services. Our business model is based on innovation, best value-proposition and application of low-cost carrier best practices. Gol had the highest on-time performance rate in the Brazilian market in 2016 and recorded the second highest on-time performance rate among low cost carriers in the world, based on the Official Airline Guide (OAG). Our market-leading on-time performance is critical to maintain high customer satisfaction levels. In 2016, we received the award for “Best customer service” in the Brazilian airline industry by Exame Magazine and, in the fourth quarter of 2016, were the most efficient in baggage handling according to Brazilian government data. Gol provides the most legroom of any domestic airline in Brazil, of 34 inches. Most recently, in October 2016, we were the first airline in South America to offer Wi-Fi on board.

We have the Lowest Operating Costs in Brazil. Our operating expense per available seat kilometer (CASK), ex-fuel, for 2016 was R$13.97 cents, the lowest in Brazil, and one of the lowest worldwide (adjusted by stage length), even among global low-cost peers.

·          Operation of a young and standardized fleet. Operating a single aircraft type fleet is a crucial factor to operating the low-cost carrier business model.  A standardized fleet reduces inventory costs, as it requires fewer spare parts, eliminates the need to train our pilots to operate different aircraft types and also simplifies our maintenance and operations processes. At December 31, 2016, our operating fleet of 121 Boeing 737 aircraft was one of Latin America’s largest and youngest fleets, with an average age of 8.0 years. Advanced technology in our newer aircraft has reduced fuel consumption and helped improve our operating margins. The arrival of our Boeing 737 Max aircraft, which we expect will begin in the second half of 2018, will reduce our fuel consumption by up to 15% and increase flight autonomy up to 6,500 km. This will allow us to further enhance our connectivity and our ability to reach important destinations for Brazilian travelers, such as Bogota, Lima, Cancun, Mexico City, Miami, Orlando, Fort Lauderdale and Panama City.

·          Flexible operating model . Our fleet and network strategies allow us to adjust to market and competitive conditions. Our leading position in Brazil’s main airports permits us to add connections to additional destinations with attractive demand and, when circumstances require, reduce our fleet and adjust our network accordingly. A recent example of this flexibility, in response to weak economic conditions in Brazil in recent years, we significantly reduced our fleet, renegotiated 82 of our operating leases with our lessors and adjusted approximately 50% of our flight network to reduce costs and adjust our capacity to focus on the most profitable routes.

·          Highest levels of safety and state of the art maintenance. We perform a full range of aircraft maintenance services to ensure our fleet operates safely and in compliance with all local and international regulations. We are certified by the International Air Transport Association (IATA) with the highest safety standards. We carry out heavy maintenance on our Boeing 737 aircraft internally at our IOSA (IATA Operational Safety Audit) certified Aircraft Maintenance Center at the Confins international airport, in the State of Minas Gerais. In 2016, we received FAA 145 Repair Station Certification from the U.S. Federal Aviation Administration to perform C-checks at our maintenance center.

·          One of the largest e-commerce platforms in Brazil . We have a robust operating platform that features advanced technology. Our effective use of technology helps to keep our costs low and our operations highly scalable and efficient. Our distribution channels are streamlined and convenient, allowing our customers to interact with us online. In 2016, we booked 80% of our ticket sales through a combination of our website and Applications Programming Interface, or API.

·          Digital solutions for clients . We offer our clients numerous digital solutions, including electronic check-in and flight purchases and changes via app, that help our clients save time and reduces our costs. Our intensive use of technology and 100% ticketless travel simplify internal controls and procedures and provide us with real time sales and operating data, that enables an advanced yield management.

Our Loyalty Program, Smiles, is the Most Valuable Loyalty Program in Brazil, with More Than 12 Million Members . Our Smiles loyalty program is a strong relationship-building tool that represents a significant competitive advantage. The Smiles loyalty program has partnerships, 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, being one of the leading frequent flyer programs in South America, with strong participation rates and brand recognition by our customers. We acquired Smiles in 2007 when we acquired VRG. In 2013, we established Smiles S.A. as a separate subsidiary to create focus and innovation, with a dedicated team. In 2013, we launched an IPO of this subsidiary to unlock value for Gol and to create even greater focus, and, since then, Smiles has become the most valuable airline loyalty program in Brazil.

We have a Strong International Alliance Network. We have a strategic partnership with Delta Air Lines, Inc., or Delta, which holds 9.5% of our share capital, and who has become a strong operational and financial partner for us as a maintenance provider and a codeshare partner. We believe that this important partnership will also help us grow our international revenues further. In addition, our international alliance reach is wide, with partner airlines offering flights covering America, Europe, Africa and Asia. We have partnership programs with important international carriers, such as Air France KLM (which holds 1.2% of our share capital), as well as Aerolíneas Argentinas, AeroMexico, Air Canada, Alitalia, Copa Airlines, Emirates, Etihad Airways, Korean Air, Qatar Airways and TAP. As of December 31, 2016 our global network included 77 interlines agreements and 12 codeshare programs. These alliances allow us to serve 120 destinations throughout the globe through codeshare agreements, in line with our low-cost carrier business model of operating a single fleet type.

We have the Most Experienced Management Team . We have the most experienced and proven management team in Brazilian air passenger transportation:

·          Our chairman and controlling shareholder Constantino de Oliveira Junior has been with Gol for 16 years, 11 years as the CEO of Gol and five years as chairman of Gol and Smiles, and has led all strategic initiatives of Gol since its start-up in 2001.

·          Our chief executive officer, Paulo Kakinoff, has been with Gol for five years after serving as our board member. Since he became our CEO, he has led our company to become the number one airline in Brazil and the market leader in air travel customer experience in the country.

·          Our chief financial officer and investor relations officer, Richard Lark, has been with Gol for 14 years.  He was our CFO from 2003 to 2008 and served on our board of directors from 2008 to 2016.

·          Our chief operating officer, Sergio Quito, has been with Gol for 12 years. He manages airline flight operations (flight crews and the Airline Operations Center – AOC), maintenance, flight crews, airport operations, flight safety and quality and security, and is a Gol Boeing 737 captain, with more than 20,000 flight hours.

·          Our chief commercial officer, Eduardo Bernardes, has been with Gol for 16 years and manages sales and marketing.

·          Our chief planning officer, Celso Ferrer, has been with Gol for 14 years. He manages revenue generation as well as our network and fleet, and he is a Gol Boeing 737 co-pilot.

·          The chief executive officer of our subsidiary Smiles, has been with Smiles since its IPO in 2013. He has 30 years of experience in the finance industry, having held senior positions at Visa and Citibank’s credit card unit in Brazil.

All members of this senior management are Brazilian, and most of them have worked together through all phases of the history of our company for more than a decade, and are exclusively dedicated to development of the Brazilian air travel business. Their combined experience in the Brazilian air travel industry is unmatched, which we believe gives us a strategic competitive advantage. All of them are shareholders and participate in our stock option and restricted stock plans.

We have a Strong Brand . We believe that the Gol brand has become synonymous with innovation and value in airline industry. Gol and Smiles are well-recognized brands that stand for best value-proposition and consistent execution of industry best practices, as well as innovative marketing and advertisement techniques with low costs that focus on social media. Our customers identify us as being safe:  We are the only airline that operates a single type fleet of Boeing 737 aircraft, which is the most reliable aircraft in its class according to Boeing. Brand and product diversification from Gollog and Gol+Conforto products enhance our brand recognition across a diverse set of customers in various businesses and represent important customer satisfaction improvements for us.

Our Strategies

Our main strategies to increase our profitability and shareholder value are:

Capitalize on our Strong Market Position in Brazil and South America . We intend to increase penetration across all traveler segments by capitalizing on our competitive strengths. Since 2008, the number of domestic airline passengers carried in Brazil has increased by more than 70% to 88.7 million in 2016, according to ANAC. Despite its economic slowdown in the recent past, Brazil is currently the fourth largest airline passenger market worldwide and IATA estimates that it will grow 5.4% per year in the next two decades by 170 million for total market size of 272 million passengers. By 2034, according to IATA forecast, the five fastest-growing passenger markets, in terms of additional passengers per year, will be China (856 million new passengers), the United States (559 million), India (266 million), Indonesia (183 million) and Brazil (170 million).

We will focus on Brazilian operations and select South American and Caribbean destinations. We believe that the airline industry may experience further consolidation and therefore believe that strengthening our existing strategic partnerships will be a key factor to our success. In this environment we intend to play a leading role in the South American airline industry and to strengthen our position as a leading player. In Brazil, we also seek to stimulate demand in markets that are currently only served by high-fare alternatives, including Campinas (VCP) in São Paulo.

Our Boeing 737 aircraft gives us a significant strategic advantage, with its low operating cost and large seat capacity. It has allowed us to build a leading market position, since it increases the supply of low-cost seats in Brazil, serves the most relevant destinations in South America and allows us to add attractive markets for Brazilians to travel internationally.

Offer the Best Service and Value to our Customers. We intend to further increase our focus on customer satisfaction and loyalty by providing a combination of superior service and competitive fares. We believe that continuing our operational success as the most on-time airline in Brazil, operating the fleet with the most legroom in the country, on-board Wi-Fi, VIP lounges and offering convenient schedules to attractive destinations will be essential to achieving this goal. Gol is the first airline in Latin America to offer onboard Wi-Fi internet access via satellite during the flight period, including TV channels, program streaming with movies, cartoons, series and games, per-per-view content music and a flight map. All online and off-line content is conveniently and easily accessed through the passenger’s mobile device (cell phone, tablet or notebook). In 2016, we were the leader in tickets sold to business travelers on domestic flights based on data from the Brazilian Association of Corporate Travel Agencies ( Associação Brasileira de Viagens Corporativas) , or ABRACORP. In addition, we will continue to use our Smiles loyalty program to increase our customer satisfaction by offering additional benefits, such as higher mileage multipliers for premium fares, upgrades and access to our recently remodeled airport lounges. We intend to further leverage our friendly services and allow customers to perform more and more activities themselves, by implementing our digital strategy.

Improve Operating Efficiency . Reducing our operating expense per available seat kilometer (CASK) and managing capacity are key to improving our profitability. We aim to maintain our position as the lowest cost airline in Brazil. We intend to continue to focus on the most profitable routes and maintain our young and fuel-efficient fleet with high utilization rates. Our aircraft utilization rate was 11.2 block-hours per day in 2016 and 11.3 block hours in 2015. We seek to further reduce our CASK by reducing our turnaround times at airports and further increasing our aircraft utilization. We expect to further improve our operating efficiency by incorporating the Boeing 737 MAX aircraft in our fleet starting in the second half of 2018, which we expect will reduce our fuel consumption by up to 15%, in relation to the Boeing 737-800 NG. We will continue to utilize technological innovations wherever possible to reduce costs and improve operating efficiency. We will continue to manage our capacity by matching our supply growth with demand growth, and adjusting our flight network to maximize utilization and profitability.

Improve our balance sheet and capital structure. We continuously focus on strengthening our balance sheet and have significantly reduced our leverage and improved our balance sheet and capital structure since 2016. We intend to further reduce our leverage and strengthen our balance sheet by numerous measures, including strict discipline in our fleet planning, better cash position, further reduction in our operating costs and the extension of the average maturity profile of our debt.

Strengthen our Smiles Loyalty Program and Continue Growth . We intend to further strengthen the Smiles loyalty program by increasing engagement with members and adding non-air redemption options to our members through new products and additional partnerships. With our independent and dedicated management team at Smiles we intend to focus on innovative practices and products to continue the growth of this program. Since Gol’s acquisition of Smiles in 2007 and segregation into a distinct company in 2013, the program has consistently increased its margins and recorded the highest returns among airline loyalty programs in Brazil and has provided significant cash and liquidity to our business. We will pursue initiatives to provide more attractive benefits to Smiles members, enhance the Smiles brand and build loyalty and revenues. We will continue our market leadership in loyalty program activities.

Enhance our International and Strategic Partnerships . We consider our airline partnerships as a way to expand globally and internationally, as well as to increase feeder traffic. We intend to increase the international cities served by Gol flights and expect to continue evaluating strategic opportunities, including investments and acquisitions that allow us to improve our sustainable competitive advantage and improve our service to our customers, enhance our brands and build loyalty and revenues. In addition, we intend to establish partnerships and alliances with regional airlines through which we can serve lower density destinations in Brazil (which are currently only served by high fare airlines) by using those airlines’ smaller aircraft, in line with our low-cost carrier single fleet type business model.

Further Innovate, Develop and Increase our Ancillary Revenues. Our ancillary revenues have become an increasingly important factor in our business, amounting to R$36.66 per passenger in 2016, compared to R$30.74 in 2015. Our ancillary revenues are derived from Gollog services, ticket change and cancellation fees, excess baggage handling charges, premium seat ( Gol+Conforto ) sales and other services. We expect further growth in these businesses, which will provide us with additional revenue at low incremental cost by:

·          Further developing Gollog. Through Gollog , our cargo transportation service, we make efficient use of extra capacity in our aircraft by carrying cargo. In 2015, we opened a new cargo terminal at Congonhas airport. The new terminal is part of our strategy to expand Gollog’s service network, providing more efficiency and convenience to our customers.

·          Continuously innovating and introducing new products to the Brazilian customer. We have a strong track record of innovation and introduction of new business practices in Brazil. For example, we were the first airline to introduce buy on board services in Brazil, the sale of the new Gol+Conforto seats (which are available free of charge for Smiles Diamond and Delta Elite customers, and to customers for an additional fee, as part of our Gol+ product) and internet on board, charges for baggage, all of which we expect to be sources of our ancillary revenues.

In addition, we will continue to analyze opportunities to increase our sources of revenue and develop new forms of improving our operating efficiency, including in the areas of our Maintenance, Repair and Overhaul (MRO) business, aircraft leasing and technology development.

Our Fleet Reduction and Network Redesign

We have in recent years faced a challenging macroeconomic scenario, which has negatively affected our results, liquidity and capital structure. In 2016, we embarked on a series of initiatives to adjust our capacity and network to the existing market conditions:

·          Fleet reduction. In 2016, we reduced our operating fleet by 21 Boeing 737 aircraft, from 142 operational aircraft at the end of 2015 to 121 at the end of 2016, representing an average of 7.4 million seats, the most aggressive capacity reduction adopted by an airline in Brazil. The decrease in the number of aircraft was achieved by the return of aircraft under finance leases, sale of aircraft and sale of our rights to three aircraft deliveries from Boeing in 2016, which would have replaced outgoing fleet aircraft.  In our sale-leaseback transactions, we obtained low lease rates so as to maintain our operating costs (CASK) low.  In February 2017, we entered into a sale and leaseback agreements for five Boeing 737 MAX 8 aircraft, with total value of US$550.0 million, according to list prices.

·          Route network redesign . In 2016, we restructured approximately 50% of the flights in our route network to focus on more profitable routes and reduced the number of take-offs and seats by 17.2% and 16.9% respectively, and the number of ASKs by roughly 7%.

·          Supplier negotiations . Contractual obligations with key suppliers were adjusted to reduce costs and conform to the new network and fleet profiles. New 737 MAX aircraft deliveries were delayed until mid-2018.

·          Leasing contract negotiations . Commercial terms of more than 70% of GLA’s aircraft operating leases were renegotiated, including returning aircraft, deferring and reducing aircraft return cost obligations and reducing lease payments. These changes are expected to result in cost reductions in operating leases in excess of US$50 million in 2017.

·          Operating cost reductions . We implemented various operating cost-saving initiatives, including overhead reduction of 7.4%, introduction of part-time employees to offset reduced demand during low seasons and renegotiations with suppliers.

Improvement of our Capital Structure

In addition to our fleet rationalization and network redesign, we adjusted our capital structure and debt profile as follows:

·          Delta financing support . Working closely with Delta, in August 2015 we entered into an unsecured term loan of US$300 million, fully guaranteed by Delta. Being able to offer this guarantee allowed us to obtain this financing on amounts and on terms that most likely would not have been available to us otherwise. Our obligation to reimburse Delta if its guarantee is called upon is secured by a pledge to Delta of our shares in Smiles. The financing support was extended in 2016 and early 2017 to a backstop guarantee for up to US$32.0 million and maintenance obligations of US$50 million.

·          Advance ticket sales . On February 26, 2016, GLA entered into a miles and tickets purchase agreement with Smiles, totaling up to R$1.0 billion, providing for advance ticket sales to Smiles in various tranches through June 30, 2017. In 2016, Smiles disbursed a total of R$760 million and, on February 3, 2017, another R$120 million as part of this agreement. On April 5, 2017 GLA and Smiles amended this agreement to extend its termination until July 31, 2018 and increase the total amount by R$480 million.

·          Debt restructuring. US$175.7 million in senior unsecured bonds were exchanged for U$81.5 million in newly issued secured bonds with maturities in 2018, 2021 and 2028 with an extinguishment in the amount owed of US$101.7 million. The maturity of the outstanding R$1.0 billion in debentures was extended to 2018 and 2019.

As a result of the fleet rationalization, network redesign, improvements to our capital structure and an improved foreign exchange environment in 2016:

·          We reduced our costs, including contracted services and other operating costs, which, combined with improved yields, have resulted in higher operating margins and increased operating cash generation.

·          We decreased our total debt by R$2.9 billion, from R$9.3 billion at December 31, 2015 to R$6.4 billion at December 31, 2016. We significantly reduced our financing costs and achieved a total adjusted debt to EBITDAR ratio of 5.9x in 2016. In March 2017, Fitch Ratings upgraded our unsecured credit rating to CCC from CC.

·          We believe our capital structure and projected cash flow are appropriate to match our operating and financing obligations and generate value for our shareholders.

Corporate Information

Our principal executive offices are located at Brazil’s largest domestic airport, the Congonhas airport, at Praça Comandante Linneu Gomes, S/N, Portaria 3, Jardim Aeroporto, CEP: 04626-020, São Paulo, SP, Brazil and the telephone number of our investor relations department is +55 11 2128-4700. Our website is www.voegol.com.br and investor information may be found on our website under www.voegol.com.br/ir. Information contained on our website is not incorporated by reference herein, and is not to be considered a part of this annual report.

Capital Expenditures

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

B.       Business Overview

Airline Business

Routes and Schedules

Our operating model is based on a highly integrated route network that is a combination of the point-to-point, hub and spoke and multiple-stop models. This combination increases the connectivity of the network, permitting travelers to fly from a given point of origin to more destinations, while maintaining a low-cost structure and improving aircraft and crew scheduling efficiency. The high level of integration of flights at selected airports allows us to offer frequent, non-stop flights at competitive fares between Brazil’s most important cities. 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 onwards to their final destinations.

Our operating model allows us to build our flight routes to add destinations to cities that would not, be feasible to serve in the traditional point-to-point model individually, but that are feasible to serve when simply added as additional points on our multiple-stop flight. We focus on the Brazilian and South American markets and carefully evaluate opportunities for continued growth. We look to increase the frequency of our flights to existing high-demand markets and add new routes to the network that can be reached with our current Boeing 737 Next Generation (NG) aircraft (for example, destinations in the Caribbean). Once the new Boeing Max aircraft are delivered, our flight autonomy will increase, allowing us to add more and more distant international destinations, including Bogota, Lima, Cancun, Mexico City, Miami, Orlando, Fort Lauderdale and Panama City, which are popular destinations for Brazilians.

As a low-cost carrier, we operate a single fleet type, and use alliances and code-share arrangements with large international carriers (including Delta and Air France KLM) and regional carriers to serve destinations that cannot be cost effectively served by our Boeing 737 aircraft.

In 2016, we adjusted approximately 50% of our flight network in response to the economic conditions, focusing on the most profitable routes and increasing our yields. We currently operate approximately 700 daily flights to 63 destinations.

Despite the recent reduction in capacity, following the general trend in the domestic industry, we maintained our position as the leading company in number of passengers transported in Brazil, in 2016, with nearly 33 million passengers transported in the domestic market and a market share of 36%. The capacity reduction effort implemented by the company during the last twelve months is intended to generate PRASK recovery, and is expected to have a meaningful impact in the coming years.

Services

Passenger Transportation

We recognize that we must offer high-quality and consistent value-proposition services to our corporate and leisure customers. We pay particular attention to the details that help to make for a pleasant, complication-free flying experience, including:

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

·          high frequency of flights between Brazil’s most important airports;

·          low cancellation and high on-time performance rates of our flights;

·          self-check-in at kiosks at designated airports;

·          dedicated female lavatories;

·          friendly and efficient in-flight service;

·          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);

·          smartphone application for check-in, electronic boarding pass and Smiles account management;

·          more legroom and greater comfort ( GOL+Conforto in the domestic flights and GOL Premium Class in the international flights);

·          in-flight entertainment and Wi-Fi access;

·          premium lounges for business class and premium Smiles passengers in the Guarulhos and Galeão Airports; and

·          expansion of Smiles’ programs to the accumulation of miles on promotional tariffs.

In general, passenger demand and profitability reach peak levels during the January and July vacation periods and in the final two weeks of December, during the Christmas holiday season. Conversely, we often witness a decrease in load factor during the week in which annual carnival celebrations take place in Brazil. Given our high proportion of fixed costs, this seasonality is likely to cause our results of operations to vary from quarter to quarter.

Ancillary Revenues and Gollog Cargo Transportation

Ancillary revenues include revenues from our Gollog services as well as baggage excess and ticket change and cancellation fees. Buy on board for food and beverages and travel insurance fees are also becoming an increasingly important part of this revenue. Further development and growth of these services are a key part of our strategy to increase ancillary revenue. We are the leading airline in Brazil in ancillary revenues, with total ancillary revenues in 2016 of R$1,195.9 million.

We are constantly evaluating opportunities to generate additional ancillary revenue 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 are in the process of installing Wi-Fi on all our flights which will be an additional source of revenue. Recently, ANAC approved new rules to allow airlines to charge for checked bags. We announced in March 2017 our intention to create a new class of tickets that will not include checked bags, which would be paid separately. There is currently an injunction barring the new ANAC rule on checked baggage fees.

We make efficient use of extra capacity in our aircraft by carrying cargo, through Gollog . The Gollog system provides online access to air waybills and allows customers to track their shipment from any computer with Internet access. Our 63 destinations throughout Brazil, South America and the Caribbean provide access to multiple locations in each region. With our capacity of approximately 700 daily flights, operated by 121 Boeing 737-700/800 aircraft, we can ensure quick and reliable delivery.

Our express delivery products – Gollog VOO CERTO, Gollog EXPRESS, Gollog ECOMMERCE and Gollog DOC – were developed to meet the growing demand for door-to-door deliveries, fixed deadlines and additional optional services. We intend to increase our efforts in the express delivery services by further strengthening our logistics capability, mainly by expanding our ground distribution network and increasing our commercial efforts.

Aircraft Fleet

Our fleet is comprised entirely of Boeing 737 NG aircraft.

In 2016, we received one aircraft under operating leases, and revised our delivery schedule with Boeing so that we will not receive any new aircraft until mid-2018. In addition, we reduced our operating fleet by 21 aircraft in 2016 and sold three aircraft that had not yet been delivered . As a result, on December 31, 2016, we had a total fleet of 130 aircraft, of which seven were in redelivery process and two under sublease, resulting in an operational fleet of 121 aircraft.

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

(1)           Includes three Boeing 737-300 from our acquisition of Webjet which were returned in 2015.

(2)           At the end of each of 2014 and 2015 two aircraft were not operational, all in redelivery process, and at the end of 2016 nine aircraft were not operational, seven in redelivery process and two under sublease.

As of December 31, 2016, of our total of 130 aircraft, 96 were under operating leases and 34 were under finance leases.

As of December 31, 2016, our operating leases had an average remaining term of 72 months.

As of December 31, 2016, our finance leases had an average remaining term of 55 m onths and we had purchase options for 31 of the aircraft under finance 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.

The average age of our operating fleet of 121 Boeing 737-700/800 aircraft as of December 31, 2016, was 8.0 years. The average daily utilization rate of our fleet was 11.2 block hours in 2016 and 11.3 block hours in 2015.

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, provides a comfortable flying experience for our customers and has 13% lower CO2 emissions than other current aircraft models. We use a single type of aircraft to simplify our operations. We would only introduce a new type of aircraft to our fleet if, after careful consideration, we determine that such a step will reduce our operating costs. We expect that our fleet of Boeing 737 MAX 8 aircraft will be delivered starting in 2018.  We expect that the new Boeing 737 MAX 8 aircraft will:

·          reduce our fuel consumption by up to 15%, in relation to the Boeing 737-800 NG, and also consume less fuel than the A320neo aircraft;

·          be equipped with the latest technology and provide improved operational performance;

·          have an increased range and maximum take-off weight (MTOW) versus both the 737-800 NG and the A320neo;

·          deliver flight autonomy of up to 6,500 km (increased from 5,500 km) and MTOW up to 82 tons (increased from 70 tons);

·          have a significantly smaller noise footprint than today’s single-aisle airplanes; and

·          be equipped with Wi-Fi antennas that will allow our customers to access to the internet during flights and enjoy our on-board entertainment platform.

With our configuration, the Boeing 737 MAX 8 will permit us to add up to nine additional seats to its configuration while maintaining its current pitch that provides the most comfort to passengers in Brazil. 

We have an order of 120 Boeing 737 MAX aircraft through 2028 and are currently the main client of the 737 family in South America and one of the five largest in the world.

Fleet Plan

The following table sets forth our year-end projected operating fleet through 2021:

The fleet plan includes the arrival of new Boeing 737-MAX aircraft, which are expected in 2018. We will revise this fleet plan according to our expectations for the growth potential in the markets in which we operate.

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, Global Distribution Systems (GDS).

Our low-cost business model utilizes internet ticket sales as its main distribution channel, especially in the local market. For the year ended December 31, 2016, 80% of our passenger revenue, whether directly from the customer or through travel agents, were booked online, making us a global leader in this area.

In addition, our customers can purchase tickets indirectly through travel agents, which are a widely-used travel service resource in Brazil, South America, Europe, North America and other regions. For the year ended December 31, 2016, travel agents provided us with approximately distribution outlets in 42 different countries. GDS allows us access to a large number of tourism professionals who are able to sell our tickets to customers around the world and enables us to enter into interline agreements with other airlines to offer more flights and connection options to our passengers, which adds incremental international passenger traffic.

Partnerships and Alliances

General

Our strong market positioning enables us to successfully negotiate a number of partnerships with supplementary major carriers worldwide, mostly in the form of codeshare agreements and interline agreements. Additional passenger inflows generated by these strategic partnerships help improve revenues at low incremental costs.

As of December 31, 2016, we had 12 codeshare agreements with Aerolíneas Argentinas, AeroMexico, Air Canada, Air France KLM, Alitalia, Copa Airlines, Delta, Emirates, Etihad Airways, Korean Air, Qatar Airways and TAP and 77 interline agreements.

Delta

Since 2011, we have developed a comprehensive partnership with Delta. As of December 31, 2016, Delta owned 9.5% of our economic interest. We also have entered into a long-term commercial agreement with Delta that has exclusivity provisions designed to strengthen the operational cooperation and synergies between the two companies, including services related to aircraft maintenance and codeshare agreements.

On August 31, 2015, Delta guaranteed a US$300 million Term Loan borrowed by Gol LuxCo from third party lenders. The Term Loan was made under a credit and guaranty agreement (the “Credit and Guaranty Agreement”) among Gol LuxCo, as borrower, Gol, the Lessee and the other guarantors thereunder (collectively, the “Term Loan Guarantors”) and the lenders party thereto (the “Third Party Lenders”). Under the terms of the Credit and Guaranty Agreement, Gol LuxCo’s obligations thereunder are guaranteed by the Term Loan Guarantors. Pursuant to a separate guaranty agreement, Delta provided to the administrative agent under the Credit and Guaranty Agreement, and the lenders under the Credit and Guaranty Agreement, a backstop guarantee of Gol LuxCo’s and the Term Loan Guarantors’ respective obligations under the Credit and Guaranty Agreement (the “Delta Guaranty”). The reimbursement obligations to Delta in connection with the Delta Guaranty are secured by a first priority security interest in favor of Delta in a portion of the shares of Smiles held by Gol. The Term Loan bears interest at a rate of 6.50% per annum, payable semi-annually. The Term Loan matures on August 31, 2020 and is not secured by any property of Gol LuxCo or the Term Loan Guarantors.

In 2016, Delta granted us credit support in the form of:

·          a backstop guarantee for up to US$32.0 million in Gol obligations under an ISDA Master Agreement with Morgan Stanley;

·          a credit line for the financing of maintenance payments of up to US$50.0 million.

In addition, in 2016, we entered into a three-party sale and leaseback transaction with Delta and GECAS with regard to a total of 12 aircraft, reducing our fleet and granting us additional liquidity.

Air France-KLM

We also have a long term strategic partnership for commercial cooperation with Air France-KLM, which currently holds 1.2% of our total capital stock. The agreement provides for an alliance committee, comprised of at least one representative of Air France-KLM, at least two members of our board of directors and at least one representative of Delta.

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 same procedure applies for international fares. The only difference is that all fares sold for interline itineraries are also excluded from the data 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 revenue. 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

By 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. In addition, engine maintenance services are rendered in different MRO facilities.

We believe that our high aircraft utilization rate has not compromised our positioning in terms of performance and reliability when compared to other Boeing operators globally.

We have 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 have four maintenance hangars, one dedicated to paintings. Our hangars are strategically located in Confins (Belo Horizonte) and São Paulo with capacity to carry out as many as nine checks simultaneously . We also have room to build an additional hangar, if needed.

We have entered into two strategic MRO partnership agreements (with Delta and MTU, respectively) in order to provide overhaul service for 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. We have recently agreed with Delta and Air France to increase our level of maintenance services with them to all of our engines starting in 2018.

In 2016, we received FAA 145 Repair Station certification from the U.S. Federal Aviation Administration to perform C-checks at our maintenance center.

Fuel

Our fuel costs totaled R$2,695.4 million in 2016, representing 29.4% of our operating costs and expenses for the year. In 2016, we purchased substantially all of our fuel from Petrobras Distribuidora, a retail subsidiary of Petrobras. In addition to Petrobras, there are two other large fuel suppliers in Brazil. In 2016, 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.

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

We continuously invest in initiatives to reduce fuel consumption, including the following:

·          Installation of winglets: We installed an aerodynamic component on the wing tips of the majority of our aircrafts for better aerodynamics and, consequently, lower fuel consumption.

·          Required Navigation Performance (RNP - AR): Precision approaches guided through a satellite navigation system that enables pilots to control aircraft in flight even in the case of low visibility, reducing dependence on air-to-ground navigation and shortening length of flight, which reduces fuel consumption and improves accessibility at airports such as Rio de Janeiro, Santos Dumont Airport - SDU.

·          Aircraft Communication Addressing Reporting System (ACARS): This is a satellite communication system that permits the exchange of data between aircraft and ground communication outlets during flights, and allows for more assertive communication and anticipated shared decision making processes, minimizing route deviations and ensuring operational 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 hedging program, based upon policies which define volume, price targets and instruments, under which we enter into fuel and currency hedging agreements with counterparties providing for price protection in connection with the purchase of fuel. 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, which may be comprised of members of our board of directors, external consultants, and senior management, meets monthly 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. We also use non-derivative instruments as alternative hedge conferring an additional average protection through fixed price fuel transactions for future delivery negotiated with our main fuel supplier.

As of December 31, 2016, we had derivatives to protect 55% of our expected fuel consumption in the first quarter of 2017.

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 average 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 ANAC’s Air Accident Prevention Program and we have implemented 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.

We maintain the highest rating (seven stars) and are ranked among the world’s safest airlines, according to AirlineRatings.com, an independent plane safety and product rating website. In January 2017, the website updated safety ratings for 425 airlines, awarding them up to seven stars for safety. Of those surveyed, 148 were given top marks but almost 50 had three stars or less. The website’s star ratings take multiple factors into account, including whether an airline has been certified by the International Air Transport Association (IATA), if it is on the EU’s airline blacklist, its crash record and whether the fleet has been grounded over safety concerns.

In June 2016, we carried out our fifth biennial IATA Operational Safety Audit (IOSA).

Environmental Sustainability

Since 2010, we prepare Annual Sustainability Reports based on Global Reporting Initiative (GRI) guidelines, an international standard for reporting economic, social and environmental performance. By adopting these parameters, we are reinforcing our accountability with various stakeholders through added transparency and credibility. 

We also 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: we have reduced costs by decreasing the necessity of flying our aircraft overseas to be serviced. We also treat all of the effluents generated in our facilities and are committed to the reuse of water. The Maintenance Center was designed to comply with environmental responsibility requirements and all of the conditions imposed by the environmental licenses and current legislation.

·          We are pioneers in incentivizing the research and development of biofuel technology. In 2014, we operated more than 365 domestic flights using renewable fuel. In 2015, we made our first international flight using renewable fuel on our Orlando – São Paulo route.

·          We were the first Brazilian airline to release our greenhouse gas inventory based on the Greenhouse Gas Protocol Initiative, or GHG Protocol.

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 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 losses.

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 competitors in Brazil are Latam Airlines Group, or Latam Brasil; Azul Linhas Aéreas Brasileiras, or Azul Brasil; and Ocean Air Linhas Aereas, doing business as Avianca, or Avianca Brasil. Latam Brasil is controlled by Latam S.A., a Chilean company.  Latam is the result of a June 2012 merger between TAM Airlines of Brazil and LAN Airlines of Chile, and is a full-service scheduled carrier offering flights on domestic routes and international routes. Azul is a regional carrier, which acquired another regional carrier, Trip, in 2012.  Azul Brasil is controlled by Azul S.A.  Azul S.A.’s voting stock is controlled by David Neeleman and Azul’s largest economic stake is controlled by the Chinese government-controlled airline Hainan Airlines.  Avianca Brasil is controlled by Synergy Group. Avianca licensed its brand to Avianca Brasil in 2010. 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 with reduced fares to attract new passengers.

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: ANAC

(1)     Known as TAM Airlines prior to its June 2012 merger with LAN Airlines of Chile.

(2)     In May 2012, Azul acquired Trip.

Domestically, we also face competition from ground transportation alternatives, primarily interstate bus companies. 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

In our international operations, we face competition from Brazilian and South American airlines that are already established in the international market and that participate in strategic alliances and codeshare 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 destinations.

The table below shows the 2016 market share of major airlines on South American routes to/from Brazil based on RPKs:

Source: ANAC

(1)   Includes Latam Airlines Brasil, Lan Chile, Lan Peru, Lan Argentina and TAM MERCOSUR

2)     Includes Avianca and TACA Peru

Smiles Loyalty Program

Overview

Smiles is one of the largest coalition loyalty programs in Brazil, with 12 million members as of December 31, 2016. Its business model is based on a pure coalition loyalty program consisting of a single platform for accumulating and redeeming miles through a broad network of commercial and financial partners.

The Smiles loyalty program was originally launched by Varig in 1994 as a frequent flyer program and was acquired by us in 2007, together with other assets of the Varig business. Beginning in 2008, the Smiles loyalty program underwent a restructuring and revitalization and, since then, the Smiles loyalty program has been transformed from a stand-alone program into an independent coalition loyalty program and has gained significant market share. On December 31, 2016, Smiles’ share of all miles issued in the domestic market was roughly 41%, up from 29% at the end of 2013. On April 26, 2013, we sold a minority stake in Smiles via an IPO with listing on the Brazilian Stock Exchange.

Currently, Smiles loyalty program allows members to accumulate miles through: (1) flights with Gol and our international partners, (2) all the significant Brazilian commercial banks that issue credit cards, including through co-branded cards issued by Bradesco and Banco do Brasil, (3) a broad network of  retail partners, including Localiza, the largest car rental agency in Brazil, Accor Hotels (Le Club), a global hotel chain, among others, (4) direct purchases of miles by customers and (5) purchase of miles and benefits through Clube Smiles (or Smiles Club). We are Smiles’ primary redemption partner but members may also redeem miles for products and services from commercial partners.

Commercial Partners

As of the date of this annual report, the Smiles network of commercial partners is composed of airlines, financial institutions, travel agencies, hotels, car rental agencies, gas stations, bookstores, media companies, drugstores, restaurants and parking lot operators, among others.

• Airlines . We are Smiles’ most important commercial partner in terms of miles and rewards volumes. We purchase miles from Smiles to distribute to our passengers. Additionally, Smiles offers redemptions with our airline partners .
• Financial Institutions . Smiles has commercial partnership agreements with all significant Brazilian commercial banks, including  more than 80% of the largest Brazilian commercial banks in terms of total assets as of December 31, 2016, according to the Central Bank. Smiles sells miles to these commercial partners, which distribute them proportionately to credit card spending by cardholders who are Smiles loyalty program members. Smiles also sells miles for co-branded credit cards issued by Bradesco and Banco do Brasil.
• Travel Companies, Hotels and Car Rental Agencies . Currently, Smiles has partnership agreements with well-known domestic and international travel companies, hotels and car rental companies. These partners include Accor Hotels, Hilton Honors, Marriott International, Starwood Hotels and Resorts Worldwide Inc., Othon Hotels, Sheraton Hotels, Atlantica Hotels International (Brasil) Ltda, and Sauípe S.A. (a tourism complex in Brazil). This network allows Smiles loyalty program members to accumulate miles at a variety of locations worldwide and throughout the course of their trips.
• Brazilian Retailers and Distributors . Smiles has commercial agreements with important Brazilian retailers, including Polishop (a domestic electronics and merchandise retailer), the newspapers O Globo and Valor Econômico, Editora Abril S.A. (one of the largest Brazilian publishing companies), Shell gas stations, Centauro (a sports clothing and equipment retail chain), Grupo Pão de Açucar and Via Varejo online websites (Assai, Pão de Açucar, Extra, Casas Bahia and Ponto Frio) and Magazine Luiza (the second largest home appliance  retailer and one of the largest online retailers in Brazil).

Competition

Smiles faces the following types of competition in Brazil: (i) frequent flyer programs, (ii) the loyalty programs of financial institutions and similar entities and (iii) other loyalty programs in general. The first group includes Multiplus, the current market leader, and other players such as the Tudo Azul program and Avianca’s Programa Amigo . The second group includes a variety of large financial institutions and similar entities that have their own loyalty programs, such as the SuperBônus Program of Banco Santander (Brasil) S.A., the Bradesco Loyalty Card Program of Banco Bradesco S.A., the Sempre Presente Program of Banco Itaú Unibanco S.A., the American Express Membership Rewards Program and Livelo, a joint venture program between Banco do Brasil and Banco Bradesco. The majority of these programs allow members to transfer accumulated reward points to programs like the Smiles loyalty program. The third group of competitors includes companies such as Dotz and Netpoints (of which Smiles is a minority shareholder), among others.

If foreign loyalty programs such as Aeroplan or Air Miles enter the Brazilian market, Smiles may face additional competition. However, entry of foreign loyalty programs would also present new opportunities for commercial partnerships.

Agreements with Smiles

Operating Agreement

On December 28, 2012, GLA entered into an operating agreement with Smiles, or the Operating Agreement, that establishes the terms and conditions of our relationship. This agreement went into effect on January 1, 2013, when Smiles began to manage and operate the Smiles loyalty program.

The 20-year Operating Agreement will be automatically renewed for successive five-year periods if neither party objects at least two years prior to its expiration. If a party is given notice of non-renewal, it may terminate the Operating Agreement early by providing written notification to the other party six months prior to the termination date.

GLA pays Smiles a monthly fee for managing our frequent flyer program. This fee is adjusted on each anniversary of the Operating Agreement in accordance with our gross monthly miles purchases and may range between 3.5% and 6.0%.

Back Office Services Agreement

On December 28, 2012, GLA entered into a back office services agreement with Smiles, or the Back Office Services Agreement, that contains the terms, conditions and levels of certain services in connection with back office activities including controllership, accounting, internal controls and auditing, finance, information technology, call center, human resources, inventory and legal matters. The amount recognized by Smiles as expenses in 2016, 2015 and 2014 totaled R$ 23.4 million, R$24.3 million and R$19.8 million, respectively.

The three-year Back Office Services Agreement is automatically renewed for successive three-year periods if neither party objects 12 months prior to its expiration. Smiles may terminate portions of the Back Office Services Agreement at any time by providing prior written notice to GLA.

Main Miles and Tickets Purchase Agreement

On December 28, 2012, GLA entered into a miles and tickets purchase agreement with Smiles, or the Miles and Tickets Purchase Agreement, that establishes the terms and conditions of purchases of miles and sales of tickets.

In order to govern pricing and availability of reward tickets and satisfy customer demand, the agreement establishes three seating classes: standard, commercial and promotional for ticketing purposes.

• Standard seats : Pricing will take into account the variation of the economic cost of the fare over the last 12 months and the characteristics of each route. The economic cost is equivalent to the sum of (i) the opportunity cost of not selling a ticket to a traveler when the flight is full – or displacement; (ii) the opportunity cost of a passenger redeeming a reward ticket who would have purchased the ticket using cash, had he or she not had available miles – or dilution; and (iii) the direct cost that GLA incurs in transporting an additional passenger on a given flight – or marginal cost. The availability of standard seating on planes is limited and controlled by GLA, although Smiles is assured a minimum aggregate number of standard seats out of total seats on all flights.
• Commercial seats : Pricing is subject to the same price and/or discount applied to third parties. The availability of commercial seats on flights is unrestricted.
• Promotional seats : Pricing is determined by an established discount table on a case-by-case basis. There is no minimum availability for promotional seats.

The price that GLA pays for miles is calculated based on the economic cost specified above, minus a portion of the breakage rate, which is the expected percentage of miles that will expire without being redeemed.

The 20-year Miles and Tickets Purchase Agreement will be automatically renewed for successive five-year periods if neither party objects at least two years prior to its expiration. If a party is given notice of non-renewal, it may terminate the agreement early by providing written notification to the other party six months prior to the termination date.

On December 30, 2016, GLA, along with Smiles, made adjustments in the prices of standard airline tickets and miles sold to GLA, representing a decrease of 5.2% and 25.3%, respectively, based on the composition of the airline tickets issued in the preceding period.

2016 Miles and Tickets Purchase Agreement

On February 26, 2016, GLA entered into a miles and tickets purchase agreement with Smiles, totaling up to R$1.0 billion, providing for advance ticket sales to Smiles in various tranches through June 30, 2017. In 2016, Smiles disbursed a total of R$760 million and, on February 3, 2017, another R$120 million as part of this agreement. On April 5, 2017 GLA and Smiles amended this agreement to extend its termination until July 31, 2018 and increase the total amount by R$480 million.

The payments made by Smiles will be governed by the agreements already existing between Gol and Smiles, with certain changes. The advances by Smiles will be remunerated at a minimum rate of 132% of the CDI, which may be increased according to market conditions at each payment date. In addition, Smiles will benefit from some measures to strengthen its competitiveness.

Industry Overview

According to the International Air Transport Association, or IATA, Brazil is the fourth largest domestic aviation market in the world and should remain the fourth largest over the next two decades with a total of 170 million passengers. Moreover, according to ANAC, there were 71.8 million domestic enplanements and 18.1 million international enplanements on Brazilian carriers in Brazil (which excludes international carriers) in 2016, out of a total population of over 206 million, according to IBGE. In contrast, according to the U.S. Department of Transportation, the United States had an estimated 716 million domestic enplanements and an estimated 102 million international enplanements in 2016, out of a total population of over 319 million, based on the latest United States census estimates. Despite its size, the Brazilian market is still under-penetrated, with an estimated 0.45 flights per capita in 2016, way below levels of developed countries like Australia (2.41), United States (2.08) and Canada (1.27), reflecting a strong potential for growth in the mid-term. In the specific case of Gol, we are very well positioned to capture the growth of the Brazilian market, with 88.7% of revenues coming from the domestic market.

Brazilian air travel has historically been affordable for business passengers and or high-income individuals, resulting in low per capita penetration rates when compared to other emerging markets and developed countries. We believe that Brazil fundamentals over the long-term are still quite attractive which bodes well for the development and growth of air travel. Long-distance   travel alternatives in Brazil are quite limited given that there is poor road infrastructure and no passenger rail or other alternative. Despite the significant growth in air travel in Brazil over the first decade after 2000 (CAGR of 12.6% over the 2000-2011 period), we believe that there is still significant upside potential for airlines in general and for low cost airlines specifically to gain market share of travelers who would ordinarily travel by bus. Moreover, Brazil’s “new middle class” consumers also allocated a greater portion of their family incomes into better vacation experiences. This explains the significant pick-up in demand for international air travel by Brazilians over the last 10 years. South American countries, the Caribbean and the United States feature among the top ten most popular tourist destinations for Brazilians traveling abroad on vacation according to industry data.

Brazil air travel is still very concentrated in a few city-pairs and business passengers account for the majority of the volume. According to industry data, business travel represents around 65% of the total demand for domestic air travel in 2016. We believe this rate is significantly higher than the business travel portion of domestic air travel in the global aviation sector. According to the latest data collected by ANAC, flights between Rio de Janeiro and São Paulo, Brazil’s busiest city-pair accounted for 7.6% of all domestic passengers in 2016. The top ten routes accounted for roughly 20% of all domestic air passengers in 2016, while the ten busiest airports accounted for 65% in 2016.

The table below sets forth information about the ten busiest routes for air travel in Brazil during 2016.

(1)   Considers flights originating in either city of the pair.

(2)   Includes flights between Congonhas and Guarulhos to either Santos Dumont or Galeão airports.

In light of Brazil’s economic growth between 2009-2013 and Government income distribution initiatives, the middle class segment (A, B and C classes) increased significantly in the last years and now accounts for roughly 50% of total consumer spending (or 42 million new consumers rose to middle class status). The Northeast region led the growth in middle class consumers, with three out of ten new middle class consumer from this region. According to ANAC, there were roughly 90 million passengers in 2016, basically unchanged when compared with 2015. As a result of increased passenger volume, the host of the World Soccer Cup in 2014 and the Summer Olympic Games in 2016, domestic airport infrastructure has required substantial improvements.

In addition, there are ongoing discussions in Brazil regarding the execution of open skies agreements, which remove restrictions on the number of flights and destinations between countries.

In 2011, the United States and Brazil entered into an open skies agreement. The countries agreed on a transition period until 2015, by which time the open skies model was expected to be in force. However, the agreement has not yet been approved by the Brazilian Congress. Its approval is expected to occur during 2017. Brazil also entered into an open skies agreement with the Latin America Civil Aviation Commission (CLAC) countries in 2016, but the agreement is also pending approval by the Brazilian Congress before it takes effect.

The Brazilian Congress is also discussing whether foreign air carriers may be able to freely operate in Brazilian territory.

Brazilian Civil Aviation Market Evolution

In the past 40 years, the domestic market generally experienced year-over-year growth in revenue passenger kilometers twice the growth rate of GDP, 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 1972 to 2000, domestic revenue passenger kilometers grew at a compound annual rate of 7.2%. However, in the ten years following the start of Gol’s operations, that is from 2000-2011 CAGR growth rate accelerated to an increase of 12.6%. During this period, Gol’s market share as measured by available seat kilometers increased from 4% to 38%.We believe that Gol positively impacted the market by more than 260% in terms of demand stimulation which we call the “Gol effect”.

From 2012 to 2016, the compound annual growth rate in industry passenger traffic, in terms of domestic revenue passenger kilometers, was 0.6%, versus a compound annual growth rate in available industry domestic capacity, in terms of available seat kilometers, of -1.7%. Domestic industry load factor, calculated as revenue passenger kilometers divided by available seat kilometers, averaged 77.7% 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.

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 in Brazil, including through the Brazilian Federal Constitution and the Brazilian Aeronautical Code. The Brazilian Aeronautical Code sets forth 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.

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.

The Brazilian Civil Aviation National Policy ( Política Nacional de Aviação Civil), or PNAC, corresponds to the guidelines and strategies that will lead the institutions responsible for the development of the Brazilian civil aviation sector, establishing strategic objectives and actions for the market.

The Ministry of Transport, Ports and Civil Aviation, formerly the Civil Aviation Secretary, monitors the implementation of PNAC by the entities responsible for the management, regulation and inspection of civil aviation, civil airport infrastructure and civil air navigation infrastructure connected to the Ministry. In addition to the Ministry of Transport, Ports and Civil Aviation, the bodies and entities of the National Civil Aviation Council ( Conselho de Aviação Civil ), or CONAC, monitor the implementation of PNAC.

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

The Ministry of Transport, Ports and Civil Aviation oversees ANAC and INFRAERO and reports directly to the Brazilian President. The Ministry is also responsible for implementation of the airport infrastructure concession plan and the development of strategic planning for civil aviation.

The National Commission of Airport Authorities ( Comissão Nacional de Autoridades Aeroportuárias ), or CONAERO, is a commission that coordinates the different entities and public agencies related to airports. This has a rule-making role in the search for efficiency and security in airports operations.

CONAERO is composed by the following individuals and representatives of entities: (i) Ministry of Transport, Ports and Civil Aviation, which chairs the commission; (ii) the Brazilian president’s chief of staff; (iii) Agriculture, Livestock and Supplies Ministry; (iv) Defense Ministry; (v) Finance Ministry; (vi) Justice Ministry; (vii) Planning, Budget and Administration Ministry; (viii) Health Ministry; and (ix) ANAC.

ANAC is currently responsible for guiding, planning, stimulating and supporting the activities of public and private civil aviation companies in Brazil. ANAC also regulates flying operations 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, controls and supervises the Brazilian Airspace Control System. The 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, including approving and overseeing the implementation of equipment as well as of navigation, meteorological and radar systems.

With respect to non-privatized airports, INFRAERO, a state-controlled corporation reporting to Ministry of Transport, Ports and Civil Aviation, is in charge of managing, operating and controlling federal airports, including some control towers and airport safety operations. With respect to the recently privatized airports (Natal, Galeão, Confins, Guarulhos, Viracopos and Brasília), although INFRAERO still holds a minority stake in each of them, INFRAERO is no longer in charge of operations, which are now handled by their respective private operators. See “Regulation of the Brazilian Civil Aviation Market–Airport Infrastructure” below.

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 Brazilian president’s chief of staff, the Minister of Planning, Budget and Management, the Minister of Justice, the Minister of Transport, Ports and Civil Aviation and the Commandant of the Air Force. CONAC has the authority to establish national civil aviation policies that may be adopted and enforced by the High Command of Aeronautics and by ANAC. 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.

Route Rights

Domestic routes . For the granting of new routes and changes to existing ones, 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. 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 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 ANAC to provide international services, with the International Relations Superintendence of ANAC, or SRI, 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 ANAC’s 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, ANAC has the authority to approve Brazilian airlines to operate new routes, subject to the airline having filed studies satisfactory to 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.

In 2010, ANAC approved the deregulation of international airfares for flights departing from Brazil to the United States and Europe, gradually removing the prior minimum fares. In addition, in 2010, 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. The agreement with the United States was signed by the parties but is pending ratification by the Brazilian Congress to become operational. A similar agreement with Europe is still in its early stages. These new regulations should increase the number of passengers in South America and grow our market. To the extent that our presence and/or the presence of our partner, Delta, increase in the South American market, this will contribute to our business. On the other hand, to the extent competition increases in the expanded South American market and we and/or Delta lose significant market share, we may be adversely affected.

Slots Policy

Domestic . Under Brazilian law, a domestic slot concession derives from a flight concession by 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 ANAC with a minimum of two months’ prior notice.

Congonhas airport in the city of São Paulo is the only slot constrained airport, where slots must be allocated to an airline before it may begin operations there. It is quite difficult to obtain and maintain a slot in Congonhas airport. The Santos-Dumont airport in Rio de Janeiro, is also a highly utilized airport with half-hourly shuttle flights between São Paulo and Rio de Janeiro, and also presents certain slot restrictions. ANAC has imposed schedule restrictions on 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 (São Paulo), 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 us.

CONAC has taken certain measures to minimize recent technical and operational problems at São Paulo’s airports, including the redistribution of air traffic from Congonhas airport (São Paulo) to the international airport in Guarulhos which is a “coordinated” airport in terms of slots. CONAC has also mentioned its intention to adjust tariffs for the use of busy airport hubs to encourage further redistribution of air traffic.

In July 2014, ANAC published new rules governing the allocation of slots at the main Brazilian airports, which consider operational efficiency (on-time performance and regularity) as the main criteria for the allocation of slots. Under these rules on-time performance and regularity are assessed in two annual seasons, following the IATA summer and winter calendars, between April and September and between October and March.

The minimum on-time performance and regularity targets for each series of slots in a season are 80% and 90%, respectively, at Congonhas airport (São Paulo) and 75% and 80%, respectively, for all other main airports. Airlines forfeit any series of slots that operate below the minimum criteria in a season. Forfeited slots are redistributed 50% to new entrants, which includes airlines that operate fewer than 5 slots in the relevant airport in the given weekday, and 50% to all airlines operating in the relevant airport based on their share of slots. In addition, in October 2014, ANAC distributed new slots at Congonhas airport, in light of increased runway capacity, exclusively to airlines with less than 12% of the slots. As of December 31, 2016 we have 45% and Latam 44% of the slots in terms of takeoffs and landings at Congonhas airport, after having held 47% and 48%, respectively.

Airport Infrastructure

INFRAERO, a state-controlled corporation, is in charge of managing, operating and controlling federal airports, including some 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. For recently privatized airports (Natal, Galeão, Confins, Guarulhos, Viracopos and Brasília), operators may freely negotiate all commercial areas according to their own criteria; there is no requirement that a public bidding must be held in the event there is more than one applicant for the use of a specific airport area.

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 areas and baggage service offices, contain provisions for periodic adjustments of the lease rates and the extension of the concession term.

All of the 60 Brazilian airports managed by INFRAERO at the end of 2016 are scheduled to receive some infrastructure investments and upgrades within the next three years. In addition, under the regional aviation development program, 270 current or new regional airports may receive investments in the next few years. These airport upgrade plans do not require contributions or investments by the Brazilian airlines and are not expected to be accompanied by increases in landing fees or passenger taxes on air travel.

The table below sets forth the number of passengers at the ten busiest airports in Brazil during 2016:

Source: INFRAERO , DAESP and Guarulhos, Brasília, Rio de Janeiro Galeão, Confins and Viracopos airports.

(1)           Considers domestic and international departures and arrivals from main Brazilian airports

Airport fees include airport charges for each landing and aircraft parking, connection fees as well as aeronautical and navigation fees.  Most of these fees vary based on our level of operations and the rates are set by INFRAERO, DECEA and private airports.  Since February 2012, the Brazilian government increased parking fees at the busiest airports, and at peak hours, which benefitted secondary hubs and off-peak flights in light of the differences in fees for the airlines that chose to operate in these airports or at these times. Currently, landing fees are fixed, based on the category of the airport and whether the flight is domestic or international. Navigation fees are also fixed, but consider the area overflown and whether the flight is domestic or international.

Airport Privatizations

In August 2011, the Brazilian government privatized the Natal airport, which construction was completed in mid-2014. In February 2012, the Brazilian government privatized the São Paulo (Guarulhos), Brasília and Campinas international airports, which will be operated by the winners of the privatization auction for periods of 20 to 30 years. In November 2013, the Brazilian government privatized Rio de Janeiro (Galeão) and Belo Horizonte (Confins) airports. Additionally, in March 2017, the Brazilian government privatized the international airports of Porto Alegre, Salvador, Florianópolis and Fortaleza. These ten airports combined account for 59% of Brazil’s total passenger volume.

The airports auctioned were:

Source: civil aviation secretary ( Secretaria de Aviação Civil )

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 CONAC, the application for a concession to operate regular air transportation services is subject to a license granted by ANAC to operate an airline and to explore regular air transportation services. The applicant is required by 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 on the Ownership of Shares Issued by Concessionaires of Air Transportation Services.” 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 and was renewed in 2009 for another ten years with an expiration date of December 14, 2019. 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 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 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 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 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. As of December 31, 2016, the foreign ownership limit for Brazilian airlines remained unchanged at 20%, although there have been repeated discussions by the Brazilian government and Congress to lift this restriction fully or partially, including most recently an announcement that the government intends to issue a new measure, subject to Congress approval, completely removing the foreign ownership limit.

The Brazilian Aeronautical Code also imposes certain restrictions on the transfer of capital stock of concessionaires of air transportation services, such as GLA, 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 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, ANAC has the authority to subject any further transfer of shares to its prior approval.

We hold substantially all of the shares of GLA, a public concessionaire 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. 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, or 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 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. This draft bill is still under discussion in the House of Representatives and, if approved, must be submitted for approval to the Senate, before being sent for presidential approval. If the Brazilian civil aviation framework changes, or ANAC implements increased restrictions, the Brazilian airline industry could be negatively affected.

C.       Organizational Structure

We are a holding company that directly or indirectly own shares of seven subsidiaries: GLA; Webjet; Smiles; four offshore subsidiaries: Gol Finance Inc., or Gol Finance; GAC Inc., or GAC; Gol LuxCo S.A., or Gol LuxCo; and Gol Dominicana Lineas Aereas Sas., which is a non-operational company currently in liquidation. GLA is our operating subsidiary, under which we conduct our air transportation business. Webjet was acquired in 2011 and we announced the winding up its activities at the end of 2012. We are the majority shareholder of Smiles, which conducts the Smiles loyalty program. Gol Finance, GAC and Gol LuxCo are off-shore companies established for the purpose of facilitating cross-border general and aircraft financing transactions.

D.       Property, Plant and Equipment

Our primary corporate offices are located 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, 2016, we had finance lease agreements for 34 Boeing 737s, 31 of which had a purchase option at the end of the contract term. We own an Aircraft Maintenance Center in Confins, in the State of Minas Gerais. The certification of our aircraft maintenance center authorizes airframe maintenance services for Boeing 737-300s and Boeing Next Generation 737-700 and 800s. We have three hangars at our Aircraft Maintenance Center, with a capacity to perform maintenance on six aircraft simultaneously and painting services on one additional aircraft. We also have room to build more hangars, if needed. We use the new facility for airframe heavy checks, line maintenance, aircraft painting and aircraft interior refurbishment. See also “Item 4—Business Overview—Aircraft Fleet” and note 14 to our consolidated financial statements included herein.