20-F 1 v100703_20f.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 20-F
 
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
þ 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number 1-15018

Votorantim Celulose e Papel S.A.
(Exact name of Registrant as specified in its charter)
 
Votorantim Pulp and Paper Inc.
(Translation of Registrant’s name into English)
 
Federative Republic of Brazil
(Jurisdiction of incorporation or organization)
 
Alameda Santos, 1357, 6th floor
01419-908, São Paulo, SP, Brazil
(Address of principal executive offices)
 

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

 
Name of each exchange on which registered:
 
New York Stock Exchange*
American Depositary Shares (as evidenced by American Depositary Receipts), each representing one share of Preferred Stock
 
New York Stock Exchange

* Not for trading purposes but only in connection with the registration on the New York Stock Exchange of American Depositary Shares representing those preferred shares.
 

 
Securities registered or to be registered pursuant to Section 12(g) of the Act:
 
None
 

 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
 
None
 

 
The number of outstanding shares of each class of stock of Votorantim Celulose e Papel S.A. as of December 31, 2007:

105,702,452
 
Shares of Common Stock
98,443,055
 
Shares of Preferred Stock
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
þ Yes o No
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
o Yes þ No
 
Note—Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer þ    Accelerated Filer o    Non-accelerated Filer o
 
Indicate by check mark which financial statement item the registrant has elected to follow.
Item 17  o    Item 18 þ
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes þ No
 

 

       
Page
 
 
 PART I
     
           
ITEM 1.
 
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
 3
 
           
ITEM 2.
 
OFFER STATISTICS AND EXPECTED TIMETABLE
 
 3
 
           
ITEM 3.
  KEY INFORMATION  
 3
 
           
ITEM 4.
  INFORMATION ON VCP  
 14
 
           
ITEM 4A.
  UNRESOLVED STAFF COMMENTS  
48
 
           
ITEM 5.
  OPERATING AND FINANCIAL REVIEW AND PROSPECTS  
 48
 
           
ITEM 6.
  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES  
69
 
           
ITEM 7.
 
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
 
 77
 
           
ITEM 8.
  FINANCIAL INFORMATION  
 79
 
           
ITEM 9.
  THE OFFER AND LISTING  
 84
 
           
ITEM 10.
  ADDITIONAL INFORMATION  
 88
 
           
ITEM 11.
  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  
 99
 
           
ITEM 12.
  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES  
 103
 
           
 
PART II
     
           
ITEM 13.
  DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES  
 103
 
           
ITEM 14.
 
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE
OF PROCEEDS
 
 103
 
           
ITEM 15.
  CONTROLS AND PROCEDURES  
 103
 
           
ITEM 16A.
  AUDIT COMMITTEE FINANCIAL EXPERT  
 104
 
           
ITEM 16B.
  CODE OF ETHICS  
 104
 
           
ITEM 16C.
  PRINCIPAL ACCOUNTANT FEES AND SERVICES  
 104
 
           
ITEM 16D.
  EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES  
 105
 
           
ITEM 16E.
  PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS  
 105
 
           
 
PART III
     
           
ITEM 17.
  FINANCIAL STATEMENTS  
 106
 
           
  FINANCIAL STATEMENTS  
 106
 
           
ITEM 19.
  EXHIBITS  
 107
 
 
i

 
INTRODUCTION
 
All references in this annual report to:
 
 
·
“VCP,” “we,” “our” and “us” are to Votorantim Celulose e Papel S.A. and its consolidated subsidiaries (unless the context otherwise requires);
 
 
·
“Votorantim group” are to the group of companies, including VCP, controlled by the Ermírio de Moraes family;
 
 
·
“Votorantim Investimentos Industriais ”, or “VID,” are to our immediate parent company and the holding company of the Votorantim Group; Votorantim Participações S.A. or “VPAR” controls three areas of the Group’s business: Votorantim Industrial, Votorantim Finance and Votorantim New Businesses, each of them containing one or more business units;
 
 
·
“BNDESPAR” are to BNDES Participações S.A. - BNDESPAR, a wholly owned subsidiary of BNDES, the Brazilian economic and social development bank owned by the Brazilian federal government;
 
 
·
“Nova” are to Nova HPI Participações Ltda., a company of the Votorantim group;
 
 
·
“the Ermírio de Moraes family” are to the families of Antonio Ermírio de Moraes, Ermírio Pereira de Moraes, Maria Helena de Moraes Scripilliti and José Ermírio de Moraes (in memoriam);
 
 
·
the “Brazilian government” are to the federal government of the Federative Republic of Brazil;
 
 
·
real,” “reais” or “R$” are to Brazilian reais, the official currency of Brazil;
 
 
·
“US$,” “dollars” or “U.S. dollars” are to United States dollars;
 
 
·
“ton” are to one metric ton (1,000 kilograms). One kilogram equals approximately 2.2 pounds;
 
 
·
“BEKP” are to bleached eucalyptus kraft pulp;
 
 
·
“ADSs” are to our American Depositary Shares, each one of our ações preferenciais, or preferred shares;
 
 
·
“CVM” are to the Comissão de Valores Mobiliários, the Brazilian securities commission;
 
 
·
“Brazilian GAAP” are to accounting practices adopted in Brazil, which are based on Brazilian corporate law (Law No. 6,404 of December 15, 1976, as amended by Law No. 10,303 of October 1, 2001, as amended), the rules and regulations of the CVM, and the accounting standards issued by the Instituto dos Auditores Independentes do Brasil, the Brazilian Institute of Independent Accountants, or IBRACON; and
 
 
·
“Commission” are to the Securities and Exchange Commission.
 
As used in this annual report, one hectare equals approximately 2.471 acres and one kilometer equals approximately 0.621 miles. References in this annual report to nominal production capacity or production capacity mean annual projected capacity for which the facility was designed, with the facility operating under optimal conditions, 24 hours a day, for 365 days a year and subject to reductions in rates of production for scheduled maintenance only. Actual production capacity will vary depending on operating conditions, the grades of pulp or paper produced and other factors.
 
The commercial selling rate in Brazil is used in this annual report rather than the noon buying rate in New York City as reported by the Federal Reserve Bank of New York because the noon buying rate was not consistently reported for reais during the periods shown in this annual report. The U.S. dollar equivalent information presented in the annual report should not be construed as implying that the real amounts represent or could have been or could be converted into U.S. dollars at these or any other rate See “Item 3—Key Information—Selected Financial Data—Exchange Rates” for information regarding exchange rates applicable to the Brazilian currency since 2003.
 
1

 
We have prepared our consolidated financial statements included in this annual report in conformity with generally accepted accounting principles in the United States, or U.S. GAAP. Our reporting currency in this annual report for all periods is the U.S. dollar.
 
We make statements in this annual report about our competitive position and market share in, and the market size of, the pulp and paper industry. We have made these statements on the basis of statistics and other information from third-party sources that we believe are reliable. We derive this third-party information principally from reports published by BRACELPA — Associação Brasileira de Celulose e Papel (the Brazilian Association of Pulp and Paper), RISI, PPPC, which is a monthly report on the pulp markets, and Hawking Wright, a specialized consulting firm in the pulp market. Although we have no reason to believe that any of this information or these reports are inaccurate in any material respect, we have not independently verified the competitive position, market share, market size or market growth data provided by third parties or by industry or general publications.
 
FORWARD-LOOKING STATEMENTS
 
This annual report includes forward-looking statements, principally in “Item 3D—Key Information—Risk Factors,” “Item 4B—Information on VCP—Business Overview” and “Item 5—Operating and Financial Review and Prospects.” We have based these forward-looking statements largely on our current expectations about future events and financial trends affecting our business. These forward-looking statements are subject to risks, uncertainties and assumptions, including, among other things:
 
 
·
general economic, political and business conditions, both in Brazil and in our principal export markets;
 
 
·
changes in market prices, customer preferences, competitive conditions and general level of demand for our products;
 
 
·
our management’s expectations and estimates concerning future financial performance, financing plans and the effects of competition;
 
 
·
our level of debt;
 
 
·
anticipated trends in the pulp and paper industry, including changes in capacity and industry price movements;
 
 
·
our capital expenditure plans;
 
 
·
changes in currency exchange rates;
 
 
·
our ability to produce and deliver our products on a timely basis;
 
 
·
existing and future governmental regulation, including environmental laws, tariffs on pulp and paper imports and import tax policies in Brazil;
 
 
·
our ability to successfully undertake or complete expansion projects and to manage the engineering, construction and regulatory challenges and costs involved in such projects; and
 
 
·
other risk factors as set forth under “Item 3D—Key Information—Risk Factors.”
 
The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar words are intended to identify forward looking statements. We undertake no obligation to update publicly or revise any forward-looking statements because of new information, future events or otherwise. In light of these risks and uncertainties, the forward looking information, events and circumstances discussed in this annual report might not occur and are not guarantees of future performance. Our actual results and performance could differ substantially.
 
2

 
 PART I
 
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
Not applicable.
 
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
ITEM 3. KEY INFORMATION
 
 
A.
Selected Financial Data
 
We maintain our books and records in reais, which are the basis for our statutory financial statements, prepared as prescribed under Law No. 6,404/76, as amended, known as the Brazilian corporate law, and used to determine income taxes and mandatory minimum dividend calculations. The statutory financial statements (not included in this annual report) are prepared in accordance with accounting practices adopted in Brazil, or Brazilian GAAP, which are based on the Brazilian corporate law, the rules and regulations of the CVM, and the accounting standards issued by the Instituto dos Auditores Independentes do Brasil, the Brazilian Institute of Independent Accountants, or IBRACON. We have also prepared consolidated balance sheets at December 31, 2007 and 2006 and the related consolidated statements of income, cash flows and changes in shareholders’ equity for the years ended December 31, 2007, 2006 and 2005, all stated in U.S. dollars in accordance with U.S. GAAP. Our U.S. GAAP financial statements are included in this annual report. The selected financial information at and for the years ended December 31, 2007, 2006, 2005, 2004 and 2003 are derived from our audited U.S. GAAP financial statements.
 
3

 
The following table presents a summary of our selected financial data at the dates and for each of the periods indicated. You should read the following information together with our financial statements, including the notes thereto, included elsewhere in this annual report.
 
   
For the Years Ended December 31,
 
   
2007
 
2006
 
2005
 
2004
 
2003
 
   
(U.S. dollars in millions, unless otherwise indicated)
 
STATEMENT OF INCOME DATA
                     
Net operating revenues:
                     
Domestic sales
 
US$
 709
 
US$
 685
 
US$
 564
 
US$
 512
 
US$
 443
 
Export sales
   
624
   
632
   
566
   
498
   
373
 
Total net operating revenues
   
1,333
   
1,317
   
1,130
   
1,010
   
816
 
Operating costs and expenses:
                               
Cost of sales
   
887
   
813
   
654
   
518
   
421
 
Selling, marketing, general and administrative
   
202
   
199
   
193
   
161
   
115
 
Gain on exchange of assets, net
   
(955
)
 
   
   
   
 
Other, net 
   
13
   
20
   
36
   
6
   
12
 
Total
   
147
   
1,032
   
883
   
685
   
548
 
Operating income
   
1,186
   
285
   
247
   
325
   
268
 
Non-operating income (expenses):
                               
Financial income (expenses), net
   
91
   
18
   
(40
)
 
(29
)
 
(6
)
Foreign exchange gain (loss) and unrealized gain (loss) on swap, net
   
214
   
(4
)
 
(5
)
 
12
   
(14
)
Total
   
305
   
14
   
(45
)
 
(17
)
 
(20
)
Income before taxes on income and equity in affiliates
   
1,491
   
299
   
202
   
308
   
248
 
Income tax (expense) benefit
   
(56
)
 
(4
)
 
8
   
(36
)
 
(23
)
Deferred income tax expense on gain on exchange of assets
   
(327
)
 
   
   
   
 
Income before equity in affiliates
   
1,108
   
295
   
210
   
272
   
225
 
Equity in earnings (losses) of affiliates
   
113
   
77
   
54
   
31
   
19
 
Net income
 
US$
1,221
 
US$
 372
 
US$
 264
 
US$
 303
 
US$
 244
 
Net income applicable to preferred stock
 
US$
 618
 
US$
 188
 
US$
 124
 
US$
 143
 
US$
 115
 
Net income applicable to common stock
   
603
   
184
   
140
   
160
   
129
 
Net income
 
US$
1,221
 
US$
 372
 
US$
 264
 
US$
 303
 
US$
 244
 
Basic an diluted earnings per share or ADR (in U.S. dollars):(1)
                               
Preferred
 
US$
 6.28
 
US$
 1.97
 
US$
 1.46
 
US$
 1.67
 
US$
 1.34
 
Common
   
5.71
   
1.79
   
1.33
   
1.51
   
1.22
 
Weighted average number of shares outstanding (in thousands):
                               
Preferred
   
98,444
   
92,240
   
85,451
   
85,773
   
85,510
 
Common
   
105,702
   
105,702
   
105,702
   
105,702
   
105,702
 
Dividends and interest attributable to capital per share (in U.S. dollars):(2)
                               
Preferred
 
US$
 0.70
 
US$
 0.80
 
US$
 0.45
 
US$
 0.58
 
US$
 0.22
 
Common
   
0.64
   
0.72
   
0.41
   
0.52
   
0.20
 

4


   
As at December 31,
 
   
2007
 
2006
 
2005
 
2004
 
2003
 
   
(U.S. dollars in millions)
 
BALANCE SHEET DATA
                     
Cash and cash equivalents
 
US$
 565
 
US$
 405
 
US$
 261
 
US$
 151
 US
$
 290
 
Available for sale securities
   
176
   
365
   
446
   
   
 
Held-to-maturity investments(3)
   
   
   
   
278
   
303
 
Property, plant and equipment, net
   
3,916
   
1,945
   
1,758
   
1,443
   
1,202
 
Investment in affiliates, including goodwill
   
1,009
   
900
   
596
   
249
   
245
 
Total assets
   
6,405
   
4,404
   
3,731
   
2,644
   
2,468
 
Short-term debt(4)
   
211
   
242
   
132
   
79
   
48
 
Long-term debt, including current portion
   
1,353
   
1,299
   
1,364
   
866
   
1,098
 
Shareholders’ equity
   
3,883
   
2,275
   
1,737
   
1,498
   
1,185
 

   
For the Years Ended December 31,
 
   
2007
 
2006
 
2005
 
2004
 
2003
 
   
(U.S. dollars in millions, except for percentages)
 
OTHER FINANCIAL DATA
                     
Gross margin
   
33.5
%
 
38.3
%
 
42.1
%
 
48.7
%
 
48.4
%
Operating margin(5)
   
89.0
%
 
21.6
%
 
21.9
%
 
32.2
%
 
32.8
%
Capital expenditures(6)
   
353
   
248
   
247
   
218
   
165
 
Acquisition of interest in equity affiliate(7)
   
   
36
   
275
   
   
 
Depreciation and depletion
   
143
   
193
   
117
   
89
   
72
 
Cash flow provided by (used in):
                               
Operating activities
   
333
   
382
   
234
   
277
   
238
 
Investing activities
   
(145
)
 
(113
)
 
(626
)
 
(170
)
 
(97
)
Financing activities
   
(113
)
 
(107
)
 
505
   
(258
)
 
39
 

   
For the Years Ended December 31,
 
   
2007
 
2006
 
2005
 
2004
 
2003
 
OPERATIONAL DATA
                     
Number of employees (at year end)(8)
   
2,855
   
3,498
   
3,620
   
3,624
   
3,702
 
Nominal production capacity (thousand metric tons):
                               
Pulp
   
1,415
   
1,480
   
1,400
   
1,400
   
1,150
 
Paper
   
365
   
640
   
635
   
610
   
580
 
Sales volumes (thousand metric tons):
   
1,597
   
1,611
   
1,493
   
1,459
   
1,175
 
Domestic market:
   
630
   
591
   
506
   
515
   
477
 
Market pulp
   
228
   
109
   
80
   
80
   
77
 
Paper
   
402
   
482
   
426
   
435
   
400
 
Printing and writing
   
287
   
371
   
331
   
338
   
313
 
Other specialty papers(9)
   
115
   
111
   
95
   
97
   
87
 
International market:
   
967
   
1,020
   
987
   
944
   
698
 
Market pulp
   
870
   
832
   
787
   
764
   
530
 
Paper
   
97
   
188
   
200
   
180
   
168
 
 

(1)
Based on the weighted average number of shares outstanding for each period. Following the reverse stock split of our shares and ADSs on October 18, 2004, we have retrospectively adjusted all shares and ADS data to reflect the reverse split. For additional information on earnings per share, see Note 2(l) to our consolidated financial statements and “Item 5A—Operating Results.”
   
(2)
Dividends and interest attributable to capital paid per shares in U.S. dollars. Dividends and interest attributable to capital per share were adjusted to reflect the reverse stock split that occurred in October 2004.
   
(3)
Includes current and non-current portions.
   
(4)
Excludes current portion of long-term debt.
   
(5)
The 2007 percentage includes the non-recurring gain of US$ 955 million related to the exchange of assets.
   
(6)
Represents cash expenditures for acquisition of property, plant and equipment and excluding the financial income derived from Três Lagoas construction deposit trust investments in 2007 of US$124 million. Disbursements from this trust may be only for property, plant and equipment related to this project.
   
(7)
Includes the excess of the cost of investment over the underlying fair value of net assets on the acquisition of a 23.03% indirect interest in Ripasa S.A. Celulose e Papel (Ripasa) in 2005 for US$ 275 million. In July 2006, VCP disbursed an additional US$ 36 million to Ripasa minority preferred shareholders in settlement of their claims challenging Ripasa’s corporate restructuring. In May, 2006, shareholders of VCP, Suzano, Ripasa and Ripasa Participações S.A. (“Ripar”) approved the corporate restructuring that allowed Ripasa’s minority preferred shareholders to exchange their interests in Ripasa for VCP and Suzano shares, thus increasing VCP’s capital increased by US$168 million.
 
5

  
(8)
The decline in the number of employees reflects our organizational restructuring and divestments that occurred during 2007, principally in the paper assets. See “Item 4 - Information on VCP - History and Development of VCP”
   
(9)
Includes sales of thermal and carbonless papers, sales of third-party products by KSR and sales of specialty papers produced at the Mogi das Cruzes mill (which was sold in April 2007), such as label papers, finish foil, soap wrapping papers, etc.
 
Exchange Rates
 
Fluctuations in the exchange rate of the real have had, and may continue to have, an adverse effect on our operational results and financial condition. The exchange rate, which has floated freely since 1999, is determined principally by negotiations within the Brazilian interbank market, but still may be influenced by occasional Brazilian Central Bank intervention to control unstable movements in the market-driven rate. All foreign exchange transactions are carried out through institutions authorized to operate by the Central Bank and are subject to registration with the Central Bank’s electronic registrations system.
 
During each year of the five year period ending December 31, 2007, the real has appreciated against the U.S. dollar 22%, 9%, 13%, 9% and 21%, respectively. At December 31, 2007, the commercial market rate for purchasing U.S. dollars was R$ 1.7713 to US$ 1.00. The real’s appreciation during this period has been due to many factors including, but not limited to, the external factors of the positive effect of trade balance surpluses on the country’s balance of payments account and the reduction in the country risk factor and the results of various internal structural adjustments to the Brazilian economy. Foreign exchange reserves have increased significantly during this period, from US$ 37 billion at January 1, 2003 to approximately US$ 182 billion at December 31, 2007.
 
The Brazilian government has, since 2000, and with the intent of simplification, consistently introduced significant changes to the Brazilian foreign exchange market. Recent changes have included, among others, the Brazilian National Monetary Council Resolution Number 3389 of August 4, 2006 which reduced exchange controls over exports. Exporters may now retain outside of Brazil up to 30% of the proceeds generated by exports with the remaining 70% still compulsorily remitted to Brazil and converted to Reais. Resolution 3417 of October 27, 2006 increased the maximum period for the compulsory liquidation of foreign exchange related to export transactions from 360 to 750 days.
 
We cannot assure you that the real will not either devalue or appreciate substantially in the near future. See “Item 5—Operating and Financial Review and Prospects—Overview—Brazilian Economic Environment.” The following table shows the commercial selling rate for U.S. dollars for the periods and dates indicated.
 
   
Exchange Rate of Reais per US$ 1.00
 
Year Ended December 31,
 
Low
 
High
 
Average(1)
 
Period-end
 
2003
   
2.8219
   
3.6623
   
3.0775
   
2.8892
 
2004
   
2.6544
   
3.2051
   
2.9263
   
2.6544
 
2005
   
2.1633
   
2.7621
   
2.4357
   
2.3407
 
2006
   
2.0586
   
2.3711
   
2.1751
   
2.1380
 
2007 
   
1.7325
   
2.1556
   
1.9483
   
1.7713
 

Exchange Rate of Reais per US$ 1.00 - Month Ended
 
Low
 
High
 
July 31, 2007
   
1.8448
   
1.9176
 
August 31, 2007
   
1.8729
   
2.1124
 
September 30, 2007
   
1.8389
   
1.9640
 
October 31, 2007
   
1.7440
   
1.8284
 
November 30, 2007
   
1.7325
   
1.8501
 
December 31, 2007
   
1.7616
   
1.8233
 
 

Source: Central Bank.
 
(1)
Represents the daily average exchange rate during each of the relevant periods.
 
6

 
 
B.
Capitalization and Indebtedness
 
Not applicable.
 
 
C.
Reasons for the Offer and Use of Proceeds
 
Not applicable.
 
 
D.
Risk Factors
 
We are subject to various risks resulting from changing competitive, economic, political and social conditions that could harm our business, results of operations or financial condition. The risks described below are not the only ones we face.
 
Risks Relating to VCP and the Pulp and Paper Industry
 
 The market prices for our products are cyclical.
 
The prices we are able to obtain for our products depend on prevailing world prices for market pulp and paper. World prices have historically been cyclical and subject to significant fluctuations over short periods of time depending on a number of factors, including:
 
 
·
worldwide demand for pulp and paper products;
 
 
·
worldwide production capacity and inventories;
 
 
·
the strategies adopted by major pulp and paper producers; and
 
 
·
the availability of substitutes for our products.
 
All of these factors are beyond our control. Over the last three years, bleached eucalyptus kraft pulp (“BEKP”) or market pulp prices in the United States, Europe and Asia, respectively, have fluctuated from lows of US$ 585, US$ 550, and US$ 500 per ton on January 1, 2005, to highs of US$ 805, US$ 780, and US$ 720 per ton at December 30, 2007 in these respective regions. Such price fluctuations occur not only year to year but also within a year as a result of global and regional economic conditions, capacity constraints and mill closures, supply and demand of both raw materials and finished products among others. In 2007, the pulp market remained favorable with robust demand, particularly in China and Europe, and reduced supply caused by low world inventories, few capacity additions, environmental issues, a shortage of wood and closures of high cost capacity, all of which contributed to price increases in all regions of US$ 20-30 per ton.
 
The price of paper products, although less volatile than the price of pulp, also experiences fluctuations in response to global demand and production and fluctuations in pulp prices. Capacity adjustments have also occurred on the paper side, and in 2006 we saw paper prices increasing for several grades in the United States and Europe. For uncoated woodfree papers, international prices climbed 15% in the first six months of 2006, but declined approximately 5% in the last quarter of the year. In 2007, the prices rose 7% from January to December in North America, and within the European market prices climbed 9% in the first nine months of 2007. For a more detailed discussion of prices of pulp and paper, see “Item 4.B—Information on VCP—Business Overview—Cyclical nature of world pulp prices.”
 
It is possible that the market prices for pulp and paper will decline in the future or that there will not be sufficient demand for our products to enable us to operate our production facilities in an economical manner.
 
7

 
The following chart shows the historical eucalyptus pulp price fluctuations by region during 2007 (list price CIF):
 
 graph

 A slowdown in demand in China may adversely affect our exports.
 
China is an increasingly important market to us. According to the Pulp and Paper Products Council (“PPPC”), the demand for chemical and market pulp in China grew to about 8.4 million tons in 2007, a 12% increase over 2006, and represented 16% of the world pulp demand in 2007, compared to approximately 2% in 1995. China currently represents approximately 15% of our total export volume and 12% of our total sales volume, including the volume originated from Ripasa. There is no assurance that demand by China for pulp will continue its current pace of growth or that China will continue to constitute a significant part of our exports. A decline in demand by China for our products could adversely affect our exports and, therefore, our financial results.
 
 Changes in worldwide or regional economic activity may adversely affect both demand and price.
 
Demand for pulp and paper products is directly linked to overall economic activity within each market we conduct commercial operations. A decrease in the level of activity in either the worldwide or any of the regional markets we operate within could adversely affect both the demand and the price of our products and thus our financial results.
 
 We face significant competition in some of our lines of business, which may adversely affect our market share and profitability.
 
The pulp and paper industry is highly competitive. Competitive features within the industry include the following:
 
 
·
in the domestic paper market, we face competition from larger international companies that have greater ability to support strategic expenditures directed to increase market share; and
 
 
·
in the international pulp and paper markets, we compete with larger competitors that have greater financial strength and higher production capacities.
 
Traditionally, imports of pulp and paper have not provided substantial competition for us in Brazil due to, among other factors, logistical costs, tariff rates and exchange rates on those products. However, currently an appreciated real has resulted in increased imports of selected grades of paper, thus increasing competition in this product line. In addition, the Brazilian government were to decrease import tariffs, we may face a sudden additional increase in competition in the domestic market by foreign producers.
 
8

 
In addition, most markets are served by several suppliers, often from different countries. Many factors influence our competitive position, including mill efficiency and operating rates and the availability, quality and cost of wood, energy, water, chemicals and labor, and exchange rate fluctuations. See “Item 3D—Risks Relating to Brazil—Exchange rate instability may adversely affect our financial condition and results of operations and the market price of our preferred shares and ADSs.” Some of our competitors have greater financial and marketing resources, larger customer bases and greater breadth of product offerings than we do. If we are unable to remain competitive with these producers in the future, our market share may be adversely affected. In addition, downward pressure on the prices of pulp and paper by our competitors may affect our profitability.
 
 Delays in the expansion of our facilities or in building new facilities may affect our costs and results of operations.
 
As part of our strategy to increase our international market share and improve our competitiveness through greater economies of scale, we may expand or build one or more production facilities. The expansion or construction of a production facility involves various risks. These risks include engineering, construction, regulatory and other significant challenges that may delay or prevent the successful operation of the project or significantly increase our costs. Our ability to complete successfully any expansion or new construction project on time is also subject to financing and other risks.
 
We may be adversely affected because:
 
 
·
we may not be able to complete any expansion or new construction project on time or within budget;
 
 
·
our new or modified facilities may not operate at designed capacity or may cost more to operate than we expect; and
 
 
·
we may not be able to sell our additional production at attractive prices.
 
 We may be adversely affected by the imposition and enforcement of more stringent environmental regulations that would require us to spend additional funds.
 
We are subject to stringent federal, state and local environmental laws and regulations in Brazil governing air emissions, effluent discharges, solid wastes, odor and reforestation, and we require permits from governmental agencies for certain of our operations. Changes in these laws and regulations and/or changes in the policies and procedures used to enforce existing laws and regulations could adversely affect us. If we fail to comply with these laws, regulations and permits, we could be fined or otherwise sanctioned by regulators or our permits could be revoked, and our ability to operate could be suspended or otherwise adversely affected. In addition, noncompliance with these laws, regulations and permits could result in criminal sanctions for us and for our employees. We could also be responsible for related environmental remediation costs, which could be substantial.
 
It is possible that governmental agencies or other authorities will pass new laws or impose additional laws and regulations even more stringent than the ones currently in force or will seek a more stringent interpretation of existing laws and regulations that would require us to spend additional funds on environmental compliance or limit our ability to operate as we currently do. In addition, these actions could increase the costs associated with renewing existing permits or applying for new ones. There can be no assurance that these additional funds or costs will not be material or that existing permits will be renewed.
 
In addition, environmental laws and regulations in certain countries may be more stringent than the ones we are subject to in Brazil, which may lead to such countries imposing trade related sanctions against Brazil or our industry. Furthermore, our inability to comply with more stringent foreign environmental laws and regulations may prevent us from seeking lower cost financing from foreign governmental related or multilateral development organizations, which may condition future financing on our compliance with more stringent environmental laws and regulations.
 
9

 
 Our insurance coverage may be insufficient to cover our losses, especially in cases of damage to our forests.
 
Our insurance may be insufficient to cover losses that we might incur. We have comprehensive insurance with leading insurers to cover damages to our mills caused by fire, general third-party liability for accidents and operational risks, and international and domestic transportation. However, we do not maintain insurance coverage against fire, disease and other risks to our forests. The occurrence of losses or other damages not covered by insurance or that exceed our insurance limits could result in significant unexpected additional costs.
 
If we are unable to manage potential problems and risks related to acquisitions and alliances, our business and growth prospects may suffer. Some of our competitors may be better positioned to acquire other pulp and paper businesses.
 
We may, as part of our business strategy, acquire other businesses in Brazil or elsewhere or enter into alliances. Our management is unable to predict whether or when any prospective acquisitions or alliances will occur, or the likelihood of a material transaction being completed on favorable terms and conditions. Our ability to continue to expand successfully through acquisitions or alliances depends on many factors, including our ability to identify acquisitions and negotiate, finance and close transactions. Even if we complete future acquisitions:
 
 
·
we could fail to successfully integrate the operations, services and products of any acquired company;
 
 
·
we could fail to select the best partners or fail to effectively plan and manage any alliance strategy;
 
 
·
the acquisitions could increase our costs;
 
 
·
our management’s attention could be diverted from other business concerns; and
 
 
·
we could lose key employees of the acquired company.
 
Our failure to integrate new businesses or manage new alliances successfully could adversely affect our business and financial performance. Furthermore, the world pulp and paper industry is undergoing consolidation, and many companies compete for acquisition and alliance opportunities in our industry. Some of our competitors have greater financial and other resources than we do. This may reduce the likelihood that we will be successful in completing acquisitions and alliances necessary for the expansion of our business. In addition, any major acquisition we consider may be subject to regulatory approval. We may not be successful in obtaining required regulatory approvals on a timely basis or at all. See “Item 4A—Information on VCP—History and Development of VCP.”
 
 We are part of a family controlled group of companies.
 
We are controlled by the Ermírio de Moraes family, which indirectly controls all of our outstanding common voting shares. Consequently, our controlling shareholders have the power to control us and all of our subsidiaries, including the power to:
 
 
·
elect our directors; and
 
 
·
determine the outcome of any action requiring shareholder approval, including transactions with related parties, corporate reorganizations and dispositions and the timing and payment of any future dividends.
 
We currently engage in, and expect in the future to engage in, commercial and financial transactions, from time to time, with our controlling shareholders or their affiliates. Commercial and financial transactions between our affiliates and us create the potential for, or could result in, conflicts of interests. For a discussion of certain related party transactions, see “Item 7—Major Shareholders and Related Party Transactions—Related Party Transactions.”
 
10

 
 We rely on third parties for some of our technology.
 
We rely on third parties for the technology that we use to make some of our value-added paper products. For example, Oji Paper of Japan has granted us the right to use its technology to manufacture and sell certain thermal papers in Brazil and to sell these products in some other countries. If a third-party licensor of technology that we use refused to continue licensing its technology to us, our results of operations could be adversely affected.
 
 Various other risks could have a material adverse effect on our financial results.
 
We are subject to various other risks affecting our forests and manufacturing processes, including fire, drought, disease, climate changes, strikes, post closings, shipping costs, electrical failures and factory explosions, which could have a material adverse effect on our financial results.
 
Risks Relating to Brazil
 
Brazilian economic and political conditions and perceptions of these conditions in the international market have a direct impact on our business and the market price of our preferred shares and ADSs.
 
Our operations are conducted in Brazil, and in 2007 we sold approximately 39% of our products in terms of volume to our customers located in Brazil. Accordingly, our financial conditions and results of operations are substantially dependent on economic conditions in Brazil. Brazil’s gross domestic product grew by 2.3% in 2005, 2.8% in 2006 and about 5.2% in 2007, but we cannot assure you that gross domestic product will increase or remain stable in the future. Future developments in the Brazilian economy may affect Brazil’s growth rates and, consequently, the consumption of pulp and paper. As a result, these developments could impair our business strategies, financial condition or results of operations.
 
The Brazilian government frequently intervenes in the Brazilian economy and occasionally makes drastic changes in policy and regulations. The Brazilian government’s actions to control inflation and affect other policies have included wage and price controls, currency devaluations, capital controls, and limits on imports. Our business, financial condition and results of operations may be adversely affected by changes in government policies as well as general economic factors, including:
 
 
·
currency fluctuations;
 
 
·
inflation;
 
 
·
interest rates;
 
 
·
energy policy;
 
 
·
liquidity of domestic capital and lending markets;
 
 
·
tax policy; and
 
 
·
other political, diplomatic, social and economic developments in or affecting Brazil.
 
Historically, the country’s political scenario has influenced the performance of the Brazilian economy and political crises have affected the confidence of investors and the general public, which resulted in economic deceleration and affected the trading prices of common shares issued by companies listed on the stock exchange. Future developments in policies of the Brazilian government and/or the uncertainty of whether and when such policies and regulations may be implemented, all of which are beyond the control of the Company could adversely affect our business, financial condition, results of operations or prospects and the market price of our preferred shares and ADSs.
 
11

 
Inflation and certain governmental measures to combat inflation may contribute significantly to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets.
 
Brazil has, in the past, experienced extremely high rates of inflation. More recently, according to the Índice Geral de Preços-Disponibilidade Interna, or IGP-DI, a general price inflation index, the Brazilian general price inflation rates were 1%, 4% and 7.9% in 2005, 2006 and 2007, respectively. Inflation itself and certain governmental measures to combat inflation in the past have had significant negative effects on the Brazilian economy. Our cash costs and operating expenses are substantially all in reais and tend to increase with Brazilian inflation because our suppliers and providers generally increase prices to reflect the depreciation of the value of the currency. If either the rate of Brazilian inflation increases more rapidly than any rate of appreciation of the U.S. dollar, then, as expressed in U.S. dollars, our operating expenses may increase. In addition, high inflation generally leads to higher domestic interest rates, and, as a result, our costs of real-denominated debt may increase. See “Item 5—Operating and Financial Review and Prospects—Overview—Brazilian Economic Environment.”
 
Exchange rate instability may adversely affect our financial condition and results of operations and the market price of our preferred shares and ADSs.
 
Because a significant portion of our revenues and assets is denominated in reais and we have U.S. dollar-denominated debt and other liabilities, we may be adversely affected by any future devaluations of the real against the U.S. dollar. The Brazilian currency has been devalued periodically during the last four decades. See “Item 3—Key Information—Selected Financial Data—Exchange Rates.”
 
Our production costs and operating expenses are substantially all in reais and will generally decrease, as expressed in U.S. dollars, as a result of any devaluation of the real. If either the rate of Brazilian inflation increases more rapidly than the rate of appreciation of the U.S. dollar against the real or the rate of appreciation of the U.S. dollar against the real increases more rapidly than the rate of the Brazilian inflation, then, as expressed in U.S. dollars, our operating expenses may increase. In addition, any significant devaluation of the real may produce exchange losses on unhedged debt denominated in foreign currency.
 
During the years 2005, 2006 and 2007 the real has appreciated against the dollar, 13%, 9% and 21%, respectively.
 
The Central Bank has intervened occasionally to control unstable movements in the foreign exchange rate. We cannot predict whether the Central Bank will continue to let the real float freely. Accordingly, it is not possible to predict what impact the Brazilian government’s exchange rate policies may have on us. We cannot assure you that the Brazilian government will not in the future impose a band within which the real/U.S. dollar exchange rate could fluctuate or set a fixed exchange rate, nor can we predict what impact such an event might have on our financial condition or results of operations.
 
Devaluations of the real relative to the U.S. dollar also create additional inflationary pressures in Brazil that may negatively affect us. They generally curtail access to foreign financial markets and may require government intervention, including recessionary governmental policies. See “—Inflation and certain governmental measures to combat inflation may contribute significantly to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets.” Devaluations also reduce the U.S. dollar value of distributions and dividends on our ADSs and the market price of our preferred shares and ADSs.
 
Developments in other markets may adversely affect the market price of our preferred shares and ADSs.
 
The market for securities issued by Brazilian companies is influenced by economic and market conditions in Brazil and, to varying degrees, market conditions in other Latin American and emerging market countries. Although economic conditions in such countries may differ significantly from economic conditions in Brazil, the reaction of investors to developments in these other countries may have an adverse effect on the market value of securities of Brazilian issuers. Developments or conditions in other emerging market countries have at times significantly affected the availability of credit in the Brazilian economy and resulted in considerable outflows of funds and declines in the amount of foreign currency invested in Brazil. Crises in other emerging market countries may hamper investor enthusiasm for securities of Brazilian issuers, including ours. This could adversely affect the trading price of the ADSs and our preferred shares and could also make it difficult for us to access the capital markets and finance our operations in the future on acceptable terms, or at all.
 
12

 
Recent speculation about, among other things, the rate of growth and the availability of credit in the United States economy has created volatility in the worldwide financial markets, including the emerging markets. Prospective negative changes in the economy in the United States may adversely affect the market price of our preferred shares and ADSs.
 
Risks Relating to Our Preferred Shares and ADSs
 
Exchange controls and restrictions on remittances abroad may adversely affect holders of our ADSs.
 
You may be adversely affected if the Brazilian government imposes restrictions on the remittance to foreign investors of the proceeds of their investments in Brazil and, as it has done in the past, on the conversion of the real into foreign currencies. These restrictions could hinder or prevent the conversion of dividends, distributions or the proceeds from any sale of preferred shares or ADSs, as the case may be, into U.S. dollars and the remittance of U.S. dollars abroad. We cannot assure you that the government will not take this type of or similar measures in the future. Holders of our ADSs could be adversely affected by delays in, or a refusal to grant, any required governmental approval for conversion of real payments and remittances abroad in respect of the preferred shares, including the preferred shares underlying the ADSs. In such a case, our ADS depositary will distribute reais or hold the reais it cannot convert for the account of the ADS holders who have not been paid.
 
Exchanging ADSs for the underlying preferred shares may have unfavorable consequences.
 
The Brazilian custodian for the preferred shares must obtain an electronic certificate of registration from the Central Bank to remit U.S. dollars abroad for payments of dividends, any other cash distributions, or upon the disposition of the preferred shares and sales proceeds related thereto. If you decide to exchange your ADSs for the underlying preferred shares, you will be entitled to continue to rely, for five business days from the date of exchange, on the ADS depositary’s electronic certificate of registration. Thereafter, you may not be able to obtain and remit U.S. dollars or other foreign currencies outside Brazil upon the disposition of the preferred shares, or distributions relating to the preferred shares, and you will generally be subject to less favorable tax treatment on gains with respect to the preferred shares, unless you obtain your own electronic certificate of registration with the Central Bank, under Resolution No. 2,689 of January 26, 2000 of the National Monetary Council, which entitles foreign investors to buy and sell on the Brazilian stock exchanges. If you attempt to obtain your own electronic certificate of registration, you may incur expenses or suffer significant delays in the application process. Obtaining an electronic certificate of registration involves generating significant documentation, including completing and filing various electronic forms with the Central Bank and the CVM. In order to complete this process, the investor will need to appoint at least one representative in Brazil with powers to perform certain actions relating to the foreign investment and will usually need to have a consultant or an attorney who has expertise in Central Bank and CVM regulations. These expenses or delays could adversely impact your ability to receive dividends or distributions relating to the preferred shares or the return of your capital in a timely manner. If you decide to exchange your preferred shares back into ADSs once you have registered your investment in the preferred shares, you may deposit your preferred shares with the custodian and rely on the ADS depositary’s electronic certificate of registration, subject to certain conditions. We cannot assure you that the ADS depositary’s electronic certificate of registration or any certificate of foreign capital registration obtained by you may not be affected by future legislative or other regulatory changes, or that additional restrictions applicable to you, the disposition of the underlying preferred shares or the repatriation of the proceeds from disposition could not be imposed in the future. See “Item 8—Financial Information—Dividend Policy and Dividends—Payment of dividends.”
 
The relative volatility and illiquidity of the Brazilian securities markets may adversely affect holders of our preferred shares or ADSs.
 
Investments in securities, such as the preferred shares or the ADSs, of issuers from emerging market countries, including Brazil, involve a higher degree of risk than investing in securities of issuers from more developed countries.
 
13

The Brazilian securities market is substantially smaller, less liquid, more concentrated and more volatile than major securities markets in the United States. Accordingly, the ability of the holders to sell the preferred shares underlying the ADSs at a price and time at which holders wish to do so may be substantially limited. The São Paulo Stock Exchange (Bolsa de Valores de São Paulo), or BOVESPA, the main Brazilian stock exchange, had a market capitalization of approximately US$ 1,4 trillion as of December 31, 2007, and an average daily trading volume of approximately US$ 667 million, US$ 1.1 billion and US$ 2.6 billion in 2005, 2006 and 2007 respectively. In comparison, the New York Stock Exchange had a market capitalization of approximately US$ 27 trillion as of December 31, 2007.
 
Because we are subject to specific rules and regulations as a Brazilian company, holders of our preferred shares or ADSs have fewer and less well- defined shareholders’ rights than investors in U.S. companies.
 
Our corporate affairs are governed by our by-laws and the Brazilian corporate law, which differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States, such as Delaware or New York, or in certain other jurisdictions outside Brazil. In addition, your rights or the rights of holders of the preferred shares under the Brazilian corporate law to protect your interests relative to actions taken by our Board of Directors or the holders of common shares may be fewer and less well-defined than under the laws of other jurisdictions outside Brazil.
 
Although Brazilian law imposes restrictions on insider trading and price manipulation, the Brazilian securities markets are not as highly regulated and supervised as the securities markets in the United States or certain other jurisdictions. In addition, rules and policies against self-dealing and regarding the preservation of shareholder interests may be less well developed and enforced in Brazil than in the United States, potentially disadvantaging holders of our preferred shares and ADSs. When compared to Delaware general corporation law, the Brazilian corporate law and practice have less detailed and less well established rules and judicial precedents relating to the review of management decisions under duty of care and duty of loyalty standards in the context of corporate restructurings, transactions with related parties and sale-of-business transactions. In addition, shareholders must hold 5% of the outstanding share capital of a corporation to have standing to bring shareholders’ derivative suits, and shareholders ordinarily do not have standing to bring a class action.
 
Also, in accordance with Brazilian corporate law and our by-laws, holders of our preferred shares, and therefore of our ADSs, are not entitled to vote at meetings of our shareholders except in limited circumstances.
 
Holders of ADSs may be unable to exercise preemptive rights with respect to our preferred shares.
 
You may not be able to exercise the preemptive rights relating to the preferred shares underlying your ADSs unless a registration statement under the Securities Act of 1933, as amended, or the Securities Act, is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available and the ADS depositary determines to make the rights available to you. We are not obligated to file a registration statement with respect to the shares relating to these preemptive rights, and we cannot assure you that we will file any such registration statement. Unless we file a registration statement or an exemption from registration applies, you may receive only the net proceeds from the sale of your preemptive rights by the ADS depositary or, if the preemptive rights cannot be sold, the rights will be allowed to lapse. See “Item 10—Additional Information—Exchange Controls—Preemptive Rights.”
 
ITEM 4.  INFORMATION ON VCP
 
 
A.
History and Development of VCP
 
We are incorporated under the laws of the Federative Republic of Brazil under the name Votorantim Celulose e Papel S.A., as a corporation with unlimited duration. We have the legal status of a sociedade por ações, or a stock corporation, operating under the Brazilian corporate law. Our principal executive offices are located at Alameda Santos, 1357, 6th floor, 01419 908, São Paulo, SP, Brazil (telephone: 55-11-2138-4287/4261/4361). Our agent for service of process in the United States is CT Corporation, 111 Eighth Avenue, New York, New York 10011.
 
14

 
At December 31, 2007, our industrial facilities consisted of one integrated pulp mill in Jacareí, state of São Paulo (integrated with our 40% stake in the joint venture with Ahlstrom Corporation (“Ahlstrom”) for the Jacareí paper mill, as discussed below), one facility exclusively dedicated to paper production in Piracicaba, state of São Paulo and a 50% stake in Ripasa Celulose e Papel, currently denominated Conpacel, located in Americana, state of São Paulo. We also have two forest bases under development in the states of Mato Grosso do Sul and Rio Grande do Sul and a Project Mill under construction in Três Lagoas, in the state of Mato Grosso do Sul. At December 31, 2007, our installed capacity was 1,415,000 tons per year of pulp and 365,000 tons per year of coated, uncoated and specialty papers with approximately 85% of our paper sales volume and 27% of our pulp sales volume are sold to the domestic market. In 2007 a number of significant transactions took place, (i) we concluded the asset swap with International Paper Investment (Holland) B.V. (“International Paper”), (ii) we sold the small scale and non-core mills of Ripasa (Embu, Cubatão and Limeira) and Mogi das Cruzes mill, (iii) we began a joint-venture with the Finnish company Ahlstrom for coated and uncoated papers in the Jacareí mill, (iv) we signed an Strategic Business Agreement (“SBA”) with Oji Paper for the technology transfer in the special papers, (v) we achieved productivity gains at Ripasa and (vi) we negotiated long-term contracts for pulp supply,in connection with the paper assets divestments. Additionally, we have received an investment-grade rating from three world’s most respected rating agencies: Standard and Poors, Fitch Rating and Moody’s. See “Item 4.A. Information on VCP - History and Development of VCP.”
 
We also have a paper distribution division, KSR, with an extensive product line, including graphic papers and products. We have an automated, modern warehouse system that permits efficient distribution and that is supported by a specialized transportation fleet for deliveries throughout Brazil.
 
Our activities began in 1988 when the Votorantim group purchased Celpav Celulose e Papel Ltda., or Celpav, a pulp and paper producer based in the state of São Paulo. We began production in 1991 after expanding and modernizing our facilities. In September 1992, the Votorantim group purchased Indústrias de Papel Simão S.A., or Papel Simão, which was listed on Bovespa. In 1995, Celpav became a subsidiary of Papel Simão, and Papel Simão changed its name to Votorantim Celulose e Papel S.A. We later transferred our operating assets to Celpav and, in July 1999, Celpav was merged into VCP.
 
In 1991, our annual capacity was 350,000 tons per year of pulp and 280,000 tons per year of paper. With the acquisition of Papel Simão, the Votorantim group added 220,000 tons of pulp and 250,000 tons of paper to the annual pulp and paper production capacity, respectively. Following the acquisition of Papel Simão, the Votorantim group’s combined pulp and paper operations were the third largest in Brazil in terms of sales. We further increased our pulp production capacity by 230,000 tons in 1996 with the addition of a new pulp production line at the Jacareí mill. We also added a new coater in 1996 at the Piracicaba mill, which increased our annual production capacity of thermal and carbonless paper to 40,000 tons per year and further production optimizations in 2001 raised the production capacity by 50,000 tons of pulp per year. Our annual production capacity of coated paper increased to 175,000 tons per year with the addition of a new coater at the Jacareí mill in 1997 and the addition of a new on line coater at the Piracicaba mill in 1998. As a result of these additions and other optimization projects, our paper production capacity reached 635,000 tons per year in 2005.
 
On December 29, 1999, we sold our 51% stake in Indústria de Papel de Salto Ltda., or Salto, to Arjo Wiggins Participações e Comércio Ltda., a subsidiary of Arjo Wiggins S.A., a French company, for a cash payment of US$ 23 million. Salto produced security, industrial and other specialty papers, including paper used for bank notes, checks, identification cards, vouchers and bibles. We realized a gain of US$ 13 million on this sale.
 
On April 19, 2000, we completed a registered offering of 7,920,000 ADSs. Each ADS represented 500 preferred shares, and the ADSs were listed on the New York Stock Exchange under the symbol “VCP.” Of the 7,920,000 ADSs being offered at that time, we sold 2,047,648 ADSs and certain of our shareholders sold the remaining 5,872,352 ADSs. Concurrently, 440,000,000 preferred shares were sold in Brazil.
 
On August 14, 2000, our Board of Directors approved the Jacareí expansion, which has expanded the pulp production capacity at our Jacareí mill by approximately 570,000 metric tons, raising our total current annual installed capacity from 850,000 in 2002 to 1.4 million metric tons per year in 2005. We had invested a total of US$ 495 million in the Jacareí expansion. The government-owned development bank, Banco Nacional de Desenvolvimento Econômico e Social—BNDES, or BNDES, financed part of our investment in the Jacareí expansion. See “Item 4—Information on VCP—Property, Plant and Equipment—Expansions.”
 
15

 
On October 3, 2001, we purchased 28.0% of the voting shares (representing 12.35% of the total capital) of Aracruz Celulose S.A., or Aracruz, from the Mondi Group, for approximately US$ 370 million. Aracruz is a Brazilian pulp exporter whose ADSs trade on the New York Stock Exchange under the symbol “ARA.” We acquired our interest in Aracruz in order to increase our exposure to the international pulp market, and we accounted for this investment under the equity method. We incorporated Newark Financial Inc. (“Newark”) to enable us to acquire our interest in Aracruz and we financed this acquisition with a bridge loan in the amount of US$ 370 million in 2001, which was refinanced in May 2002 with a US$ 380 million syndicated loan and fully paid in 2005. See “Item 5—Operating and Financial Review and Prospects—Liquidity and Capital Resources—Debt.” Our acquisition of 28% of Aracruz’s voting shares was unconditionally approved by the Conselho Administrativo de Defesa Econômica, known as CADE, the Brazilian antitrust regulator, on November 25, 2003. We reduced the book value of our investment in Aracruz to an amount equal to the market value of Aracruz ADRs at December 31, 2002. The impairment provision of US$ 136 million was determined based on the market price of US$ 18.56 per each Aracruz ADRs on December 31, 2002, and the amount was charged directly to income. On December 31, 2007 and 2006 the market price for each Aracruz ADR was US$ 74.35 and US$ 61.21, respectively.
 
We do not expect to have significant operational involvement at Aracruz at this time. A subsidiary of ours became a party to the Aracruz shareholders’ agreement, along with BNDESPAR, the Lorentzen Group and the Safra Group. Under the shareholders’ agreement, our subsidiary is entitled to and has appointed three directors to the Aracruz Board of Directors, which currently consists of ten directors. The shareholders’ agreement, which expires on May 11, 2008, provides that the maximum number of shares of voting stock of Aracruz to be held by any party to the shareholders’ agreement may not exceed 28% of the total outstanding shares of voting stock of Aracruz. In addition, the shareholders’ agreement requires that each person or entity who acquires shares of voting stock of Aracruz from any of the parties to the shareholders’ agreement become a party to such agreement.
 
On December 1, 2001, VCP Exportadora e Participações S.A., or VCP Exportadora, incorporated in April 2001, indirectly acquired VCP North America Inc., incorporated in Delaware, United States, or VCP North America, and VCP Trading N.V. incorporated in Curaçao, or VCP Trading, from Votorantim International Holding N.V., for US$ 50,000 and US$ 30,000, respectively, for the purpose of centralizing our commercial operations in VCP Exportadora.
 
In January 2002, we incorporated VCP Florestal, which assumed all of the assets and liabilities relating to our forestry operations. In March 2002, we incorporated VCP Overseas Holding KfT, or Overseas Holding, our wholly owned subsidiary incorporated in Hungary. In June 2002, we incorporated St. Helen Holding III, B.V., located in Curaçao.
 
In February 2003, Arapar S.A. and Lorentzen Empreendimentos S.A., collectively Grupo Lorentzen, on the one hand, and SODEPA, on the other hand, as shareholders of Aracruz, entered into an agreement pursuant to which each party agreed not to sell their respective shareholding in Aracruz without the consent of the other.
 
In November 2004, we signed an agreement with Suzano Bahia Sul Papel e Celulose S.A., or Suzano, for the acquisition of the common and preferred stock of Ripasa S.A. Celulose e Papel, or Ripasa. On March 31, 2005, we finalized the acquisition, through a 50% joint venture, of 77.59% (our interest - 38.80%) indirect interest in the voting capital and 46.06% (our interest - 23.03%) indirect interest in the total capital of Ripasa, for US$ 275 million. A purchase option was also signed for the option to purchase common shares and preferred shares, totaling 22.41% of the voting stock and 13.45% of the total stock, respectively and to be exercised within six years, for a total current amount of US$ 179 million.
 
On January 26, 2005, in an Extraordinary General Meeting, our shareholders determined that VCP Florestal be merged into us to achieve cost reductions and increased business synergies between the two companies. VCP Florestal was dissolved as a result of the merger and we succeeded it with respect to all rights and obligations thereof. There was no increase in our capital stock as a result of the merger as we owned all the shares of VCP Florestal.
 
16

 
On July 20, 2005, VCP and Suzano announced a proposed corporate restructuring to be implemented in Ripasa, which would allow that company’s minority shareholders (around 1,300 shareholders) to migrate to VCP and Suzano. This restructuring was examined by the CVM, which did not object to or restrict its realization; however, the restructuring was suspended by judicial decision. Given the potentially lengthy period of delay to reach a favorable outcome and the fact that the synergies generated by the acquisition of Ripasa were not being fully realized, on April 26, 2006, VCP and Suzano, in order to settle the judicial action and implement the restructuring, entered into an agreement with the group of Ripasa’s preferred shareholders, who had brought the action to block the acquisition. Ripasa’s minority shareholders received shares of VCP and Suzano plus a complementary amount in cash equivalent to R$ 1.0712 for each Ripasa preferred share in their possession on the date of registration. Ripasa’s restructuring was concluded and, in September 2006, VCP and Suzano started to sell Americana’s unit products as a pre-consortium stage whereby each party purchases 50% of Ripasa’s production and resells it within its own distribution channels. In August 2007, the Brazilian anti-trust authority (CADE) approved the Ripasa purchase with minor restrictions. We are still waiting for the Brazilian tax authorities’ approval to transform Ripasa’s unit of Americana into a consortium (Conpacel). See “Competition” for more details about the Ripasa transaction.
 
Following the corporate restructuring, the said call options and the put option of certain former controlling shareholders of Ripasa, were modified to substitute the Ripasa shares for shares in VCP and Suzano as those former Ripasa minority shareholders had exchanged their shares for shares in VCP and Suzano. Accordingly, VCP has a call option to acquire 3,124,139 of its own non-redeemable preferred shares during a twelve-month period starting on March 31, 2010. At December 31, 2007, the total updated amount was US$ 358 million for both VCP and Suzano interests. The former shareholders of Ripasa, now shareholders of VCP, who are party to the agreement, have a put option which may require VCP to acquire all their non-redeemable preferred shares during a period of five years through March 31, 2010. Pursuant to the agreement, as a required condition precedent, the put/call options can only be exercised if the underlying shares are free of liens and encumbrances. For more information on the call and put options, see Note 4(a) to our financial statements.
 
In November 2005, we announced the beginning of the social and environmental licensing process for the implementation of a bleached eucalyptus pulp factory to be built in Rio Grande do Sul. If implemented, this unit will occupy an area of approximately 450 to 500 hectares, located in the region of Rio Grande-Pelotas-Arroio Grande. Overall nominal capacity is expected to be 1.3 million tons of pulp per year. We are progressing on the environmental licensing and the project should be submitted to the Board of Directors approval by 2009, after which the basic engineering and the technical proposals should be developed.
 
In February 2006, we announced that Standard & Poor’s Ratings Services (S&P) assigned its ‘BBB-’ foreign and local currency global scale corporate credit ratings to VCP, an investment grade rating category. According to S&P, the outlook is stable for VCP, which reflects the assumptions that VCP will improve its financial performance by 2006 based on the recovery of the domestic paper sector; will continue to adopt a prudent financial policy, presenting comfortable levels of cash holdings; and will start to show debt de-leverage at the same pace as its debt amortization, depending on future investment opportunities.
 
In April 2006, for administrative and economic reasons, we merged VCP Exportadora e Participações S.A., a wholly owned subsidiary, into VCP and assumed all of the assets and liabilities relating to its export operations.
 
In September 2006, we announced a plan to divest our non-integrated special paper mill located in the city of Mogi das Cruzes in the state of São Paulo. For additional information on our divestiture plan, see note 4 (c) to our financial statements.
 
In September, 2006, International Paper, a wholly owned subsidiary of International Paper Company, and VCP entered into an Exchange Agreement (the “Exchange Agreement”). Pursuant to the terms of the Exchange Agreement, International Paper agreed to exchange its pulp mill project (the “Project Mill”) being developed in Três Lagoas, state of Mato Grosso do Sul, Brazil (together with approximately 100,000 hectares of surrounding forestlands) for VCP’s Luiz Antonio pulp and uncoated paper mill and approximately 60,000 hectares of forestlands located in the state of São Paulo, Brazil. International Paper has already fully funded the Project mill as stated at the exchange asset date in the amount of US $1.15 billion for the mill construction. Pursuant to an amendment to the agreement, all financial income accruing from the funds in trust will be applied, exclusively, to the project under construction. This financial income in 2007 totaled US$ 124 million.
 
17

 
On January 2, 2007, VCP created a new subsidiary, LA Celulose e Papel Ltda. (“LA”), as part of the asset exchange agreement with International Paper. This wholly owned subsidiary has no significant assets or liabilities. On January 2, 2007, VCP transferred to LA the assets of the Luiz Antonio mill and related forests. On February 1, 2007, VCP transferred LA to International Paper and received Chamflora (then an International Paper subsidiary) in exchange. Chamflora had previously contracted an internationally recognized engineering and construction company, Pöyry Engenharia (“Pöyry”), on an EPC Engineering, Procurement and Construction, or EPC, basis to build the Três Lagoas mill as a turn-key project. Chamflora has already paid Pöyry for the EPC, which had in turn transferred to a commercial bank acting as the Trustee Bank (“Trustee”) the corresponding funding of this project. These resources have been and will continue to be disbursed by the Trustee in accordance with the physical construction schedule of the project, which also contemplates the orders with third parties to supply equipment and services being rendered in Três Lagoas to Chamflora. Effective February 1, 2007, and with the completion of the asset exchange, Chamflora’s name was changed to VCP Mato Grosso do Sul Celulose Ltda. (VCP-MS), and is accounting for these EPC disbursements as a “Construction in Progress”. Upon the completion of the construction and start-up of the mill, these costs will be transferred to the appropriate fixed assets accounts. Additionally, pursuant an amendment to the agreement all financial income accruing from the funds in trust will be applied, exclusively, to the project under construction. See Item 4C “Organizational Structure” and Item 10.C “Additional Information—Material Contracts.”
 
A third party, Pöyry, was contracted in 2006 by International Paper's subsidiary (now denominated VCP-MS) as a project manager for the project mill construction. Pöyry will manage subcontractors and acquire the equipment and other supplies in order to place the plant in operation. Pöyry will earn a management fee and will bear the construction risks and will be entitled to any surpluses or be responsible for shortfalls.
 
The Luiz Antonio mill produces 355,000 metric tons of uncoated papers and 100,000 metric tons of market pulp annually. The 100,000 metric tonnes of market pulp will be supplied to VCP, for its use in other facilities, on competitive terms under a long-term supply agreement. The Três Lagoas project mill is expected to be completed in May 2009 and to have a nominal capacity of 1,300,000 tons of market pulp per annum.
 
Under the Exchange Agreement, International Paper is granted the right to construct, at its cost, up to two paper machines adjacent to, and integrated with, the Project Mill. If International Paper exercises its right to build one or both paper machines adjacent to the Project Mill, (1) certain parcels of real property will be retained by International Paper upon which the paper machines and ancillary facilities will be constructed and (2) the paper machines will be supported by long-term supply agreements under which VCP will provide International Paper pulp on competitive terms and utilities and other services at rates based on VCP’s actual operating costs.
 
In November 2006, Fitch Ratings has assigned ‘BBB-’ foreign and local currency issuer default ratings (IDRs), and investment grade rating, to the Company. According to Fitch Ratings, the rating outlook is stable. VCP’s ratings are supported by its strong business position and solid financial profile. The rating confirms our strategy to diversify our products and markets, maintaining competitive costs and the commitment with business sustainability.
 
In February 2007, we concluded the exchange of our industrial and forestry assets located in the city of Luiz Antonio (state of São Paulo) for International Paper’s pulp mill project and forestry assets located in Três Lagoas (state of Mato Grosso do Sul), which are held by our wholly owned subsidiary VCP-MS.
 
Also in February 2007 we announced the sale to Suzano of our 50% interest in the Ripasa unit located at Embu, in the municipality of São Paulo, as part of the Ripasa reorganization. The Embu unit was valued at US$ 40 million, so our 50% indirect interest totaled US$ 20 million. The closing date of the divestment was on March 30, 2007. This transaction was in line with our strategic plan to divest Ripasa’s non-strategic units. The Embu unit had a production capacity of 48,000 tons per year of cardboard.
 
In May 2007, we announced an intended joint venture agreement with the Finnish company Ahlstrom for the paper production in our facility located in Jacareí, state of São Paulo. The agreement was concluded in September 2007 and Ahlstrom acquired a 60% interest of this new joint venture for the paper assets in Jacareí mill, denominated Ahlstrom VCP Indústria de Papéis Especiais S.A. (“Ahlstrom VCP”) with an option to purchase the remaining 40% within two years.
 
18

 
The specialty papers produced at the Jacareí mill are primarily directed to the labeling applications and flexible packaging markets, in which Ahlstrom will reinforce its worldwide leadership position. The paper assets of the joint venture have an annual production capacity of approximately 105,000 tons per year of uncoated wood-free papers, with capacity to convert up to 80,000 tons per year of coated papers. The parties also signed a long-term agreement whereby VCP will supply eucalyptus pulp, utilities and other services to the joint venture operations at the Jacareí mill at competitive prices.
 
Under the terms of the agreement, Ahlstrom has an option to purchase an additional 20% and, at a later stage, the remaining 20% of the shares in the joint venture held by VCP, whereas VCP has an option to sell the same number of shares at the same time. The first option can be exercised at any time from the beginning of the second year of the venture’s operations through the end of that year. This first option allows VCP to sell and/or Ahlstrom to buy 20% of VCP’s interest for the equivalent of US$ 38 million in reais. The second option can be exercised at any time between the beginning of the third year of operations and terminates at the end of the fourth year of operations. This option allows VCP to sell and/or Ahlstrom to buy the remaining 20% of its interest (if the first option has been exercised) or the remaining 40% (if the first option has not been exercised). The price of this second option will be calculated based on a formula determined in the contract such that the total amount to be paid for the 100% interest will not be less than US$ 165 million and not be higher than US$ 190 million. See Item 4C “Organizational Structure” and Item 10.C “Additional Information - Material Contracts.”
 
In May, 2007 Standard & Poor’s Ratings Services (S&P) upgraded our foreign and local currency global scale corporate credit rating to “BBB” from “BBB-,” strengthening our position within the investment grade rating category. The outlook is stable. The rating reflects our solid and long-standing track record of financial performance coupled with the reduced country risks and better economic prospects for Brazil. The upgrade is also supported by the steady ongoing and increasing export base of our company which guarantees its strong capacity to service debt and which should be strengthened by the relevant cash generation originated from the Três Lagoas project from 2009 onwards. Additionally, the Brazilian forest product industry shows positive long-term trends in which we have a highly competitive position, with one of the lowest pulp production costs in the world, and contributing to prudent growth prospects through organic expansions.
 
In June 2007, we redifined the scope of the pulp project mill now under construction in Três Lagoas, state of Mato Grosso do Sul, by increasing the nominal capacity from 900,000 tons to 1,300,000 tons per year of bleached eucalyptus pulp with a total estimated cost for the mill of approximately US$ 1.5 billion. The capacity and value of the project were redefined due to three factors: (i) changes in market conditions such as commodities and international price increases, especially for metals; (ii) currency appreciation over the US dollar; and (iii) strong demand for equipment in every sector of the economy. The resulting capacity increase will result in the plant being more competitive and the optimization of the investment per metric ton. We believe that the pulp project mill in Três Lagoas, in the state of Mato Grosso do Sul, has a potential for a future second phase expansion.
 
In August 2007 we and Suzano announced, as part of the Ripasa reorganization, the sale of our respective interests in the Ripasa’s units located in Cubatão and Limeira, to MD Papéis LTDA for a total of US$ 65 million. The closing of the transaction occurred in November 2007. The Cubatão unit has a production capacity of approximately 61,000 tons per year of graphic, editorial and special printing and writing papers. The Limeira unit has a production capacity of approximately 58,000 tons per year of cardboard. This transaction concluded the restructuring process of Ripasa.
 
Also in August 2007 we announced the execution of a long term SBA with Oji Paper. The agreement will allow us to further our offering of thermal paper technologies in Brazil and the region of Latin America, while allowing Oji to expand its worldwide presence as a market leader in thermal technology. Through the execution of the SBA, we will be able to draw on the technologies of Oji as well as its global subsidiaries including the technology of Kanzaki Specialty Papers, Inc, (KSP) Kanzan Spezialpapiere GmbH (Kanzan) and Oji Paper Thailand Ltd. (OPT). Going forward, we will be prepared to meet the growing demands of an expanding market by drawing on the technological process of Oji Paper globally. The SBA agreement coupled with the expansion of our Piracicaba mill will permit the continuation of enhanced quality and improved value to our customers.
 
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On August 9, 2007, the Administrative Council for Economic Defense (CADE) approved with minor restrictions relating to Corporate Governance and free competition, the acquisition of RIPASA by VCP and Suzano, announced in 2004. Approval is still pending from tax authorities to convert the Americana mill production unit into a consortium (Conpacel).
 
In October 2007, Moody’s assigned issuer ratings of Baa3 on its global scale and Aa1.br on its Brazilian national scale to VCP, an investment grade rating category. The ratings outlook was stable. According to Moody’s, the ratings reflect primarily our position as one of the lowest cost pulp producers globally based on a long-term sustainable business model, depicted by structural cost advantages against most international peers, including substantial self-sufficiency in wood fiber and electricity, and efficient logistics. The stable outlook reflects Moody’s view that our company will remain a global cost-competitive pulp producer over the near term, and will prudently manage its capital structure during its expansion program while simultaneously maintaining healthy liquidity levels.
 
In October 2007, our subsidiary VCP-MS signed an agreement with ALL - América Latina Logística S.A (“ALL”) for ALL to provide transport services for more than 1 million tons per year of pulp from Três Lagoas to the port of Santos for a twenty-year term beginning in 2009. The agreement provides primarily for (i) railway transportation service from the facility to the port of the pulp volume produced in Três Lagoas; (ii) construction of a railway spur line connecting ALL’s main rail line to the facility; and (iii) investments by both companies for wagons, locomotives and permanent railway infrastructure.
 
Capital Expenditures
 
Our capital expenditures disbursements totaled US$ 353 million in 2007, US$ 248 million in 2006 and US$ 247 million in 2005. We expect our capital expenditure to be US$ 583 million in 2008. The increase in capital expenditures from 2006 to 2007 was mainly due to continued large investments in a new forest reserve (land acquisition and plantation) in Rio Grande do Sul State, in the south of Brazil, and plantation and additional land acquisition for the pulp project mill in Três Lagoas, state of Mato Grosso do Sul acquired by exchange in 2007. These expenditures for land acquisition and forestry plantation not only reduce our dependence on raw materials from third parties, but also assure our supply of raw materials for current or eventual expansion of our pulp mill capacity.
 
We believe that our participation in Ripasa as a production unit, with 50% of volumes being sold by VCP, the corresponding synergies and our prior investments in our own facilities will allow us to continue to grow and continue to implement our business plan.
 
The table below sets forth a breakdown of our most significant capital expenditures for the periods indicated:
 
   
For the years ended December 31,
 
   
2007
 
2006
 
2005
 
   
(in US$ millions)
 
Expansion
 
US$
 67
 
US$
 47
 
US$
 32
 
Forests (includes land purchase)
   
216
   
116
   
131
 
Improvements/modernization 
   
12
   
33
   
35
 
Other (includes maintenance and information technology)
   
58
   
52
   
49
 
Total
 
US$
 353
 
US$
 248
 
US$
 247
 

If we consider our 50% stake in Ripasa, we have an additional capital expenditure of US$ 57 million, primarily related to the expansion of the pulp capacity of the mill (Project P630), increasing our total capital expenditure for 2007 to US$ 410 million.
 
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The following table shows the estimated breakdown of planned capital expenditures during 2008, which is expected to be financed by cash generated from operations and by existing cash:
 
   
US$ in millions
 
Expansion projects 
 
$
247
 
Forests (includes land purchase) 
   
281
 
Improvements/modernization 
   
13
 
Other (includes maintenance and information technology) 
   
42
 
Total
 
$
583
 

If we consider our 50% stake in Ripasa, US$ 47 million, we have for 2008 a total capital expenditure amounting to US$ 629 million. Planned land acquisition and forestry plantation in 2008 will occur principally in Rio Grande do Sul and Mato Grosso do Sul states. Disbursements for expansion will be principally related to the capacity expansion of the Três Lagoas mill, currently under construction, including US$ 129 million for the Três Lagoas mill related mostly to costs associated with the increase in nominal capacity and similar matters. Disbursements from the construction trust account for the initial project are not included within these amounts.
 
 
B.
Business Overview
 
We are one of the largest pulp and paper products companies in Brazil and among the leading Brazilian producer of wood-free printing and writing papers and specialty papers in terms of net operating revenue and total assets, according to Bracelpa. We produce bleached eucalyptus kraft pulp (“BEKP”), which is a high-quality variety of hardwood pulp. In 2006 and 2007 we sold approximately 63% and 80%, respectively, of our pulp production to third parties, and we use the remainder internally to manufacture a wide range of printing and writing paper products, including coated and uncoated printing and writing papers, thermal papers, carbonless papers and other specialty papers.
 
Operations
 
Our total sales volume was 1,492,527 tons in 2005, 1,611,398 tons in 2006 and 1,596,988 tons in 2007. Our net revenues were US$ 1,130 million in 2005, US$ 1,317 million in 2006 and US$ 1,333 million in 2007.
 
In 2007, 40% of the volume and 53% of total sales were derived from the domestic market compared to 37% and 52%, respectively, in 2006, 34% and 50% , respectively, in 2005. In the pulp market, the domestic market accounted for 21% of the sales volume and 18% of the revenues derived from pulp in 2007. In the paper market, the domestic market accounted for 80% of the sales volume and for 87% of the revenues derived from paper in 2007. The table below sets forth the percentages of our net revenues in 2007, 2006 and 2005 that correspond to the domestic and export markets and the breakdown by product of our net revenues:
 
   
2007
 
2006
 
2005
 
Sales by market
             
Domestic
   
53
%
 
52
%
 
50
%
Export
   
47
%
 
48
%
 
50
%
                     
Sales by product
                   
Market Pulp
   
49
%
 
39
%
 
39
%
Paper
   
51
%
 
61
%
 
61
%

In 2007, we produced 1,394,370 tons of eucalyptus pulp compared to 1,444,480 tons in 2006 and 1,372,197 tons in 2005. In 2007, we sold 1,097,652 tons of this production as market pulp to third-party producers and we used the remainder to manufacture paper products. Our production and related U.S. dollar based exports of pulp also increased during 2007. We sold US$ 439 million in 2005, US$ 520 million in 2006 and US$ 657 million in 2007. The increase in our market pulp revenues from 2005 to 2007 was mainly due to the debottlenecking of the new pulp line and the divestiture process the company has been through releasing part of the pulp used as integrated to market pulp. See “Item 4—Information on VCP—History and Development of VCP.”
 
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In 2007, our sales volume of paper products decreased to 499,336 tons from 669,593 tons in 2006. This decrease in sales volume is mainly due to the divestiture process in which the company has begun focusing more on pulp and continuing to shift our paper sales mix toward higher margin products. Uncoated and coated printing and writing paper sales accounted for 64% of our total paper products revenues in 2007 and 72% of our total paper products revenues in 2006. The remainder of our revenues from paper products in 2006 and 2005 were made up of sales of special and chemical (thermal and carbonless) paper, accounting for 36% in 2007 and 28% in 2006 of paper sales. Our printing and writing papers are used for a variety of business supplies, including notebooks, books, continuous forms, labels, brochures and magazines. Our market share in Brazil in 2007, based on data from Bracelpa, was 32% for coated papers, 15% for uncoated cut-size papers and 12% for uncoated offset papers. We sold 20% of our total printing and writing paper sales volume outside of Brazil in 2007 (30% in 2006).
 
Our Ownership Structure
 
We are part of the Votorantim group, one of the largest privately held Brazilian groups of companies. The Votorantim group was founded in 1918 by Senator José Ermírio de Moraes and is controlled by the Ermírio de Moraes family. The three core businesses of the Votorantim group are cement, aluminum and pulp and paper. The Votorantim group is also involved in other industries, including metallurgy, financial services, chemicals and agribusiness. The following chart shows our ownership structure and principal subsidiaries as of December 31, 2007 (see “Item 4.c.—Organizational Structure” for the total economic structure of VCP):
 
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VCP’s immediate parent company is VID, which in turn is ultimately controlled by VPAR, which in turn is controlled by Hejoassu Administração Ltda., which is controlled by the Ermírio de Moraes family. As of December 31, 2007, our total shares outstanding were 204,145,507 (105,702,452 voting and 98,443,055 preferred).
 
Our Business Strategy
 
We intend to be one of the leaders in the pulp and paper industry, building on our competitive strengths with the aid of the Votorantim Management System (SGV - Sistema de Gestão Votorantim) in order to create sustainable value to our shareholders. The principal components of our strategy are to:
 
 
·
be an important player in the international pulp market, leveraging the structural competitive advantages in Brazil;
 
 
·
consolidate our leadership position in the growing regional market for specialty papers;
 
 
·
expand our production capacity through both mill expansion and strategic acquisitions, alliances and joint ventures to meet increased demand in both the domestic and export markets;
 
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·
achieve sales of 6 million tons per year of market pulp and reducing the paper presence to 0.5 million tons per year of printing and writing papers by 2020; and
 
 
·
focus on Research and Development and in genetics development aided by operational efficiency and cost control programs.
 
Expand our presence in the international pulp market
 
We intend to take advantage of our competitive strengths to increase our market share in the international pulp market. In 2007, we sold approximately 80% of our market pulp tonnage outside of Brazil (88% in 2006), compared to 2% in 1996 when we began exporting. Our technology, productivity, sustainability of our forest operations and our use of cloning methods in addition to the high forest yields due to climate and soil conditions in Brazil and the short harvest cycle are important competitive advantages over producers in many other countries, and allow us to play an active and competitive role in the global pulp market. Investment in Aracruz and the Jacareí expansion reinforce our presence in the international pulp market. The Três Lagoas pulp mill now under construction obtained via our asset exchange with International Paper, as supported by continued investment in new forestry bases in the Brazilian states of Rio Grande do Sul and Mato Grosso do Sul, are the sources for future organic growth in the pulp business.
 
Maintain our leadership position in the growing regional market for coated, thermal and carbonless papers
 
We are currently a market leader for value-added papers, such as coated papers, in Brazil. We are also one of the main players for uncoated printing and writing paper in Brazil. We expect domestic demand to grow along with the expected growth in the economy of Brazil over the next few years. In order to consolidate our market position, we focus on long-term relationships with our customers by seeking to increase our understanding of our customers and their industries and to tailor our products to their specific needs. Our investment in Ripasa strengthens our presence in the domestic coated and uncoated market.
 
Continue to shift our paper sales mix toward higher margin products
 
We believe that an improved product mix with more value-added products can increase operating margins even if average paper prices do not improve significantly. In addition, these products are subject to less cyclical price variations. Therefore, we seek to increase our production of value-added paper products, such as coated, thermal, carbonless and other specialty papers; our sales of these papers increased to approximately 60% of our net paper sales in 2007, from approximately 33% in 1997. We are producing higher margin products to replace products that Brazilian consumers previously had to import, such as labels for beer and soft drinks.
 
We have developed our production facilities for thermal and carbonless papers through a licensing arrangement with a leading producer in the area of chemical papers, Oji Paper, which allows us to benefit from Oji Paper’s technology. We expect to continue to benefit from an increase in domestic demand and continue to work closely with our customers to develop new products. We estimate that, since 2003, we have lost approximately 14% of our coated paper domestic market share mainly to imports, which became more competitive as the real appreciated against the U.S. dollar. We plan to take advantage of the opportunity to recover our market share if the real depreciates or stabilizes against the U.S. dollar.
 
Increase operating efficiencies
 
We intend to remain a low-cost producer of pulp and paper by continuing our ongoing program to increase operating efficiencies and reduce operating costs per unit. We intend to continue to:
 
 
·
focus on reducing wood costs through increased eucalyptus yields and reduced harvesting costs;
 
 
·
focus on improving the efficiency of our operations through investment in harvesting equipment, production facilities and advanced information technology; and
 
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·
improve information flow to facilitate decision-making.
 
Continue to develop state-of-the-art technology in the forest area
 
Technological research and improvement has made it possible to attain productivity records, together with a lesser impact on the environment. In the forest area, the gain in competitiveness is the result of an intense research program and the adoption of modern forestry practices. The genetic improvement of eucalyptus trees allowed for the plantings of clones of selected trees, resulting in higher productivity. Today, 95% of planting is done with cloned seedlings. We have achieved speed, better seedling use and quality thanks to a pioneering procedure of multiplication of clones. We use the most modern technology for planting, harvesting, storing and transporting with a completely mechanized system. Currently, wood production per hectare has reached 45-50 cubic meters, compared to 30 cubic meters recorded in 1987.
 
Expand our forest and mill production capacity through both expansion and strategic acquisitions to meet increased demand in both the domestic and export markets
 
We intend to further increase our production capacity through both the expansion of existing facilities and strategic acquisitions. We continue to pursue growth opportunities to create value for our shareholders through strategic acquisitions, alliances and joint ventures and we intend to participate in the continuing consolidation among pulp and paper producers, both domestically and internationally.
 
In February 2007, we exchanged our existing Luiz Antonio pulp and paper facility for a pulp mill project, in the state of Mato Grosso do Sul, which was mostly funded by International Paper, being built and expected to be completed in May 2009. We continue to acquire land for a new forest base in both the south and western regions of Brazil, preparing fiber supply for future growth. Between 1997 and 2007, the average annual rate of paper consumption in Brazil increased by 3.3%, reaching 8.0 million tons in 2007, as estimated by Bracelpa. In recent years, there has been a marked increase in paper consumption in Brazil. We believe that demand for pulp and paper in the domestic and export markets will continue to grow over time.
 
Our Products
 
We produce a variety of pulp and paper products. We produce pulp both for sale (market pulp) and for use in our paper production. We sell BEKP, to both the Brazilian domestic and export market. We produce coated and uncoated printing and writing paper and other specialty/chemical papers. Within the printing and writing paper category, we produce cut-size, folio-size, and rolled products. The following table sets forth the breakdown by categories of our net operating revenues for the periods indicated:
 
   
Years ended December 31,
 
   
2007
 
2006
 
2005
 
Market Pulp 
   
49
%
 
39
%
 
39
%
Paper:
                   
Uncoated (P&W/Cut Size)
   
19
%
 
31
%
 
31
%
Coated
   
13
%
 
13
%
 
14
%
Specialty / Chemical papers
   
19
%
 
17
%
 
16
%

24

 
Pulp
 
Production
 
The following table sets forth our total hardwood pulp production, total Brazilian hardwood pulp production, and our hardwood pulp production as a percentage of total Brazilian pulp production for the periods indicated:
 
   
Years ended December 31,
 
   
2007
 
2006
 
2005
 
VCP’s production (in tons)
   
1,394,370
   
1,444,480
   
1,372,197
 
Total Brazilian production (in tons)
   
11,800,000
*  
11,180,000
   
8,093,529
 
VCP’s production as percentage of total Brazilian production
   
11,8
%
 
12.9
%
 
17.0
%
 

Sources: Bracelpa and VCP. Figures for Brazilian production changed due to updated reports released by Bracelpa.
 
(*)
Bracelpa: figure through November 2007.
 
Sales
 
In 2007, we sold 1,097,652 tons of bleached pulp as market pulp to third parties in the domestic market and outside of Brazil. We had a 26% share of the Brazilian domestic market for bleached hardwood pulp as of Bracelpa’s figures released in December 2007. In recent years, however, we have sought to increase our sales of market pulp outside of Brazil. In 2007, approximately 80% of our market pulp sales volume was to customers located outside of Brazil. The following table sets forth our sales volume of pulp to the export market by geographic region for the periods indicated:
 
   
Year ended December 31,
 
   
2007
 
2006
 
2005
 
   
Tons
 
% of Total
 
Tons
 
% of Total
 
Tons
 
% of Total
 
North America
   
81,038
   
9.3
   
77,075
   
9.3
   
75,987
   
9.7
 
Latin America
   
1,685
   
0.2
   
   
   
1,608
   
0.2
 
Europe
   
557,610
   
64.1
   
508,489
   
61.1
   
474,484
   
60.3
 
Asia/Middle East/Oceania/Africa
   
229,563
   
26.4
   
246,618
   
29.6
   
234,865
   
29.8
 
Total Exports
   
869,897
   
100.0
   
832,182
   
100.0
   
786,944
   
100.0
 

In 2007 Santher remained our largest domestic customer of pulp, followed by the joint venture between Ahlstrom and VCP and IBEMA. UPM-Kymmene, Georgia Pacific, APP, M-Real and PKS were our largest customers of exported pulp.
 
Demand for our pulp has generally exceeded our production capacity even during cyclical downturns of the pulp industry, and, according to a study conducted in November 2007 by Hawkins Wright, an independent international consulting firm, the projected average demand growth in the world for bleached eucalyptus kraft pulp, or BEKP, is 8.7% per year from 2006 to 2011 (and 2.2% per year for the total white pulp demand), while the total white pulp capacity (including BEKP) projected average growth is 3.9% per year in the same period.
 
We have long-term sales contracts with substantially all of our customers in the domestic and the export markets. These contracts generally provide for the sale of our market pulp at prices we announce each month. These prices may vary among the different geographic areas where our customers are located. Usually the price arrangements under our long-term contracts are consistent with prices for our other sales within the same region and follow the established list price of BEKP announced by major global pulp producers. The sales contracts provide for early termination in the event of a material breach, the insolvency of one of the parties or force majeure events of extended duration.
 
25

 
Paper
 
Our paper products can be divided into three major categories:
 
 
·
uncoated printing and writing papers;
 
 
·
coated printing and writing papers; and
 
 
·
carbonless and thermal and other specialty papers.
 
The production and sale of uncoated printing and writing papers is our major line of paper business, accounting for approximately 38% of our total net paper sales and 84% of our paper exports in 2007. The following table provides a brief description of our principal paper products and lists the facilities where they are produced:
 
Product
 
Description
 
Facility
Coated printing and writing paper
 
Coated woodfree paper used for labels, self-adhesive, flexible packaging markets and publishing sector (magazine, book and catalogue) inserts brochures and other publications; pioneer line of coated cut-size paper for small/home office market designed for printing of high-resolution and high-quality images; coated paper to be used on labels for plastic PET soft drink packaging.
 
Jacareí
Piracicaba
Americana
         
Uncoated printing and writing paper
 
Uncoated woodfree paper in reels, sheets and cut-size designed for maximum performance in photocopying machines and laser and inkjet printers, and alkaline offset paper.
 
Jacareí
Americana
         
Carbonless paper
 
Used to produce multi-copy forms for credit card receipts, invoices and other applications in place of traditional carbon paper.
 
Piracicaba
         
Thermal paper
 
Traditionally used in fax machines; new applications include supermarket receipts, bar code labels, toll tickets, water and gas bills and receipts for ATMs and credit card machines.
 
Piracicaba


Source: VCP.
 
Production
 
Production of paper is a multi-stage process, which begins with the production of its principal raw material, pulp, from wood. Throughout the production process from wood to paper, various pulp and paper products are produced that may be converted by us into value-added products or sold.
 
We employ advanced, automated harvesting equipment in our forests. On easily accessible terrain, the harvesting process involves a feller-buncher that cuts and gathers a number of trees and lays them in bundles in the forest. Branches are removed by advanced equipment. A skidder then carries the trees to a track area, where a log cutter removes the tops, cuts the trees into logs and loads the logs on trucks for transportation to the mill. On difficult terrain, a harvester cuts, de-limbs and debarks the trees, then cuts them into logs and stacks them in bundles in the forest. A forwarder carries the bundles to a loading area, where a loader loads the logs on trucks for transportation to the mill. Recently, we acquired a simulator to train harvest equipment operators, which lowers the number of hours dedicated to employee training, in addition to reducing equipment-operating time.
 
The logs are transported by truck from the forests. The logs are then taken by conveyor belt to be debarked and chipped. The chips are sent to digesters, where they are mixed with chemicals and cooked under pressure. During this process, lignin and resins are removed from the wood. The removed lignin is used as fuel for the pulp mill.
 
26

 
In 2001, we introduced a new, more efficient production process whereby wood chips for the production of pulp are produced at plantation sites using portable chipping equipment. With these chipping machines, we are able to carry out chipping in the forest and thereby improve tree utilization and reduce noise levels at the mill. In addition, forest residues are returned directly to the plantation soil, contributing to the recycling of nutrients. Approximately 30% of the wood required for the Jacareí mill is supplied in the form of chips directly from the forest.
 
The unbleached pulp is then sent through the oxygen delignification process and the chemical bleaching process. The cellulose fibers are screened, pressed and dried. The dried pulp is cut into sheets and baled, resulting in market pulp. In recent years, pulp customers, particularly in Europe, have preferred pulp that is bleached with little or no chlorine compounds due to environmental concerns relating to the bleaching process. All of the phases in the pulp production process that have reduced amounts of chlorine create effluents, which are sent to an effluent treatment station, where approximately 90% of the organic charge is removed.
 
To produce printing and writing paper, we use 100% short-fiber eucalyptus bleached pulp. Once in the paper mill, the pulp is sent to refiners, which increases the level of resistance of the fibers for the production of specific grades of paper. Certain materials are then added to the refined pulp to strengthen and improve the quality of the paper. These additives include synthetic sizing and precipitated calcium carbonate (the alkaline process). The mixture is pumped to the paper machine where the paper is pressed and dried. Finally, the resulting paper is sent to be finished in accordance with client specifications.
 
The following table sets forth our paper production, total Brazilian paper production, and our total paper production as a percentage of total Brazilian production for the periods indicated:
 
   
Year ended December 31,
 
   
2007
 
2006
 
2005
 
VCP’s production* (in tons)
   
423,568
   
611,044
   
602,214
 
Total Brazilian paper and paperboard production (in tons)
   
8,970,000
**   
8,724,631
   
8,597,716
 
VCP’s production as percentage of total Brazilian production
   
4.7
%
 
7.0
%
 
7.0
%


Sources: Bracelpa and VCP.
 
(*)
Considers total production paper and coater machines, excluding base paper production for coated paper.
 
(**)
For 2007, estimated figure from Bracelpa.
 
Printing and Writing Paper. According to Bracelpa, in 2007, we were Brazil’s third largest producer of uncoated offset paper and second largest producer of uncoated cut-size paper, and we ranked first in coated paper production. During 2007, we produced 348,065 tons of printing and writing paper consisting of approximately 202,115 tons of uncoated and 145,950 tons of coated paper. Our coated paper is used for a variety of purposes, including labels, inserts, brochures and magazine covers. Uses for our uncoated paper include notebooks, books and continuous forms. We produce coated and uncoated paper in reels and sheets and in cut-size paper. We currently have estimated domestic market shares of 32%, 12% and 15% in the coated, uncoated (offset) and cut-size printing and writing markets, respectively.
 
27

 
The following table sets forth our printing and writing paper production, total Brazilian printing and writing paper production and our production as a percentage of Brazilian production of such products for the periods indicated:
 
   
Year ended December 31,
 
   
2007
 
2006
 
2005
 
VCP’s production* (in tons)
   
348,065
   
525,476
   
520,294
 
Uncoated paper (in tons)
   
202,115
   
382,436
   
376,211
 
Coated paper (in tons)
   
145,950
   
143,040
   
144,083
 
Total Brazilian production (in tons)
   
2,538,000
**   
2,512,956
   
2,414,014
 
VCP’s percentage of Brazilian production
   
13.7
%
 
20.7
%
 
21.6
%


Sources: Bracelpa and VCP.
 
(*)
Considers total production paper and coater machines excluding base paper production for coated paper.
 
(**)
For 2007, estimated figure from Bracelpa.
 
Carbonless and Thermal Papers. In 2007, we produced 67,148 tons of carbonless and thermal paper at our Piracicaba production facility. We produce carbonless and thermal paper in reels and sheets for use as facsimile and medical paper as well as supermarket receipts, banking and commercial automation paper, bar code paper, toll tickets and commercial invoices.
 
In addition, we have a technology transfer agreement with Oji Paper pursuant to which Oji Paper agreed to share secret formulae, processes, technical information and know-how developed by it for thermal paper. The agreement also grants us an exclusive, non-assignable license to manufacture and sell certain thermal papers in Brazil and a non-exclusive, non-assignable license to sell such products in Latin America, Africa and the Middle East. This existing agreement was enhanced by the execution, in August 2007, of a long-term SBA with Oji Paper. The agreement will allow us to further expand the offering of thermal paper technologies in Brazil and the Latin America region, thereby allowing Oji to expand its worldwide presence as a market leader in thermal technology. Through the execution of the SBA, we will be able to draw on the technologies of Oji as well as their global subsidiaries including the technology of Kanzaki Specialty Papers, Inc, (KSP) Kanzan Spezialpapiere GmbH (Kanzan) and Oji Paper Thailand Ltd. (OPT). Going forward, we will be prepared to meet the growing demands of an expanding market by drawing on the technological process of Oji Paper globally. The SBA agreement coupled with the expansion of our Piracicaba mill will permit the continuation of enhanced quality and improved value to our customers.
 
Other Specialty Papers. Prior to the sale of Mogi das Cruzes mill in May 2007 we were one of the largest producers of specialty papers in Latin America. In 2007, we produced 8,355 tons of other specialty papers from our Mogi das Cruzes facility, including art papers for catalogues, folders, letters and envelopes and finish foil for the furniture industry. With the sale of this facility we have exited this line of paper business as part of our strategy of shifting our paper sales mix to higher margin products.
 
The following table sets forth our carbonless, thermal and other specialty paper production.
 
   
Year ended December 31,
 
   
2007
 
2006
 
2005
 
VCP’s carbonless and thermal paper production* (in tons)
   
67,148
   
62,466
   
59,386
 
VCP’s other specialty paper production* (in tons)
   
8,355
   
23,102
   
22,534
 
Total* (in tons)
   
75,503
   
85,568
   
81,920
 


Sources: VCP.
 
(*)
Consider total production paper and coater machines excluding base paper production for coated paper.
 
28

Sales
 
We sell our paper products in all major world markets. The following table sets forth our sales volume of paper to the export market by geographic region for the periods indicated:
 
   
2007
 
2006
 
2005
 
   
Tons
 
% of total
 
Tons
 
% of total
 
Tons
 
% of Total
 
North America
   
20,774
   
21.3
%
 
59,822
   
31.8
%
 
66,551
   
33.3
%
Latin America(1)
   
57,883
   
59.4
%
 
51,531
   
27.4
   
53,767
   
26.9
 
Europe
   
15,648
   
16.0
%
 
62,536
   
33.3
   
61,173
   
30.7
 
Middle East/Asia/Africa/Other
   
3,194
   
3.3
%
 
14,150
   
7.5
   
18,216
   
9.1
 
Total Exports
   
97,499
   
100.0
%
 
188,039
   
100.0
%
 
199,707
   
100.0
%


(1)
Excluding Brazil.
 
The following table sets forth our domestic sales of specialty, carbonless and thermal paper, Brazilian specialty, carbonless and thermal paper sales, and our sales as a percentage of Brazilian sales for such products for the periods indicated:
 
   
Year ended December 31,
 
   
2007
 
2006
 
2005
 
VCP’s carbonless and thermal paper sales (in tons)
   
66,353
   
64,186
   
60,669
 
VCP’s other specialty paper sales(1) (in tons)
   
48,054
   
45,976
   
33,765
 
Total (in tons)
   
114,407
   
110,162
   
94,434
 


(1)
Includes sales of third-party products by KSR and sales of specialty papers produced at the Mogi das Cruzes mill (divested in May 2007).
 
Source: VCP
 
Printing and writing paper represents the largest category of paper exports from Brazil. In 2006 and 2007, we exported 187,644 tons and 97,220 tons, respectively, of printing and writing paper, which primarily consisted of uncoated paper.
 
The following table sets forth our exports and domestic sales of coated and uncoated papers for the periods indicated:
 
   
Year ended December 31,
 
   
2007
 
2006
 
2005
 
VCP’s exports (in tons)
   
97,220
   
187,644
   
199,424
 
Brazilian exports (in tons)
   
863,100
*  
800,297
   
903,527
 
VCP’s percentage of Brazilian exports
   
11.2
%
 
23.4
%
 
22.1
%
VCP’s domestic sales (in tons)
   
287,430
   
371,393
   
331,434
 
Brazilian market (in tons)
   
1,604,250
*  
1,616,800
   
1,496,003
 
VCP’s percentage of Brazilian market
   
18.0
%
 
23.0
%
 
22.2
%


Sources: Bracelpa and VCP.
 
(*)
Bracelpa: figure through November 2007.
 
The customer base for our paper products is diversified. None of our customers individually accounted for more than 10% of our domestic or international sales of paper products in 2007.
 
29

 
Raw Materials
 
Wood
 
Our pulp production is 100% based on bleached eucalyptus hardwood grown in sustainable forest plantations. We use modern technologies that enable us to obtain high product quality in producing ECF pulp and VCF pulp.
 
We rely exclusively on eucalyptus trees to meet our pulpwood requirements. Eucalyptus trees are among the fastest growing trees in the world. The combination of modern technology with Brazil’s climate and soil conditions permit eucalyptus tree harvest rotations of approximately seven years. The table below presents both the harvest rotation cycle and the per annum yield per hectare in Brazil as compared to those of other principal pulp producers and illustrates this competitive advantage:
 
Country
 
Harvest (years)
 
Yield (m3/ha/yr)
Brazil
 
7
 
45-50
Argentina
 
7-12
 
25
Chile
 
10-12
 
20-50
Indonesia
 
7
 
20-35
Australia
 
7
 
20-25
Iberia
 
12-15
 
10-12
Sweden
 
35-40
 
5.5
Finland
 
35-40
 
4
USA
 
25
 
10
Canada
 
45
 
7

Energy and chemicals
 
We use several sources to generate thermal and electrical energy for the pulp and paper production process, including biomass derived from wood debarking, chip screening rejects, fuel oil, natural gas and black liquor. By producing electricity internally, we realize substantial savings compared to purchasing electrical energy in the open market. In 2007, we generated approximately 82.3% (66.2% in 2006) of our energy requirements for the pulp and paper production process internally, of which 79.1% is from renewable fuels, such as biomass and black liquor, and 20.9% is from non-renewable fuels, such as fossil fuels (oil and gas). Recovery boilers recycle substantially all of the chemicals used in the pulp production process. We believe that our sources of supply will allow us to maintain a cost advantage in these areas for the foreseeable future.
 
In 2007 we purchased approximately 17.7% (34% in 2006) of our energy requirements from concessionaires, including CPFL—Companhia Paulista de Força e Luz (for the Piracicaba facility), Bandeirante (for the Jacareí facility) and Eletropaulo (for our headquarters), as well as from fuel oil and natural gas suppliers. In 2007, we began operating a new combined cycle gas turbine and heat recovery boiler in the Jacareí mill, and, consequently, reduced the global percentage of our purchased electrical energy from 34% to 17%. The new gas turbine system improved our already low dependence on external supplies of energy.
 
The pulp production process traditionally involved the use of elementary chlorine. In recent years, demand for pulp that is bleached with little or no chlorine has grown significantly because of concerns over possible carcinogenic effects of chlorinated organic compounds released in water. This pulp, known as elementary chlorine-free pulp, or ECF, is produced without using elementary chlorine in its bleaching process. It uses chlorine dioxide instead. As a result, we only produce ECF pulp. Our bleaching sequences are based mostly on oxygen compounds, such as oxygen, ozone and hydrogen peroxide, which are more environmentally friendly. In addition, we have developed a bleaching process referred to as Votorantim chlorine free, or VCF pulp, which utilizes a smaller amount of chlorine dioxide than the ECF process. In 2007, 100% of our pulp was produced without the use of elementary chlorine.
 
30

 
At December 31, 2007, we had long-term “take-or-pay” contracts with suppliers of chemical products for periods from 1 to 10 years. Our contractual obligations in connection with such contracts are US$ 58 million per year. Additionally, we have long-term “take-or-pay” contracts with a supplier of pulp for 30 years. The contractual obligation in connection with this contract is US$ 42 million per year. See note 15(d) to our financial statements.
 
Water
 
We currently require about 26 cubic meters of water per ton of pulp and paper (32 cubic meters per ton of pulp and paper in 2006). The costs of obtaining our water were not a significant component of our total cost of raw materials in 2007. We get our water from several rivers in the state of São Paulo, Brazil, including the Paraíba do Sul, Piracicaba. We believe our average water supplies are currently adequate and that our water consumption per ton is very low; particular in the Jacareí mill because of that facility’s use of more modern technology.
 
Beginning in 2003, the Brazilian government imposed tariffs on the industrial use of river water. For the Paraíba do Sul River, which is located near the Jacareí mill, the levying of tariffs related to water consumption started in the beginning of 2003. From our experience to date, the imposition of such tariffs has not had a significant impact on our production costs. The levying of tariffs for water consumption from the Piracicaba River started in 2006.
 
Eco-efficiency
 
Our papers now emphasize eco-efficiency throughout the production process through a seal of approval that highlights the care shown regarding environmental preservation in each product sold. At the beginning of 2007, new Copimax paper packaging was introduced as a way of communicating the fully self-sustainable nature of its production. The brand furthermore showed its pioneering quality in the Brazilian market for printer and copier papers: it was the first to receive the Forest Stewardship Council (FSC) seal of approval, a worldwide recognition of products deriving from responsible forestry management and manufacturing policies. The eco-efficiency production factors also include:
 
 
·
Sustainably managed forests in the state of São Paulo, awarded FSC certification;
 
 
·
Low consumption of water to produce pulp: 30 cubic meters per ton produced;
 
 
·
Reutilization of 85% of the water in the production process;
 
 
·
84% of energy comes from renewable sources, such as biomass;
 
 
·
Reduction of the emission of greenhouse gases through control of atmospheric emissions, and the priority use of railroads and waterways for the transportation of raw materials and finished products;
 
 
·
100% of the industrial residues are treated through the 3R concept (reduce, reutilize, recycle);
 
 
·
First Brazilian company in the sector to sign the U.N.’s international Cleaner Production Declaration;
 
 
·
Socio-environmental programs that encourage the development of partners in communities.
 
Transportation
 
For wood transportation we use trucks and also the railroad. The trucks are owned and operated by independent contractors to transport wood from our forests to our production facilities. The train is operated by a private railway concession and also transports wood from our forests to a dedicated wood train terminal in the Jacareí Mill. Our forests are located an average distance of 357 kilometers from our pulp mills. We also use trucks owned and operated by third parties to transport finished pulp and paper products from our facilities to our customers in Brazil and other regions in Latin America. To the port of Santos, from which we handle 100% of our exportation products, the transport is done by train. Santos is located on the coast of the state of São Paulo approximately 150 kilometers from the Jacareí mill.
 
31

 
In 1998, we obtained a concession from the state government of São Paulo to operate a terminal and a warehouse in Santos under a renewable ten-year operational lease agreement with CODESP, which is the government-owned corporation that owns and operates the port. This lease was non-cancelable during the initial period and set to expire in 2007. In September 2003, an amendment to the agreement renewed it for another ten years from September 2007 to September 2017. The terminal has facilitated the growth of our exports because it allows us to load vessels with pulp directly from our terminal, thereby significantly reducing freight and handling costs. Our yearly expense for this has been approximately US$ 0.3 million, and future annual lease payments under the CODESP lease will also be approximately US$ 0.3 million per year. There is no contingent rent under the contract. In addition, in 2001, we rented another warehouse at the terminal in Santos in anticipation of future increases of our pulp exports as a result of the Jacareí expansion. This expanded our total warehouse area in Santos to 16,020 square meters from 9,550 square meters, and our total warehouse volume capacity in Santos increased to 38,000 tons from 28,000 tons.
 
In December 2002, we signed a contract with MRS Logística S.A., or MRS, a private railway concession, in order to invest in a private railway from the Jacareí plant to the port of Santos to transport pulp to the port from the mill. In March 2005, we signed another contract with MRS to transport wood to our Jacareí mill and also approved an investment to construct a railway terminal to receive this wood in the Jacareí plant. The new wood terminal has been operational since October 2005 and has resulted in a significant reduction in VCP’s wood transportation costs. As part of our agreement with MRS in 2002 MRS was responsible for the reconstruction of the 27-kilometer railway and the investment in dedicated railway wagons, while we were responsible for the construction of the building of terminals inside the Jacareí plant and at the port of Santos. Total investment was approximately US$ 9.4 million and we were responsible for 50% of the costs incurred, which has been disbursed. The pulp transportation agreement also requires the transportation of a minimum tonnage, equivalent to US$ 7.4 million per year, over a ten-year period. For the wood transportation agreement, the minimum tonnage requirement is equivalent to US$ 1.3 million per year, starting in 2006. In 2007, we shipped 825,000 tons of pulp and over 120,000 tons of wood through MRS and paid US$ 11.5 million to MRS.
 
In 2007 we conducted a tender for the outsourcing of integrated logistics for the plants of Jacareí, Piracicaba, Ripasa and Três Lagoas for four years. This contract was awarded to Abrange Logística, a logistics operator expert that will capture economies of scale and synergies and reduce our costs. They were contracted to handle all the operational activities, from receiving the raw material to delivering the product to the final customer. This has resulted in lower costs, gains of scale, lower investment in infrastructure and greater specialization in providing services to clients. Another logistical advantage comes from KSR, a paper distribution unit which is the leader in the sector in Brazil. KSR plays a strategic role by reaching all regions of Brazil and servicing clients in areas such as printing, editorial, stationery, copying, small business, converters (forms, notebooks), newspaper and public bodies. KSR has 27 affiliates and an automated storage system which results in a fast service, supported by a specialist fleet which can make deliveries throughout Brazil.
 
In October 2007, our subsidiary VCP-MS signed an agreement with ALL to provide transport services for more than 1 million tons per year of pulp from Três Lagoas to the port of Santos for a twenty year term beginning in 2009. Our total investment will be approximately US$ 70 million and the object of the agreement includes primarily (i) railway transportation service from the facility to the port of the pulp volume produced in Três Lagoas; (ii) construction of a railway spur line connecting ALL’s main rail line to the facility; and (iii) investments by both companies for wagons, locomotives and permanent railway infrastructure.
 
The VCP unit in Três Lagoas, in the state of Mato Grosso do Sul, is the largest eucalyptus pulp facility under construction in Brazil, with a capacity of 1.3 million tons per year. The Project Mill construction is under Pöyry management and, when concluded in May 2009, will result in the state of Mato Grosso do Sul becoming a significant Brazilian pulp production center, thereby contributing to the social and economic development of the region.
 
In order to simplify and increase the productivity of the deliveries of pulp to our final customers in Europe, the United States and Asia, we made in 2007 a complete reassessment of the logistics set up for all those three regions. Those changes will be implemented during the year of 2008 and the main consequence is a reduction on the number of ports from 14 to 10 and logistics suppliers from 13 to 7 (ship owners and terminal operators). All those modifications will guarantee to VCP a very competitive and stable total cost to serve all offshore clients throughout the next years.
 
32

 
Marketing and distribution
 
We sell our pulp and paper products in both the domestic and export markets. In 2006 and 2007, approximately 88% and 80%, respectively, of our sales volume of market pulp and 28% and 20%, respectively, of our sales volume of paper products were made outside of Brazil. Our internal sales staff consists of 48 employees operating throughout Brazil. We also have 255 employees assigned to KSR—our paper distributor—and 80 independent sales agents. Abroad, our sales staff consists of 11 employees, operating throughout North America, Europe and Asia.
 
Through KSR and our internal sales staff, we focus on developing close, long-term customer relationships by meeting the customer’s specific requirements. We constantly seek to increase our understanding of our customers and their industries and to tailor our products to their specific needs. See “Item 5—Operating and Financial Review and Prospects—Research and development, patents and licenses, etc.” for a detailed description of our technology upgrades in the area of customer relationships.
 
Pulp
 
Our internal sales staff handles substantially all of our domestic market pulp sales. We sell pulp to other Brazilian paper producers, including Fábrica de Papel Santa Therezinha S.A. (a company specialized in the production of tissue and special paper) and Arjo Wiggins Ltda. (the largest producer of security and fine papers) and beginning September 2007, Ahlstrom VCP our new joint venture in the Jacareí mill. In addition, due to the expansion of the Jacareí facility, we are selling substantially more market pulp abroad. In order to distribute and market this additional market pulp, we operate our own terminal at the port of Santos. The delivery of pulp is done through proper equipment and logistics, providing high productivity in all stages of the process.
 
Currently, our pulp and paper products are distributed overseas through, the following wholly owned subsidiaries: VCP Overseas; Newark, a wholly owned subsidiary of VCP Exportadora; VCP North America; and VCP Trading. Effective January 2006, VCP implemented a new international sales structure, intended to streamline and integrate its growing volume of export sales. This structure included the establishment by VCP Overseas of a branch office, located in Zug, Switzerland, which is responsible for all export and sales transactions. In April 2006, for administrative and economic reasons, we merged VCP Exportadora into VCP and assumed all of the assets and liabilities relating to its export operations and also significantly reduced the involvement of the other subsidiaries mentioned above in sales activities.
 
In 2007, we opened our Representative Office in China, located in Shanghai to develop a closer relationship with our clients in Asia and to pursue new profitable supply agreements for our company’s future expansions.
 
Paper
 
In 2007, approximately 80% of paper sales volume and 87% of our net revenues derived from paper came from the domestic market compared to 72% and 79%, respectively, in 2006. We sell 20% of our paper products through KSR. Domestically, KSR’s distribution network consists of 27 branches, which are strategically located with warehouses used for storage purposes, and a workforce composed of 85 independent sales agents. In 2007, KSR was the segment leader in paper distribution in Brazil, with a market share of approximately 22% of the distribution sales. Through KSR, we sell our paper products to approximately 15,600 customers, including small printers, stationery stores and industrial companies throughout Brazil, as well as the Brazilian government. KSR also sells the products of other paper companies in areas where they do not compete with us, in both the export and domestic markets. As a result, we are able to offer a wide range of complementary products, with prompt delivery. In 2007, through KSR we had net revenues of US$ 151 million, representing 22% (US$ 131 million and 22%, respectively, in 2006) of our total consolidated paper sales in the domestic market.
 
33

 
Sales of our products to our domestic customers are for cash, credit or through a program called the vendor program. For purposes of this annual report, we have referred to our credit sales as the “non-vendor program.”
 
The vendor program is available to some of our domestic customers, and approximately 23% of our domestic sales in 2007 were made by this method. Under the vendor program, the customer agrees to pay the bank and the bank in turn pays us on behalf of the customer for the purchase price of the product. We, as the vendor, act as a guarantor under the arrangement with the bank so that the customer can take advantage of lower interest costs. The lower interest rate is a result of the bank typically looking to us, and not our individual customers, as the primary support for the credit risk. The vendor program is a means by which the bank essentially finances customers’ purchases.
 
A customer applying for the vendor program must first be approved by us. If we determine that the customer is creditworthy, the customer enters into a standard-form agreement with the bank that is providing the financing, which is guaranteed by us. The bank then forwards to us an amount of money equal to the purchase price of the products sold. The standard-form agreement into which the customer enters with a bank specifies loan repayment terms that are generally more favorable than prevailing market rates because the customer receives the benefit of our financial strength through our guarantee. We guarantee full repayment of the loan and, in the event of a customer default, the bank charges our cash account for the principal amount of the loan, plus interest, 15 days after the due date of the loan. We closely monitor the collection of these amounts and are advised by the bank once amounts have been settled. If we are called upon to settle the obligation with the bank, we pursue the customer through legal proceedings for final settlement of amounts due to us. The accounting and management controls exercised over these “receivables” are no different from our systems in place to monitor our direct receivables due from direct sales customers. We consider this vendor program to be an important component of our sales and marketing efforts and believe that the favorable credit terms we are able to offer our customers give us an additional competitive advantage.
 
Additional tax benefits arise under this facility because the interest charged by the bank to the customer is not subject to the sales taxes that would otherwise accrue had we incorporated the finance charges into the sales value and billed the amount directly to our customer.
 
Under the terms of our vendor program, the maximum allowable term for payment is generally 180 days, though in the case of a few customers, we extend the term to 240 days. The terms of the vendor program depend on the customer’s credit rating, which is based on our own internal credit review.
 
Historically, the amounts we have paid on our guarantees, net of amounts recovered from customers, have been negligible. In 2007, 2006 and 2005, we recovered 100% of the amounts we paid under guarantees.
 
Our customers who make purchases using credit agree to payment terms that effectively include finance charges. The finance charge on each sale is the difference between the amount the customer agrees to pay at the due date and the cash sales price. The finance charges are recognized over the payment period and are included in financial income.
 
We retain the same risk of loss on customer accounts under the vendor program that we do under our own non-vendor program. To mitigate this risk, we continuously monitor the receivables under both programs and periodically update our assessment of each customer. In addition, we continuously evaluate both vendor program receivables and our receivables for collectibility.
 
We estimate that for 2005, 2006 and 2007, an average of approximately 8% of our total number of regular domestic customers (approximately 22%, 22% and 23% respectively, of total domestic sales value) obtained our guarantee for their loans. Our vendor program exposure was US$ 57 million at December 31, 2005, US$ 120 million at December 31, 2006 and US$ 127 million at December 31, 2007.
 
Competition
 
The international markets for pulp and paper products are highly competitive and involve a large number of producers worldwide. As an integrated pulp and paper producer, we compete not only with other integrated pulp and paper producers but also with companies that produce only pulp or paper. Many of these producers have greater financial resources than we do. Our production levels have been, and will continue to be small by comparison to overall world pulp and paper production, and the prices for our products will depend on prevailing world prices and other factors.
 
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According to preliminary information released by Hawkins Wright (an “Outlook for Market Pulp”) at November 30, 2007, world market pulp capacity should reach 54.3 million tons out of which 43% is softwood, 44% is hardwood and the remaining percentage other pulp grades. During 2007, the world’s net capacity increased by 2.26 million tons (3,000 additions and 740,000 capacity closures).
 
Based on 2007 preliminary figures from Bracelpa on net revenues of Brazilian pulp and/or paper producers, we were the second largest Brazilian producer, behind Aracruz. In the domestic market, with respect to market pulp, we had the largest Brazilian market share in terms of volume, with 26%.
 
According to Bracelpa, with respect to writing and printing uncoated paper, we were the third largest Brazilian producer in 2007 in terms of volume, producing more than Santa Maria, but less than International Paper and Suzano/Bahia Sul. In addition, in 2007, we were the leader in Brazil in the production of certain specialty papers and carbonless and thermal paper. We had a leadership position in 2007 in coated paper in Brazil with a 30% market share followed by Ripasa and Suzano. Our main competitors in carbonless and thermal paper are located outside Brazil.
 
During the period of 2005 to 2007 our main domestic competitors announced/concluded the following major changes in the pulp production capacity:
 
2005: (i) Veracel, jointly owned by Aracruz and Stora Enso, began its start-up in May. Full capacity of 1,000,000 tons of BEKP was reached before year-end; (ii) Suzano began the construction of a new 950,000,000 BEKP line with start-up expected for the second half of 2007 of its Mucuri facility.
 
2006: No significant events.
 
2007: Suzano’s Mucuri facility began its startup in September 2007.
 
Environmental policies
 
As part of our commitment to sustainable development, we are developing one of the largest forest plantations in Brazil. Annually we plan to plant approximately 60,000 hectares of Eucalyptus to supply the future pulpwood requirements of the existing and planned mills. All the forest operations are developed based on Environmental Planning in order to promote the environmental improvement of the site, looking for forestry sustainability, biodiversity and environmental sanity.
 
By the end of 2007, the timberland area under our control, in states of São Paulo, Rio Grande do Sul and Mato Grosso do Sul was about 480,000 hectares, of which 41% are mainly preserved as conservation areas with native vegetation. If we consider approximately 52,000 hectares associated with our 50% stake in Ripasa, we control more than 500,000 hectares. For conservation areas, environmental planning may recommend the plantation or recovery (recovery by means of natural regeneration) of native vegetation. In partnership with various universities, we conduct research and monitor the fauna and flora of the sites.
 
35

 
These timberlands are distributed as follows within Brazil:
 
   
Total area (hectares)
 
Percentage of total area preserved as native forests and/or for environmental recovery
 
São Paulo
   
180,000
   
41
%
Mato Grosso do Sul
   
189,000
   
33
%
Rio Grande do Sul
   
111,000
   
53
%
TOTAL
   
480,000
       

Our policy for quality of the environment, health and safety, based on the following principles:
 
 
·
to fulfill the needs and expectations of investors, customers, suppliers, professionals, communities and other parties involved in our business;
 
 
·
to operate responsibly and in compliance with laws, regulations and corporate commitments;
 
 
·
to ensure the integrity, qualification and career development of our employees; and
 
 
·
to provide continuous improvement in management systems and processes, including the prevention and reduction of wastes, accidents and adverse impacts on the environment.
 
We use technologies that process and bleach pulp and paper wood pulp with ozone, which minimizes water consumption and reduces effluents and organic chlorine compounds.
 
We have an electronic system that monitors and coordinates all our environmental activities to facilitate operational control, management of environmental risks and compliance with legal requirements at the Jacareí plant.
 
We obtained an ISO 14001 (environmental) certification for the forestry area and for the industrial area of the Jacareí mill in February 2004. All integrated industries, forestry areas in São Paulo and the port terminal of Santos are certified as conforming to international standards.
 
The forestry operation in São Paulo is also certified as Well Managed Forest Plantation by the Forest Stewardship Council since September 2005 (Capão Bonito Region) and since December 2006 (Paraiba Valley Region).
 
Brazilian environmental regulation and investments
 
The federal constitution assigns to the federal government, the states, the federal district and the municipalities the responsibility for environmental protection and preservation of the Brazilian fauna and flora. However, the authority to enact laws and issue regulations with respect to environmental protection is granted jointly to the legislative branches of the federal government, the states and the federal district. The municipalities may only issue regulations with respect to matters of local interest or to supplement federal and state laws. The state agency for pollution control in the state of São Paulo is CETESB—Companhia de Tecnologia de Saneamento Ambiental, or CETESB. Pursuant to the pollution control laws of the state of São Paulo, as enforced by CETESB, the installation, construction or expansion, as well as the operation, of industrial equipment likely to cause pollution must be licensed by CETESB.
 
A renewable licensing system was introduced in São Paulo in December 2002, according to which previously issued licenses shall be renewed upon CETESB’s convocation. The new licenses issued by CETESB under this system are valid for periods of up to six years for installation licenses and ten years for environmental licenses. The use of efficient environmental management systems and the practice of environmental auditing are taken into account by CETESB in granting longer validity terms for licenses. Our operations are subject to various environmental laws and regulations issued by these authorities, including those relating to air emissions, effluent discharges, solid waste disposal, odor and reforestation.
 
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We have expended more financial resources to modernize our equipment, processes and environmental quality gains. In addition, we invested in environmental education, communities’ sewage treatment system and other projects. Our investments amounted to US$ 10 million in 2007, US$ 13 million in 2006 and US$ 23 million in 2005.
 
We cannot assure you, however, that the implementation of more stringent environmental regulations in the future will not require significant capital or other expenditures. For a description of certain legal matters relating to environment regulation, see “Item 8―Financial Information―Consolidated Statements and Other Financial Information―Legal Matters.”
 
In Brazil, individuals or legal entities that violate environmental laws can be punished by criminal sanctions that range from fines to imprisonment, in the case of individuals, or dissolution, in the case of legal entities. In addition, administrative sanctions that can be imposed include, among others:
 
 
·
fines;
 
 
·
partial or total suspension of activities;
 
 
·
forfeiture or restriction of tax incentives or benefits; and
 
 
·
forfeiture or suspension of participation in credit lines with official credit establishments.
 
In addition to criminal and administrative sanctions, pursuant to Brazilian environmental laws, the violator must also repair the damage that was caused to the environment and/or indemnify third parties, regardless of the existence of actual fault.
 
We have received a number of administrative warnings in the past five years for isolated violations of the maximum levels for emissions or effluents, including odors. The largest payment we have made individually was related to a solid residue release that occurred on September 10, 2005, when an industrial embankment burst at the Jacareí unit and non-dangerous residues (class 2A) covered part of a road and a stream, causing reversible damage to the environment. VCP took all necessary measures to reduce the damage to the environment and community. We acted in a transparent manner by immediately notifying CETESB and other government agencies of the incident, as well as issuing a press release. We developed a project to recover the industrial embankment and to reduce the damage to the environment, representing an investment cost of approximately US$ 9 million, of which US$ 3 million were disbursed in 2005 and US$ 6 million in 2006. In 2007, an additional US$ 2 million out of US$ 4 million was disbursed. In view of continuing to invest in environmental projects, we also have a project to provide alternatives to treat solid waste disposals. We expect a total investment cost of US$ 11.6 million, of which US$ 4.5 million was disbursed in 2007 and US$ 7.1 million is expected to be disbursed in 2008. This project will be divided into four phases: composting, which will involve two phases, lake cleaning and extension of the industrial embankment.
 
Environmental indicators
 
Our operating and production processes utilize natural resources and generate liquid effluents, residual wastes and air emissions which may adversely affect the environment.
 
According to ecoefficiency, environmental management aims to produce the minimum waste acceptable by the environment. We believe that by using state-of-the-art technology, in conjunction with environmental management system, environmental protection becomes more efficient and it is possible to pursue the path to sustainability.
 
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Liquid effluents
 
Water is critical to the process of manufacturing pulp and paper. We obtain water from the rivers that flow adjacent to our mills. After the water has been used in the manufacturing process, we pass the effluents through mechanical and biological treatments before returning them to the rivers. We also have emergency lagoons and tanks that enable us to avoid releasing untreated effluents into the rivers in the event of a problem with our effluent process. Effluent characteristics are monitored constantly through chemical, physical and biological analyses. We also have a spill control system to avoid disturbances in the wastewater treatment plant.
 
Our units use a two-stage process to treat the effluents generated during the production process. During the first stage, solids such as fibers, clay and carbonates are removed from the effluents. During the second stage, these solids undergo a biological treatment in which suspended and dissolved materials are broken down through the action of microorganisms. We hired a third party to evaluate the quality of the effluents generated during the production process and with the results of these analyses, we implement actions to minimize the generation of effluents and maximize the reutilization in the process. Our industrial units are developing alternatives that seek to reduce the consumption of water and the generation of effluents by optimizing the production process and increasing the reuse and recirculation of water. In Jacareí mill, the closing circuit project reached a water reutilization rate of 85%. For a description of the imposition of tariffs on river water use, see “—Raw materials—Water” above.
 
Solid wastes
 
We have identified productive uses for a portion of the solid waste generated during our pulp and paper production processes and have adopted the following programs for handling and disposal of such solid waste residue:
 
 
·
co-processing with ceramic manufacturing companies (Piracicaba and Jacareí mills);
 
 
·
licensed landfills (Jacareí mill); and
 
 
·
use in forests as soil correction agents.
 
With respect to the co-processing activities at our Piracicaba and Jacareí facilities, we use industrial residue as the raw material to manufacture bricks. Currently, both facilities’ solid waste residue is being recycled and used in ceramic factories around the city. We have been using these selective waste collections and recycling systems at the Jacareí facility since 2001 and the Piracicaba since 2002.
 
The remainder of solid waste is either sold to third parties for use in their production processes or disposed of in sanitary landfills. The small amount of hazardous waste generated at our facilities is collected, treated and disposed of in accordance with the requirements of Brazilian law.
 
Atmospheric emissions
 
As a byproduct of production, certain compounds and particulate emissions are released into the atmosphere. In order to control these emissions, the sources of these emissions are fitted with control equipment such as electrostatic precipitators, multi-cyclones and gas scrubbers, which minimize or remove certain particles and compounds from the emissions. In order to control odor emissions, our Jacareí mill uses an efficient system for collection and incineration of odoriferous, diluted and concentrated gases and are outfitted with an alternative gas scrubber removal system to be used when incineration is not possible. In addition, the auxiliary boilers, which previously burned fuel oil, were adapted to burn natural gas in 2001. The expansion of the Jacareí facility included similar equipment and processes to control emissions.
 
Forest preservation
 
All our wood comes from tree plantations rather than native forests. The land we manage is generally not of high enough quality to be used for other forms of agriculture. Our cultivation program seeks to preserve the health of our forests, and Brazilian law requires that at least 20% of our land either be covered with native forests or cultivated with indigenous species of trees rather than eucalyptus or pine.
 
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Forestry Certification System
 
In October 2002, VCP received ISO 9001/2000 and ISO 14001 certifications for forests located in Capão Bonito and Jacareí regions. The forestry areas controlled by VCP, which supply pulpwood to Jacareí pulp mill, are also certified by FSC (Forest Stewardship Council). Capão Bonito region was certified in September 2005 and Vale do Paraíba regions were certified in December 2006. CERFLOR Certifications (Brazilian Certifications) for the forest area which supplies Jacareí pulp mill are still in process and should be concluded in early 2007. VCP will reach approximately 70% to 80% of certified pulpwood production for the Jacareí mill.
 
Natural resources
 
Since the 1990s, we have been harvesting eucalyptus through uniform micro-propagated seedlings from carefully selected trees. The characteristics of the seedlings we select are matched to different growing regions and our products. This method allows us to (1) greatly increase forestry productivity, (2) comply with environmental regulations, and (3) contribute to carbon reduction in the atmosphere.
 
Pursuant to the Brazilian Forestry Code (Law No. 4,771 of September 15, 1965), we set aside a portion of our forests for preservation, conservation and environmental recovery. These areas consist of either native forests or riparian buffer zones, or are maintained to satisfy specific ecological interests. We also invest in environmental studies, together with domestic and international universities, research centers and renowned consultants, in order to improve the environmental conditions of our plantations, and ensure that we protect the native fauna in the areas in which we operate. We created a program designed to protect and preserve the fauna of areas with distinctive environmental aspects. This program has been implemented at Fazenda São Sebastião do Ribeirão Grande, a large private native forest in the Vale do Paraíba region, and at Várzea do Jenipapo in the Ribeirão Preto region.
 
Insurance
 
We maintain insurance policies for our mills against fire, lightning and explosion by any cause up to US$ 159 million; as for the basic coverage and additional coverages, Electrical Damages up to US$ 1.9 million, Windstorm (extended coverage) up to US$ 5.7 million, Machinery Breakdown up to US$ 4.8 million and Business Interruption up to US$ 311 million. We renewed this insurance on December 1, 2007.
 
We do not maintain insurance against fire, disease and other risks to our forests. We have taken various steps to prevent fires from occurring at our forests, including the maintenance of fire observation towers, a fleet of fire engines and teams of fire-fighting personnel, which we believe are safe and cost-effective methods of fire prevention. In each of the past three years, forest fires have not resulted in material damages to our total planted area. Given the natural protection afforded by the dispersion of our forests, we do not believe that insuring our forests would be cost-effective. We do not make provisions for risks of loss from fire and other casualties, all losses and damages that occur are charged to expense when incurred. We have not suffered a material loss from either fire or disease in the forests that we harvest.
 
Overview of the Pulp and Paper Industry
 
Pulp Industry Overview
 
Wood pulp is the principal ingredient in the manufacture of wood-containing paper. Pulp is classified according to (a) the type of wood or fiber from which it is made, (b) the manner in which the wood or fiber is processed, and (c) whether it is bleached.
 
There are two types of wood pulp that can be produced. Hardwood pulp is produced using hardwood trees, such as eucalyptus, aspen, birch and acacia. Pulp made from hardwood, such as eucalyptus, has short fibers and is generally better suited to manufacturing coated and uncoated printing and writing papers, tissue and coated packaging boards. Short fibers are the best type for the manufacture of wood-free paper with good printability, smoothness, brightness and uniformity. Softwood pulp is produced using softwood trees, such as pines and fir. Pulp made from softwoods has long fibers and is generally used in manufacturing papers that require durability and strength, such as kraftliner, and those requiring high opacity, such as newsprint and directory papers. We produce only hardwood pulp from planted eucalyptus trees.
 
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The pulp manufacturing process may determine a pulp’s suitability for particular end uses. Mechanical pulp refers to pulp processed to leave in some lignin and other organic materials holding the wood fibers together. Chemical pulp refers to pulp made using chemical processes to dissolve the lignin. Among the various chemical processes for chemical pulp, the most common is the kraft process, which we use to produce our pulp. The kraft process helps to maintain the inherent strength of the wood fibers and thus produces a pulp that is especially well suited for manufacturing printing and writing papers, specialty papers and tissue.
 
Bleached pulp is used for a variety of purposes, including printing and writing papers, specialty papers and tissue. Unbleached pulp is brown in color and is used in the production of wrapping paper, corrugated containers and other paper and cardboard materials. Many companies, including us, have been using the ECF methods in their production of bleached pulp. ECF is a bleaching process that does not utilize elementary chlorine and chlorine chemical compounds, respectively. These two processes have been developed in part to eliminate any possible carcinogenic effects attributed to the dioxins that are produced during the bleaching process and released in the water.
 
As a result of the variety of wood types and processes used to produce pulp, the pulp market has become increasingly specialized in terms of technical characteristics. Hardwood and, particularly, eucalyptus pulp, exhibit many of the physical and chemical properties most valued by printing and writing paper manufacturers and other bleached pulp consumers, such as opacity, grade and printability. As a result of increasing specialization, many manufacturers developed their own customized mix of pulp inputs known as “furnish” for use in their paper manufacturing. In addition, as more paper manufacturers have come to appreciate the technical characteristics of hardwood pulp and rely upon a significant hardwood pulp component in their furnishings, the market for hardwood pulp has grown more rapidly than the market for softwood pulp.
 
Eucalyptus is one of many types of hardwood used to make pulp. We believe that for certain uses eucalyptus pulp is superior because of the greater consistency in the quality of its fibers and because it can improve paper’s opacity, formation and printability. Eucalyptus pulp has gained wide acceptance among producers of printing and writing papers in Europe and among producers of tissue papers in North America because of its softness and absorbency. In addition, eucalyptus trees generally grow straighter and have fewer branches than most other hardwood trees. This allows for dense growth, easy harvesting and decreased need for pruning.
 
Paper Industry Overview
 
There are six major groups of paper products produced by the paper industry:
 
 
·
newsprint paper, used to print newspaper;
 
 
·
printing and writing papers, used for a broad range of purposes, including writing, photocopying, commercial printing, business and computer forms;
 
 
·
tissue papers, used to produce tissue, toilet papers and paper towels;
 
 
·
packaging papers encompassing kraft paper, containerboard (corrugated paper and linerboard) and liquid packaging board;
 
 
·
cardboard; and
 
 
·
specialty papers.
 
We produce printing and writing papers, specialty papers, and thermal and carbonless paper, a subcategory of specialty papers.
 
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Printing and writing papers are classified according to whether they are coated or uncoated, and whether the pulp from which they are made is chemically processed to eliminate lignin, called wood-free paper, or contains some lignin, called mechanical or wood-containing. We make uncoated and coated wood-free printing and writing paper.
 
Printing and writing paper is sold either in reels or in packages of pre-cut sheets, called cut-size. We sell our paper in both reels and cut-size. Reels of paper are used by manufacturers of paper products such as business forms, writing pads, packaged sheets of pre-cut paper, books and envelopes. Customers require different size reels depending on the type of machines they use. Cut-size paper is used in offices for general commercial purposes, such as photocopying and writing. There has been a general trend in recent years toward the use of standardized pre-cut sheets rather than preprinted and continuous business forms and computer paper. This trend has led many paper producers, including us, to reduce sales of reels and to integrate cutting machines in their paper mills, increasing their production of cut-size papers.
 
The market for paper has a large number of producers and consumers and more product differentiation than the market for pulp. Prices for paper are cyclical but are less volatile than pulp prices. The prices for paper and paperboard have historically followed the trends of pulp prices. The key factors that drive paper prices are overall economic activity, capacity expansion and fluctuations in current exchange rates.
 
In 2005, Brazilian paper companies increased their export volumes in order to compensate the demand reduction in the domestic market. Regarding the international market, although the appreciation of the real of approximately 13% in 2005, 9% in 2006 and 17% in 2007 impacted our revenues, the volume sold increased due to a good economic environment, especially for the North American and European markets. After suffering some years at low price levels, international paper prices start a recovery in the first half of 2006, with price increases being announced in February, April and June 2006, in both North America and Europe. For uncoated woodfree papers, international prices rose 15% in the first six months of 2006 and fell about 5% in the last quarter of 2006. In 2007, prices rose 7% from January to December in North America, and in the European market, prices climbed 9% in the first nine months of 2007.
 
The Brazilian pulp and paper industry
 
Brazil is predominantly a tropical country, with approximately 90% of its territory located north of the Tropic of Capricorn. As a result, in most regions of Brazil, the soil and climate are very favorable to forest growth. In Brazil, eucalyptus trees have short growing cycles of approximately seven years, compared to 10 to 12 years for eucalyptus trees in Chile and 25 years in the United States. The production of wood in Brazil, therefore, requires less time and a smaller growing area than in North America and Europe, which results in higher yields.
 
Brazil’s high technology and natural advantages in forestry make it one of the world’s lowest-cost producers of pulp, and in the last 20 years Brazil has become an important pulp exporter. As one of the world’s lowest-cost producers of pulp, Brazilian pulp producers are able to weather more favorably than other producers through periods of low pulp demand. This shorter maturing period also enables Brazilian producers to expedite the process of genetically improving the Eucalyptus species utilized. In this manner, the Brazilian Eucalyptus is one of the pulping trees species that have evolved more rapidly and consistently over recent years, resulting in significant improvements in its productivity.
 
Capitalizing on its advantages in pulp production, Brazil has developed a diversified paper industry with modern technology and a potential for growth in both the domestic and export markets. In recent years, there has been a marked increase in paper consumption in Brazil, which is an important indicator of the economic development of a country. Between 1997 and 2007, the average annual rate of paper consumption increased by approximately 3% per year, reaching 8.0 million tons in 2007, according to estimated figures from Bracelpa. We believe that there is growth potential for domestic consumption, because per capita consumption is still low in comparison with developed countries. Per capita consumption of paper is estimated at 39.5 kilos per year, according to PPI, a news and information provider for the pulp, paper, converting forest products and allied industries.
 
According to preliminary data from PPI (Pulp and Paper Industry), in 2007, Brazil was the twelfth largest paper producer and the sixth largest pulp producer in the world. Brazilian pulp and paper companies have made large investments over the last ten years in order to compete more effectively and on a larger scale with traditional pulp suppliers in the international market. In addition, technological development in the paper industry has been supported by the research efforts of major producers and by financing from BNDES.
 
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Consolidation in the Brazilian pulp and paper industry is currently under way. The table below shows the market participation of the five largest producers in terms of sales for the years indicated:
 
   
Year ended December 31,
 
(in thousands of tons)
 
2007*
 
2006
 
2005
 
2004
 
2003
 
Brazilian pulp production (1)
   
11,800.0
   
11,180.0
   
10,352.0
   
9,620.1
   
9,104.2
 
Brazilian paper production
   
8,970.0
   
8,724.6
   
8,597.0
   
8,452.4
   
7,811.1
 
Total pulp and paper production
   
20,770.0
   
19,904.6
   
18,949.0
   
18,072.5
   
16,915.3
 
Total five top producers
   
NA
   
11,982.3
   
11,461.9
   
10,987.2
   
10,547.0
 
% Top five
   
NA
   
60.2
%
 
60.5
%
 
60.8
%
 
62.4
%


(1)
Pulp numbers represent pulp volume produced.
 
Source: Bracelpa.
 
NA: Not Available. At the time of the filing of this document, the updated information was not released by Bracelpa.
 
(*)
For 2007 Bracelpa figures through November 2007.
 
Brazil produces both commodity grade paper, such as kraft linerboard, and more value-added paper products, such as thermal, carbonless and fiduciary paper. Brazil is self-sufficient in all types of paper, except newsprint, coated paper and certain specialty grades. The paper market is larger than the pulp market in terms of the numbers of producers, consumers and variety of products. Paper prices tend to be less volatile than prices for pulp.
 
Cyclical nature of world pulp prices
 
World pulp prices are cyclical because demand for paper depends heavily on general economic conditions and because production capacity adjusts slowly to changes in demand.
 
Over the last three years, bleached eucalyptus kraft pulp (“BEKP”) or market pulp prices in the United States, Europe and Asia, have fluctuated from lows of US$ 585, US$ 550, and US$ 500 per ton on January 1, 2005, to highs of US$ 805, US$ 780, and US$ 720 per ton at December 30, 2007 in these respective regions. Such price fluctuations occur not only year to year but also within a year as a result of global and regional economic conditions, and supply and demand. The price of paper products, although less volatile than the price of pulp, also experiences fluctuations in response to global demand and production and fluctuations in pulp prices. Capacity adjustments have also occurred on the paper side, and in the first half of 2006 we saw paper prices increasing for several grades in the United States and Europe. For uncoated woodfree papers, international prices climbed 15% in the first six months of 2006 but declined approximately 5% in the last quarter of the year. In 2007 the prices rose 8% on average, following the same capacity adjustments.
 
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The following table sets forth the estimated cash production costs per ton of bleached hardwood kraft market pulp pre-sold in Northern Europe, Brazil and the United States for the second quarter of 2007, for producers in the regions indicated. Cash production costs are total production costs less depreciation and depletion and does not include any transportation costs. Amounts have been expressed on a per ton basis in U.S. dollars, with local currencies translated at prevailing exchange rates. Particular producers may have production costs significantly above or below regional averages.
 
BHKP operating costs, Q2 2007
 
Cash production costs (per ton)
 
Indonesia
 
US$
 291
* 
Brazil
   
309
 
Chile
   
307
 
Finland/ Sweden
   
484
 
Iberia
   
470
 
France/Belgium
   
511
 
Southern U.S.
   
495
 
Eastern Canada
   
561
 


Source: Hawkins Wright as of July 2007.
 
* Mixed with native forest.
 
 
C.
Organizational Structure
 
The chart below shows our organizational structure as of December 31, 2007 (% of total capital):
 
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Our operations are conducted by Votorantim Celulose e Papel S.A. as the controlling and principal operating company. We are a member of the Votorantim group, which has other interests in Brazil and abroad, principally in cement, metallurgy, agribusiness, chemicals and financial services. In 2006, consolidated net operating revenues of the Votorantim group reached approximately US$ 13 billion (US$ 7.8 billion in 2005) based on the Consolidated Financial Statements in accordance with Brazilian GAAP, data translated to U.S. dollars at 2006 year-end exchange rates, of which 10% (18% in 2005) represented pulp and paper activities. Net consolidated sales include the industrial units of the Votorantim group, as well as Votorantim Finanças, which includes Banco Votorantim. Our immediate parent company is Votoramtim Investimentos Industriais (VID), which in turn is controlled by Hejoassu Administração S.A. Hejoassu is formed by the Board Members of the Votorantim Group. It is composed by family members, responsible for the main decisions and business strategies. Hejoassu is controlled by the Ermírio de Moraes family. See “Item 4—Information on VCP—Business Overview—Our Ownership Structure.”
 
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On March 1, 2002, we incorporated VCP Overseas, our wholly owned subsidiary incorporated in Hungary.
 
As of December 31, 2002, we had a 50% stake in Voto-Votorantim Overseas Trading Operations N.V. and three wholly owned subsidiaries, VCP Terminais Portuários S.A., VCP Exportadora and VCP Florestal. In April 2001, we incorporated VCP Exportadora as a wholly owned subsidiary, and in the fall of 2001 we incorporated Newark, which was used to acquire our interest in Aracruz.
 
In order to facilitate access to our international customers and to the international financial markets, we have established two subsidiaries of Newark, VCP Trading and VCP North America, to manage our exports to clients in Europe and in North America, respectively, until 2005. As of January 2006 we have been performing the total export sales from VCP Overseas Holding Limited Budapest, Zug (Switzerland).
 
In November 2004, we signed an agreement with Suzano Bahia Sul Papel e Celulose S.A., or Suzano, for the joint acquisition of all of the common and preferred stock of Ripasa. On March 31, 2005, we finalized the acquisition, through a 50% joint venture, of 77.59% (our interest - 38.80%) indirect interest in the voting capital and 46.06% (our interest - 23.03%) indirect interest in the total capital of Ripasa. We disbursed US$ 275 million for our 50% interest in the venture. A purchase and sale option was also signed for the sale of 37,449,084 common shares and 12,388,719 preferred shares, totaling 22.41% of the voting stock and 13.45% of the total stock, to be exercised up to 2010 for a total amount of US$ 160 million for VCP and Suzano interest at that date (our interest was US$ 80 million).
 
On July 20, 2005, VCP and Suzano announced a restructuring plan for Ripasa, including a delisting of Ripasa from the Bovespa, through a share exchange by VCP’s and Suzano preferred shares. Each of Ripasa’s preferred shares would correspond to 0.0072 VCP preferred shares and to 0.0167 Suzano class “A” preferred shares. The reasons for the restructuring were: (i) to permit Ripasa’s current minority shareholders to hold VCP and Suzano shares, which were more liquid than those of Ripasa; and (ii) to allow future reorganization of Ripasa, which would permit cost reductions, operational gains, enhanced competitiveness and economies of scale for the companies. The restructuring plan was analyzed and approved by the CVM; however, certain minority shareholders filed a judicial action and suspended the process. On April 26, 2006, VCP and Suzano entered into a judicial agreement with a group of Ripasa’s preferred shareholders, with the aim of settling the claims challenging Ripasa’s corporate restructuring, and implementing the restructuring, once the conditions in the agreement were met.
 
Since the conditions of the agreement were met (including suspension of the ongoing legal procedures relating to the restructuring, and the absence of any decision, judicial or administrative, that prevented or hindered the restructuring, or rendered it inadvisable) the restructuring was concluded in July 2006, VCP and Suzano paid the group of minority shareholders R$ 1.0538 for each Ripasa preferred share held by them (corresponding to an additional US$ 36 million cash disbursement by VCP). VCP’s capital increased, in 2006, by R$ 573,629.83 from R$ 2,478,582,123.76 to R$ 3,052,211,393.59, upon the issuance of 12,532,009 preferred shares with no par value.
 
The acquisition of the share control in Ripasa and its future transformation into a production unit was already approved by CADE.
 
Following the corporate restructuring, the said call options and the put option of certain former minority shareholders of Ripasa, were modified to substitute the Ripasa shares for shares in VCP and Suzano as those former Ripasa minority shareholders had exchanged their shares for shares in VCP and Suzano. Accordingly, VCP has a call option to acquire 3,124,139 of its own non-redeemable preferred shares during a twelve-month period starting on March 31, 2010. At December 31, 2007, the total updated amount was US$ 358 million for VCP and Suzano’s combined interest. The former shareholders of Ripasa, now shareholders of VCP, who are party to the agreement, have a put option which may require VCP to acquire all their non-redeemable preferred shares during a period of five years through March 31, 2010. Pursuant to the agreement, as a required condition precedent, the put/call options can only be exercised if the underlying shares are free of liens and encumbrances. For more information on the call and put options see Note 4(a) to our financial statements.
 
On January 26, 2005, in an Extraordinary General Meeting, our shareholders decided that VCP Florestal would merge into us to achieve cost reductions and increased business synergies between the two companies. VCP Florestal was dissolved as a result of the merger and we succeeded to all its rights and obligations. There was no increase in our capital stock as a result of the merger, due to the fact that we owned all the shares of VCP Florestal.
 
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On June 24, 2005 Voto-Votorantim IV, a wholly-owned subsidiary of VPAR, issued US$ 400 million, 7.75% Fixed Rate Notes due 2020 in the international capital market, under Rule 144A and Regulation S of the U.S. Securities Act of 1933. Along with VPAR, VCP is a guarantor of 50% of the debt issued by Voto-Votorantim IV and in turn received US$ 200 million of the proceeds, which is also 50% of the total loan. On September 6, 2005, we acquired a 50% interest in Voto-Votorantim IV. Of the proceeds of US$ 200 million, US$ 125 million was used by St. Helen III to repay the debt incurred with Voto-Votorantim II.
 
On July 20, 2005, Ripasa’s restructuring was concluded and, in September 2006, VCP and Suzano started to sell Americana’s unit products as a pre-consortium stage. We are still waiting for the Brazilian tax authorities’ approval to transform Ripasa’s unit of Americana in a consortium (Conpacel). Upon approval, VCP will sell 50% of the unit’s production (its interest) as if it were any other VCP’s unit.
 
In April 2006, for administrative and economic reasons, we merged VCP Exportadora e Participações S.A., VCP’s 100% subsidiary, into us and assumed all of the assets and liabilities relating to our export operations.
 
In September 2006, we announced a plan to divest our non integrated special paper mill located in the city of Mogi das Cruzes in the state of São Paulo. The unit was sold in May 2007. Additionally, we declared the intention to sell our 50% stake in the other three production mills of Ripasa, in addition to the Americana mill, which produce cardboard and special papers. These units were sold in March 2007 (Embu unit) and in August 2007 (Cubatão and Limeira). This divestment plan is part of our strategy to focus and grow in the production of market pulp and printing & writing papers (coated and uncoated) in large scale.
 
In September, 2006, International Paper, a wholly owned subsidiary of International Paper Company, and VCP entered into the Exchange Agreement. Pursuant to the terms of the Exchange Agreement, International Paper agreed to the Project Mill being developed in Três Lagoas, state of Mato Grosso do Sul, Brazil (together with approximately 100,000 hectares of surrounding forestlands) for VCP’s Luiz Antonio pulp and uncoated paper mill and approximately 60,000 hectares of forestlands located in the state of São Paulo, Brazil. International Paper has already fully funded the project mill in the amount of US$ 1.15 billion.
 
The Luiz Antonio mill produces 355,000 metric tons of uncoated papers and 100,000 metric tons of market pulp annually. The 100,000 metric tonnes of market pulp will be supplied to VCP, for its use in other facilities, on competitive terms under a long-term supply agreement. The Três Lagoas project mill is expected to be completed in January 2009 and to have a capacity of 1,100,000 tons of market pulp per annum.
 
Under the Exchange Agreement, International Paper is granted the right to construct, at its cost, up to two paper machines adjacent to, and integrated with, the Project Mill. If International Paper exercises its right to build one or both paper machines adjacent to the Project Mill, (1) certain parcels of real property will be retained by International Paper upon which the paper machines and ancillary facilities will be constructed and (2) the paper machines will be supported by long-term supply agreements under which VCP will provide International Paper pulp on competitive terms and utilities and other services at rates based on VCP’s actual operating costs. See “Item 4.A—Information on VCP—History and Development of VCP,” “Item 10.C—Additional Information—Material Contracts,” and Note 4(b) to our financial statements.
 
 
D.
Property, Plant and Equipment
 
Our main production facilities are located in the state of São Paulo and there is also the Três Lagoas facility which is under construction, located in the state of Mato Grosso do Sul. We also have forests plantations in the State of São Paulo, timberland in the State of Rio Grande do Sul which have been acquired since 2004 and timberland in the State of Mato Grosso do Sul obtained via the asset swap with International Paper, effective February 2007. The state of São Paulo accounts for more than 33% of Brazil’s gross domestic product, and is home to most of the domestic consumers of pulp and paper products. In 2007, our forests (including purchased wood) were located an average of 357 kilometers from our pulp mills, which is, in turn, located an average of 150 kilometers from Santos, which is the port facility that we use for most of our exporting activities. The relatively short distance between our forests, our plants, our port facility and most of our domestic customers results in relatively low transportation costs.
 
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The following table sets forth the distance between our forests (including the transport of pulpwood purchased in the market) and our mills, the distance of these mills to the port of Santos, and the nominal capacity of each mill at December 31, 2007:
 
Facility
 
Pulp/Paper
 
Distance from
forest (pulp) or
pulp mill (paper)