20-F 1 d20f.htm FORM 20-F Form 20-F
Table of Contents

As filed with the Securities and Exchange Commission on June 22, 2011

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR

15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

Commission File Number: 33-99720

CELULOSA ARAUCO Y CONSTITUCIÓN S.A.

(Exact name of Registrant as specified in its charter)

Arauco and Constitution Pulp Inc.

(Translation of Registrant’s name into English)

Republic of Chile

(Jurisdiction of incorporation or organization)

Avenida El Golf 150

14th Floor

Las Condes, Santiago

Chile

(Address of principal executive offices)

Gianfranco Truffello

Tel.: 56-2-4617221 E-mail: gtruffello@arauco.cl

Avenida El Golf 150

14th Floor

Las Condes, Santiago

Chile

(Name, telephone, e-mail and/or facsimile number and address of company contact person)

 

 

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

None

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:

Title of each class:

7.75% Notes due 2011

5.125% Notes due 2013

5.625% Notes due 2015

7.50% Notes due 2017

7.25% Notes due 2019

5.00% Notes due 2021

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:    Shares of Common Stock, without par value: 113,152,446.

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    N/A

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer  ¨     Accelerated filer  ¨     Non-accelerated filer  x

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

U.S. GAAP  ¨     International Financial Reporting Standards as issued by the International Accounting Standards Board  x     Other  ¨

Indicate by check mark which financial statement item the registrant has elected to follow:    Item 17  ¨     Item 18  ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨     No  x

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  

PART I

     2   

Item 1.

   Identity of Directors, Senior Management and Advisers      2   

Item 2.

   Offer Statistics and Expected Timetable      2   

Item 3.

   Key Information      2   

Item 4.

   Information on the Company      19   

Item 5.

   Operating and Financial Review and Prospects      45   

Item 6.

   Directors, Senior Management and Employees      65   

Item 7.

   Major Shareholders and Related Party Transactions      70   

Item 8.

   Financial Information      72   

Item 9.

   The Offer and Listing      76   

Item 10.

   Additional Information      77   

Item 11.

   Quantitative and Qualitative Disclosures About Market Risk      85   

Item 12.

   Description of Securities Other than Equity Securities      86   

PART II

     87   

Item 13.

   Defaults, Dividend Arrearages and Delinquencies      87   

Item 14.

   Material Modifications to the Rights of Security Holders and Use of Proceeds      87   

Item 15.

   Controls and Procedures      87   

Item 16A.

   Audit Committee Financial Expert      88   

Item 16B.

   Code of Ethics      88   

Item 16C.

   Principal Accountant Fees and Services      88   

Item 16D.

   Exemptions from the Listing Standards for Audit Committees      89   

Item 16E.

   Purchases of Equity Securities by the Issuer and Affiliated Purchasers      89   

Item 16F.

   Change in Registrant’s Certifying Accountant      89   

Item 16G.

   Corporate Governance      89   

PART III

     90   

Item 17.

   Financial Statements      90   

Item 18.

   Financial Statements      90   

Item 19.

   Exhibits      90   

 

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CERTAIN TERMS AND CONVENTIONS

Celulosa Arauco y Constitución S.A. is a corporation (sociedad anónima) organized under the laws of the Republic of Chile, and subject to certain rules applicable to Chilean public corporations (sociedades anónimas abiertas). Except where otherwise specified or the context otherwise requires, when we refer to the “Company,” “Arauco” or “we,” in this annual report, we mean Celulosa Arauco y Constitución S.A. and its consolidated subsidiaries. When we refer to “Chile,” we mean the Republic of Chile; when we refer to “Argentina,” we mean the Argentine Republic; when we refer to “Brazil,” we mean the Federative Republic of Brazil; and when we refer to “Uruguay,” we mean the Oriental Republic of Uruguay. All references to “tons” are to metric tons (1,000 kilograms), which equal 2,204.7 pounds. One “hectare” equals 10,000 square meters or 2.471 acres. Discrepancies in any table between totals and the sums of the amounts listed are due to rounding.

Unless otherwise specified, all references to “$”, “U.S.$”, “U.S. dollars” or “dollars” are to United States dollars; references to “Chilean pesos” or “Ch$” are to Chilean pesos; references to “Argentine pesos” or “AR$” are to Argentine pesos; references to “Brazilian reals” or “R$” are to Brazilian reals; references to “€” or “euro” are to the euro, the single European currency established pursuant to the European Economic and Monetary Union; and references to “UF” are to Unidades de Fomento. The UF is a unit of account that is linked to, and adjusted daily to reflect changes in, the Chilean consumer price index reported by the Chilean National Institute of Statistics (Instituto Nacional de Estadísticas). At December 31, 2010, one UF equaled U.S.$45.80 and Ch$21,455.60.

PRESENTATION OF FINANCIAL DATA

This report includes the audited consolidated balance sheets of Arauco and our subsidiaries as of December 31, 2010 and 2009 and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2010, 2009 and 2008 (collectively, the “audited consolidated financial statements” or “financial statements”).

For Chilean statutory reporting purposes, effective as of January 1, 2009, we were required to prepare our annual audited financial statements in accordance with the International Financial Reporting Standards or “IFRS”. Therefore, our financial statements as of and for the year ended December 31, 2009 were our first annual audited consolidated financial statements required to be prepared in accordance with IFRS. Our consolidated financial information as of and for the year ended December 31, 2008 included in our audited consolidated financial statements was restated in accordance with IFRS. For SEC reporting purposes, we prepare our audited annual consolidated financial statements in accordance with IFRS.

IFRS differs in certain significant respects from generally accepted accounting principles in the United States, or U.S. GAAP. As a result, our financial information presented under IFRS is not directly comparable to our financial information presented in prior years under U.S. GAAP, and readers should avoid such a comparison.

For your convenience, this annual report contains certain translations of Chilean peso amounts into U.S. dollars at specified rates. Unless otherwise indicated, the U.S. dollar equivalent for information in Chilean pesos is based on the observed exchange rate reported by Banco Central de Chile, the Central Bank of Chile, which we refer to as the “Central Bank of Chile” or the “Central Bank.” The Federal Reserve Bank of New York does not report a noon buying rate for Chilean pesos. On December 31, 2010, the observed exchange rate for Chilean pesos was Ch$468.01 to U.S.$1.00, and on June 21, 2011, the observed exchange rate was Ch$472.95 to U.S.$1.00. You should not construe these translations as representations that the Chilean peso amounts actually represent such dollar amounts or could be converted into U.S. dollars at the rates indicated or at any other rate. See “Exchange Rates.” Unless otherwise specified, references to the devaluation or the appreciation of the Chilean peso against the U.S dollar are in nominal terms (without adjusting for inflation) based on the observed exchange rates published by the Central Bank of Chile for the relevant period.

 

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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

SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial information as of December 31, 2008, 2009 and 2010 and for each of the years then ended is derived from, should be read in conjunction with, and is qualified in its entirety by reference to, our audited consolidated financial statements which have been prepared in accordance with IFRS.

 

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IFRS differs in certain significant respects from U.S. GAAP. As a result, our financial information presented under IFRS is not directly comparable to our financial information presented under U.S. GAAP in prior years, and readers should avoid such a comparison.

 

      As of and for the year ended December 31,  
     2008     2009     2010  
     (in thousands of U.S.$, except ratios and per share data)  

INCOME STATEMENT DATA

      

Revenue

   U.S.$ 3,713,893        3,113,045        3,788,354   

Cost of sales

     (2,331,854     (2,152,535     (2,298,191

Gross profit

     1,382,039        960,510        1,490,163   

Other operating income

     104,270        181,383        378,188   

Distribution costs

     (455,197     (388,535     (379,579

Administrative expenses

     (259,025     (249,340     (323,916

Other operating expenses

     (50,782     (59,681     (50,642

Other income (loss)

     (444     64,102        292   

Financial income

     19,408        19,313        22,154   

Financial costs

     (175,241     (193,872     (213,912

Participation in income (loss) in affiliates and joint ventures accounted through equity method

     5,839        6,621        (7,693

Exchange rate differences

     (67,778     17,632        (16,288

Income before income tax

     503,089        358,133        898,767   

Income tax

     (98,044     (53,537     (198,018
                        

Net income

     405,045        304,596        700,749   

BALANCE SHEET DATA

      

Current assets

     1,995,990        2,272,313        3,152,116   

Property, plant and equipment

     4,615,971        4,969,753        5,088,745   

Biological assets(1)

     3,652,433        3,757,528        3,790,958   

Total assets

     10,239,840        11,413,827        12,506,332   

Total current liabilities

     812,915        951,413        1,209,061   

Total non-current liabilities

     3,419,689        4,079,981        4,456,696   

Total equity

     6,007,236        6,382,433        6,840,575   

CASH FLOW DATA

      

Net cash flow from operating activities

     769,736        751,025        1,137,275   

Net cash flow from investing activities

     (466,731     (717,291     (669,414

Net cash flow from financing activities

     (378,484     302,372        33,852   
                        

Net change in cash

     (75,479     336,106        501,713   

OTHER FINANCIAL DATA

      

Capital expenditures(2)

     432,398        362,690        595,520   

Depreciation and amortization

     189,256        207,415        233,655   

Stumpage(3)

     311,950        198,675        271,515   

EBIT(4)

     667,817        322,635        786,668   

Net insurance coverage

         114,093   

Adjusted EBITDA(4)

     1,169,023        728,725        1,405,931   

Adjusted EBITDA/total interest expense

     6.65        3.76        6.57   

Adjusted EBITDA/sales revenue

     31.4     23.4     37.1

Average debt(5)/EBITDA

     —          4.02        2.37   

Total debt(6)

     2,651,943        3,202,919        3,449,569   

Total debt(6)/capitalization(7)

     30.6     33.4     33.5

Total debt(6)/shareholders’ equity

     44.1     51.1     51.2

Ratio of earnings to fixed charges(8)

     3.6        2.7        5.0   

Working capital(9)

     1,183,075        1,320,900        1,943,055   

Number of shares

     113,152,446        113,152,446        113,152,446   

Net income per share

     3.58        2.66        6.14   

Dividends paid

     317,588        135,175        158,781   

Dividends per share (U.S.$ per share)

     2.81        1.19        1.40   

 

(1)

Biological assets refer to our forests and long-standing trees.

(2)

Accrued for the period.

(3)

Under IFRS, stumpage consists of the fair value of non-cash cost items associated with biological assets.

(4)

We calculated EBIT by subtracting marketing costs, distribution costs and administrative costs from gross profit, and Adjusted EBITDA by adding depreciation and stumpage to EBIT. We present Adjusted EBITDA because we believe it is a useful indicator of performance. We believe that neither EBIT, EBITDA or Adjusted EBITDA should be considered in

 

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isolation or as a substitute for net income, as an indicator of operating performance, as an alternative to cash flow or as a measure of liquidity. The following table presents, for the periods indicated, our calculations of EBIT, EBITDA and Adjusted EBITDA.

 

      As of and for the year ended December 31,  
     2008     2009     2010  
     (in thousands of U.S.$, except ratios and per share data)  

Net income

   U.S.$ 405.045        304.596        700.749   

(+) Other operating expenses

     50.782        59.681        50.642   

(-) Other operating income

     (104.270     (181.383     (378.188

(+) Financial costs

     175.241        193.872        213.912   

(-) Financial income

     (19.408     (19.313     (22.154

(+) Other (loss) income

     444        (64.102     (292

(+) Participation in (loss) income in associates and joint ventures accounted through equity method

     (5.839     (6.621     7.693   

(+) Exchange rate differences

     67.778        (17.632     16.288   

(+) Income Tax

     98.044        53.537        198.018   

EBIT

     667,817        322,635        786,668   

(+) Depreciation and amortization

     189,256        207,415        233.655   

EBITDA

     857,073        530,050        1,020,323   

(+) Stumpage

     311,950        198,675        271.515   

(+) Net insurance coverage(10)

     —          —          114,093   
                        

Adjusted EBITDA

     1,169,023        728,725        1,405,931   

 

(5) 

Average debt is calculated as the average between the beginning and the end of the applicable year.

(6)

Total debt is calculated as total financial debt, including accrued interest.

(7) 

Capitalization is calculated as total financial debt, including accrued interest, plus total shareholders’ equity.

(8)

For purposes of computing the ratio of earnings to fixed charges, earnings consist of earnings before income taxes plus fixed charges. Fixed charges consist of interest expense (including capitalized interest) and amortization of any discount and issuance costs related to our offerings of debt securities.

(9)

Working capital is calculated by subtracting current liabilities from current assets.

(10)

Net insurance coverage refers to the net effect of income (expenses) related to the earthquake impact.

 

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EXCHANGE RATES

The following table sets forth, for the periods and dates indicated, certain information concerning the observed exchange rates reported by the Central Bank. No representation is made that the Chilean peso or U.S. dollar amounts referred to in this annual report could have been or could be converted into U.S. dollars or Chilean pesos, as the case may be, at the rates indicated or at any other rate. The Federal Reserve Bank of New York does not report a noon buying rate for Chilean pesos. See “Item 10. Additional Information—Exchange Controls.”

 

     Daily Observed Exchange Rate  

Year Ended December 31,

   High      Low      Average(1)      Period-End  
            Ch$ per U.S.$         

2006

     549.63         511.44         529.64         532.39   

2007

     548.67         493.14         521.06         496.89   

2008

     676.75         431.22         521.79         636.45   

2009

     643.87         491.09         559.67         507.10   

2010

     549.17         468.01         510.22         468.01   

December

     485.34         468.01         473.83         468.01   

2011

           

January

     499.03         466.05         490.21         484.14   

February

     485.34         468.01         473.83         475.21   

March

     485.37         472.74         479.84         479.46   

April

     476.90         460.04         470.35         460.09   

May

     474.19         461.65         467.96         465.13   

 

Source: Central Bank of Chile

 

(1) 

For each year, the average of the month-end exchange rates for the relevant year. For each month, the average daily exchange rate for the relevant month.

On June 21, 2011, the observed exchange rate was Ch$472.95 to U.S.$1.00.

 

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FORWARD-LOOKING STATEMENTS

This annual report on Form 20-F contains words such as “believe,” “expect,” “anticipate” and similar expressions that identify forward-looking statements, which reflect our views about future events and financial performance. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements.

Forward-looking statements involve inherent risks and uncertainties. These forward-looking statements are based on current plans, estimates and projections; therefore, readers should not place undue reliance on them. Actual results could differ materially from those projected in such forward-looking statements because of various factors that may be beyond our control, including but not limited to our ability to service our debt, fund our working capital requirements, comply with financial covenants in certain of our debt instruments, fund and implement our capital expenditure programs and maintain our relationships with customers, as well as a change in control, the effects on us from competition, future demand for forestry, panels and wood products in the Chilean, Argentine, Brazilian, Uruguayan and export markets, international prices for forestry and wood products, the state of the Chilean and world economies and manufacturing industries, the relative value of the Chilean peso compared to other currencies, inflation, increases in interest rates and changes in our regulatory environment. Forward-looking statements in this annual report speak only as of their dates, and we do not undertake any obligation to update or revise any of them, whether as a result of new information, future events or otherwise.

 

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RISK FACTORS

We are subject to various changing economic, political, social and competitive conditions, particularly in our principal markets. Any of the following risks, if they actually occur, could materially and adversely affect our business, financial condition, results of operations and cash flows.

Risks relating to us and the forestry industry

Fluctuations in market price for our products could adversely affect our financial condition, results of operations and cash flows.

Prices for many of the products we sell can fluctuate significantly. The price of commodities such as pulp, plywood, fiberboard and sawn timber has a high correlation with international prices. Consequently, the prices that we are able to charge for these products are highly dependent on prevailing international prices. Historically, such prices have been subject to substantial variation. For example, during the period from January 1, 2007 to December 31, 2010, the average price for Norscan bleached softwood kraft market pulp (pulp produced in Canada and Northern Europe sold to manufacturers of paper products delivered in Northern Europe, or NBSK), which is the benchmark for softwood bleached pulp, ranged from a low of U.S.$577.09 per metric ton in March 2009 to a high of U.S.$979.02 per metric ton in July 2010. During the last quarter of 2008 and the first quarter of 2009 there was a very rapid and significant reduction in the international prices of the products we sell and commodity prices in general. The continuation of severe global economic conditions may continue to exert downward pressure on commodity prices, including the international prices of the products we sell, which could result in material and adverse declines in our revenues, results of operations and financial condition. We have no control over the factors that cause prices to change which include, among others:

 

   

worldwide demand (which may be affected by a number of factors, including economic or political conditions in Asia, Latin America, North America and Europe);

 

   

prevailing world prices, which historically have been subject to significant fluctuations over relatively short periods of time, depending on worldwide demand;

 

   

world production capacity;

 

   

the business strategies adopted by major integrated forestry, pulp and paper producers and other major producers; and

 

   

the availability of substitutes.

In addition, the prices of many of the products we sell are correlated to some extent, and historical fluctuations in the price of one product have usually been accompanied by similar fluctuations in the prices of other products. If the price of one or more of the products that we sell were to decline significantly from current levels, it could have a material adverse effect on our revenues, results of operations and financial condition.

Worldwide competition in the markets for our products could adversely affect our business, financial condition, results of operations and cash flows.

We experience substantial worldwide competition in each of our geographical markets and in each of our product lines. Several of our competitors are larger than we are and have greater financial and other resources, which they could use to take steps that could materially and adversely affect our financial and competitive position. The pulp industry is sensitive to changes in industry capacity and producer inventories, as well as to cyclical changes in the world’s economies, all of which may significantly affect selling prices and, thereby, our profitability. Increased competition could materially and adversely affect our business, financial condition, results of operations and cash flows.

 

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Global economic developments, and particularly economic developments in the Asian and U.S. economies, could have an adverse effect on the demand for our products, our financial condition, results of operations and cash flows.

The global economy, and in particular global industrial production, is the primary driver of demand for pulp, paper and wood products. Global industrial production dropped during the second half of 2008 and first half of 2009 due to the financial crisis and global economic conditions, resulting in a significant and widespread contraction in demand for pulp, paper and wood products. A continued decrease in the level of activity in either the domestic or the international markets within which we operate could adversely affect the demand and the price of our products and thus our cash flows and operational and financial results.

Due to this downturn in global industrial production, our pulp segment experienced significant price declines in the last quarter of 2008 and the first quarter of 2009 which severely affected our results. In addition, the significant downturn in the home-building industry in the United States and Europe has resulted in increased inventories of available new homes, significant declines in home prices, loss of home-equity values and loss of consumer confidence and demand. As a result of these events, our plywood and panel sales were adversely affected, continuing a downward trend both in volume and price across all markets. Our medium-density fiberboard molding sales also experienced a sharp decline in volume mainly due to the lower activity in the United States and Canadian construction markets. Our wood products segment, which is also highly dependent on the strength of the home-building industry, experienced decreases in its prices of and demand for its products.

The decrease in demand of sawn timber products due primarily to the credit crisis and continued downturn in the real estate market in the United States and decrease in demand for sawn timber products resulted in our decision to close five sawmills in 2008 and 2009. As a result, in 2008 we recorded a pre-tax impairment charge totaling U.S.$32.9 million, relating to the closure of our sawmills in such year. Additionally, during 2008 and as a result of the impact that the credit crisis had on the Brazilian market and the reduction of the quantities to be produced by the Curitiba fiberboard panels plant, we decided to conduct an impairment analysis pursuant to which we recorded in 2008 a pre-tax impairment charge of U.S.$32.5 million to reduce the carrying value of this plant to the estimated sales price minus selling costs. See Note 14 to our audited consolidated financial statements incorporated by reference or included elsewhere herein.

Export sales of our products to Asia accounted for 34.5% of our sales revenue in 2010 compared to 40.0% in 2009, 32.0% in 2008 and 31.3% in 2007, and export sales to the United States accounted for 9.1% of our sales revenue in 2010 compared to 10.3% in 2009,14.0% in 2008 and 12.0% in 2007. In addition, during 2009 we exported a significant quantity of our sawn timber products, especially to Asia and the Middle East, in order to avoid additional personnel reductions in the facilities and to mitigate the impact of the global economic downturn on our sawn timber division. Our business, financial condition, results of operations and cash flows could be materially and adversely affected if the economic conditions in Asia, the United States and elsewhere abroad continue to deteriorate, and if we are unable to reallocate our sawn timber and other products to other markets on equally beneficial terms, which could require us to recognize additional impairment charges.

We depend on free international trade as well as economic and other conditions in our principal export markets.

In 2010, export sales, defined as sales out of the country where our goods were produced, accounted for 69.9% of our total sales revenues. During this period, 40.2% of our export sales were to customers in Asia, 15.5% to customers in North America, 10.2% to customers in Europe, 8.3% to customers in Central and South America and 2.0% to customers in other countries. As a result, our results of operations and cash flows depend, to a significant degree, on economic, political and regulatory conditions in our principal export markets. Our ability to compete effectively in our export markets could be materially and adversely affected by a number of factors beyond our control, including deterioration in macroeconomic conditions, exchange rate volatility, government subsidies, and the imposition of increased tariffs or other trade barriers. If our ability to sell our products competitively in one or more of our principal export markets were impaired by any of these developments, it might be difficult to re-allocate our products to other markets on equally favorable terms and our business, financial condition, results of operations and cash flows might be adversely affected.

 

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We are located in a seismic area that exposes our property in Chile to the risk of earthquakes, and we experienced significant business disruption and losses as a result of the February 27, 2010 earthquake.

Chile is located in a seismic area that exposes our property in Chile, including our facilities, plants, equipment and inventories, to the risk of earthquakes and even subsequent tsunamis in some areas. A significant earthquake or other catastrophic event could severely affect our ability to meet our production targets, satisfy customer demand and could require us to make unplanned capital expenditures, resulting in lower sales and having a material adverse effect on our financial results.

On February 27, 2010, an earthquake measured at a magnitude of 8.8 on the Richter scale, followed by a tsunami that affected the coast, occurred in the South-Central Region of Chile, an area where we maintain a substantial portion of our Chilean industrial operations. Immediately after the earthquake, all of our production units applied their contingency plans, which involved shutting down operations and evaluating the damage caused to each facility by the earthquake. As a result of the earthquake and the subsequent tsunami, our Mutrún sawmill was destroyed. Our other operations that were adversely affected by the earthquake and tsunami reopened gradually. As of today, all of our operations have reopened and are currently operating at full operational capacity, except for the Mutrún sawmill, which was destroyed and will not be reopened. The Mutrún sawmill represented 6% of our sawn timber production capacity in Chile.

The suspension of our operations in Chile resulted in significant asset impairment charges due to earthquake-related damage to property and inventories as well as a significant decrease in our sales volumes due to plant closures which had an adverse effect on our results of operations and cash flows. Our insurance policies provide coverage for certain damages to our property, plant, equipment and inventories and for business interruption caused by such damages up to an aggregate amount of U.S.$650 million, with a deductible of U.S.$3 million for property damage and a deductible of 21 days for business interruption. On July 1, 2010 we received an advance insurance payment of U.S.$100 million, which included compensation for losses caused by physical damage (U.S.$30 million) and downtime (U.S.$70 million). During November, 2010 we received an advance insurance payment of U.S.$185 million, which included compensation for losses caused by physical damage (U.S.$75 million) and downtime (U.S.$110 million). Although as of December 31, 2010 we registered an amount of U.S.$166 million under Trade and other receivables in respect of insurance proceeds that we currently expect to receive in the future for earthquake-related property damage (U.S.$152 million) and claims due to business interruption (U.S.$14 million), we can provide no assurance that we will receive additional insurance proceeds in excess of the two advance payments above mentioned, and we do not expect insurance proceeds to compensate us fully for the losses we have incurred. We may expect to incur additional losses as a result of the earthquake and subsequent tsunami, and we may not have correctly estimated the losses suffered to date.

We cannot assure you that we will not experience other suspensions or interruptions or unexpected damage to our property as a result of other earthquakes, aftershocks, tsunamis, any related repair and maintenance or other consequences associated with such events, any of which could have a material and adverse effect on our revenue, results of operations and financial condition.

The costs to comply with, and to address liabilities arising under, environmental laws and regulations could adversely affect our business, financial condition, results of operations and cash flows or cause us to incur material costs and liabilities.

In each country where we have operations, we are subject to a wide range of national and local environmental laws and regulations concerning, among other matters, the preparation of environmental impact assessments for our projects, the protection of the environment and human health, the generation, storage, handling and disposal of wastes, the discharge of pollutants into the air, soil and water and the remediation of contamination. As a forest products manufacturer, we generate air and water emissions and solid and hazardous wastes. These emissions and waste disposals are subject to limits or controls prescribed by law or by our operating permits, and we may be required to install or upgrade our pollution control equipment in order to meet these legal requirements. We have made, and expect to continue to make, expenditures to maintain compliance with environmental laws. Notwithstanding our policy to strictly comply with all requirements established by applicable environmental laws, any failure to comply with such environmental laws may result in civil, administrative or criminal fines or sanctions,

 

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claims for environmental damages, remediation obligations, the revocation of environmental authorizations or the temporary or permanent closure of facilities. Environmental requirements are also a factor in the development and operation of new projects. Environmental regulations in Chile and other countries in which we operate have become increasingly stringent in recent years (for example, in connection with the approval of new projects), and this trend is likely to continue. Future changes in environmental laws, or in the application, interpretation or enforcement of those laws, including new or stricter requirements related to harvesting activities, air and water emissions and climate change regulations, could result in substantially increased capital, operating or compliance costs, impose conditions that restrict or limit our operations or otherwise adversely affect our business, financial condition, results of operations and cash flows. These changes could also limit the availability of our funds for other purposes, which could adversely affect our business, financial condition, results of operations and cash flows.

We have been subject to a number of environmental administrative and judicial proceedings in Chile, including proceedings related to the Valdivia Mill (starting 2004-2005), the Arauco Mill (2004), the Nueva Aldea Complex (2004-2005) and the Licancel Mill (2007). As a result of these proceedings, we have been subject to fines and sanctions, including orders to suspend or limit our operations. Additional proceedings, enforcement actions or claims related to compliance with environmental requirements or alleged environmental damages may also be brought against us in the future. Any such proceedings or claims may have an adverse effect on our business, financial condition, results of operations and cash flows. See “Risk factors—Risks relating to us and the forestry industry—Environmental concerns led us to temporarily suspend our operations at the Valdivia Mill in 2005 and the Licancel Mill in 2007, which adversely affected, and in the future may continue to adversely affect, our business, financial condition, results of operations and cash flows”.

Environmental concerns led us to temporarily suspend our operations at the Valdivia Mill in 2005 and the Licancel Mill in 2007, which adversely affected, and in the future may continue to adversely affect, our business, financial condition, results of operations and cash flows.

Valdivia Mill

Our operations at the Valdivia Mill, an industrial development in the Province of Valdivia, have been subject to environmental scrutiny by Chilean environmental regulators and the Chilean public since the mill began its operations in 2004. A variety of concerns and claims were raised regarding the mill’s potential environmental impacts in the area. Primarily, it was alleged that the mill’s operations impacted the nearby Carlos Anwandter Nature Sanctuary and contributed to the migration and death of black-neck swans living in the area. In connection with an environmental administrative proceeding, environmental regulators required us to temporarily suspend operations at the Valdivia Mill for approximately one month in January 2005.

In June 2005, we again suspended operations at the Valdivia Mill until certain technical and legal conditions could be clarified with the applicable regulatory authorities. We estimate this suspension resulted in a loss of sales of approximately U.S.$1.0 million per day and a loss of profits of approximately U.S.$250,000 per day. Pursuant to the decision of our board of directors, based on certain clarifications provided by the Environmental Regional Commission (Comisión Regional del Medio Ambiente), or COREMA, of the Tenth Region of Chile, the mill resumed operations in August 2005, after 64 days of suspended operations, at 80% of its authorized production capacity. In order to achieve the full production capacity authorized by applicable permits, the mill had to fulfill certain new requirements established by the COREMA. In January 2008, the COREMA authorized the Valdivia Mill to return to its annual authorized production capacity of 550,000 metric tons. The mill gradually increased its production over a four-month period starting in March 2008 and reached full capacity in June 2008.

In June 2007, we were required to submit to the COREMA of the Tenth Region of Chile an environmental impact study for the implementation of substantial technological improvements on the quality of the effluents generated by the Valdivia Mill. In June 2008, the COREMA approved that environmental impact study subject to certain conditions that, in our opinion, adversely affected the feasibility of the project. For such reason, we filed an appeal before the Directive Council (Consejo Directivo) of the National Environmental Commission (Comisión Nacional del Medio Ambiente), or CONAMA, challenging the conditions imposed by the COREMA. This administrative appeal was partially accepted by the CONAMA, but some of the conditions that we believe adversely affect the feasibility of the project were maintained. As a result, in September 2009 we presented another appeal in the relevant court, and as of the date of this annual report such appeal remains pending.

 

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Prior to October 2007, the Valdivia Mill was under the jurisdiction of the COREMA of the Tenth Region of Chile, but in October 2007 it became subject to the jurisdiction of the COREMA of the Fourteenth Region of Chile. In February 2009, as previously required by the COREMA of the Tenth Region of Chile, we submitted to the COREMA of the Fourteenth Region of Chile an environmental impact study for the construction of a pipeline to discharge the Valdivia Mill’s wastewater in the Pacific Ocean near Punta Maiquillahue, which complies with the requirement of COREMA that such wastewater be discharged in a body of water other than the Cruces River, the Carlos Anwandter Nature Sanctuary or their respective sources. This environmental impact study was approved by the COREMA in February 2010, but has been partially challenged by us before the Directive Council (Consejo Directivo) primarily because it included a future prohibition on the discharge of wastewater into the Cruces River under all circumstances, even in the case of certain emergencies. As of the date of this annual report, the Directive Council has not resolved the action presented by us. On March 26, 2010, certain indigenous communities located in San José de la Mariquina filed a constitutional action (recurso de protección) against the COREMA of the Fourteenth Region of Chile, challenging the resolution that approved our environmental impact study in February 2010. Such action was rejected by the Court of Appeals of Valdivia. The indigenous communities appealed before the Supreme Court of Chile, which appeal was rejected by such court on October 14, 2010.

Resolution of our proceeding with the CONAMA or the pending appeals before the Chilean courts regarding the resolutions that approved the environmental impact studies of the pipeline and the effluent quality improvement projects, as well as the construction and operation of the pipeline, are each subject to many environmental, regulatory, engineering and political uncertainties. As a result, we cannot provide any assurances that the projects will be finally approved as requested or completed. If either the request for the necessary permits for the construction of the pipeline is rejected, or the installation of the pipeline is delayed for reasons attributable to us, we may face sanctions that include warnings, fines or the revocation of the Valdivia Mill’s environmental permit for operation. Alternatively, if any rejection or delays are attributable to reasons beyond our control, we believe that the environmental authorities should extend the applicable deadlines. However, we can provide no assurances that any deadline extensions would be granted, even if we comply with all the requirements that may be set forth by those authorities. See “Item 4. Information on the Company—Description of Business—Pulp—Pulp mills—Chile—Valdivia Mill” and “Item 8. Financial Information—Legal Proceedings.”

The suspension of operations at the Valdivia Mill in 2005 adversely affected our business, financial condition, results of operations and cash flows. Any future suspension of operations at the Valdivia Mill or at any other of our significant operating plants can be expected to have similar adverse effects. We offer no assurance that the Valdivia Mill will be able to operate without further interruption. See “Item 8. Financial Information—Legal Proceedings.”

Licancel Mill

In June 2007, our operations at the Licancel Mill, a pulp mill located in the Seventh Region of Chile, became subject to environmental scrutiny by Chilean environmental regulators and the public due to the death of fish in the Mataquito River, approximately 15 kilometers downstream of the mill. As a result, in June 2007 Chilean authorities, including certain public health authorities and the Superintendencia de Servicios Sanitarios (Sanitary Services Superintendency), required that we suspend activities at the Licancel Mill and that we suspend any further discharges into the river. In 2007, we invested U.S.$8 million in a new effluent treatment system for the Licancel Mill, and the mill resumed operations during January 2008. On September 7, 2007, the National Defense Council instituted a civil lawsuit seeking reparations, damages and indemnification from us for environmental harm allegedly caused by the Licancel Mill. The National Defense Council agreed to terminate this lawsuit pursuant to an agreement with Arauco dated January 29, 2010. The resolution that approved the agreement and declared the lawsuit terminated was challenged by certain third parties, which challenge was rejected by the court. Nevertheless, we can offer no assurance that the Licancel Mill will be able to operate without further interruptions. Any future suspension of operations at the Licancel Mill would adversely affect our business, financial condition, results of operations and cash flows. We estimate that the suspension of operations at the Licancel Mill resulted in a total loss of profits of U.S.$24 million. Several proceedings have been commenced regarding the events at the Licancel Mill and the death of fish at the Mataquito River. For further details in respect of the proceedings related to the 2007 suspension of operations at the Licancel Mill, see “Item 8. Financial Information—Legal Proceedings.”

 

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We are subject to legal proceedings related to our mills which could adversely affect our business, financial condition, results of operations and cash flows.

On April 27, 2005, the National Defense Council (Consejo de Defensa del Estado), the Chilean national agency that institutes legal proceedings on behalf of the Chilean government, instituted a civil lawsuit seeking reparations, damages and indemnification from us for environmental harm allegedly caused by the effluent discharges from our Valdivia Mill. The National Defense Council has not quantified the damages it is seeking in connection with the Valdivia Mill lawsuit. In addition, on September 7, 2007, the National Defense Council instituted a civil lawsuit seeking reparations, damages and indemnification from us for environmental harm allegedly caused by the effluent discharges from our Licancel Mill.

The National Defense Council and Arauco agreed to terminate the proceeding related to the Licancel Mill in January 2010. The resolution that approved the agreement and declared the lawsuit terminated was challenged by certain third parties, which challenge was rejected by the court.

The Valdivia Mill lawsuit remains under review by the court as of the date of this annual report. If the result of the Valdivia Mill lawsuit is unfavorable to us, we may be required to invest a significant amount of funds and/or take other actions to repair any environmental harm a court determines we have caused, which could materially and adversely affect our business, financial condition, results of operations and cash flows. We cannot predict the outcome or impact of this lawsuit or when it may be resolved.

Since the end of 2004, we have been subject to various criminal proceedings relating to alleged violations of several environmental laws in Chile, each of which has been either terminated or abandoned by the prosecutor (decisión de no perseverar) as of the date of this annual report. See “Item 8. Financial Information—Legal Proceedings.” The commencement of similar criminal proceedings against Arauco at any time in the future could adversely affect some of our mills. We can neither predict the likelihood that we will face such similar proceedings in the future, nor the likely outcome or impact of any such proceedings.

Although Chilean law in general provides that only individuals can be convicted in criminal actions, Chilean Law Nº 20,393, which was published in the Official Gazette on December 2, 2009, provides an exception to this general rule, under which criminal responsibility of legal entities can be established for criminal offenses related to financing of terrorism, asset laundering or bribery. We do not have knowledge of any fact that could result in such criminal responsibility for the Company. See “Item 8. Financial Information—Legal Proceedings.”

We are also subject to certain other proceedings relating to our mills. We cannot assure you that, as a result of such proceedings, our mills will be able to operate without interruption. Any such interruption, or unexpected costs to resolve such proceedings, could have a material and adverse effect on our business, financial condition, results of operations and cash flows.

Material disruptions at any of our manufacturing, mills processing or remanufacturing facilities could negatively impact our financial results.

A material disruption at any of our manufacturing, mills processing or remanufacturing facilities could prevent us from satisfying customer demand for our products, meeting our production targets and/or require us to make unplanned capital expenditures, resulting in lower sales, which would have a negative effect on our financial results. As disclosed in “Risk Factors—Risks relating to us and the forestry industry—We are located in a seismic area that exposes our property in Chile to the risk of earthquakes and we experienced significant business disruption and physical damages as a result of the February 27, 2010 earthquake,” which describes in detail the business interruption and losses suffered by us as a result of the February 27, 2010 earthquake and subsequent tsunami, our Chilean facilities are located in a region known for seismic activity that exposes our facilities in Chile to the risk of earthquakes and in some areas, to subsequent tsunamis. In addition, our facilities (or any of our machines within an otherwise operational facility) could cease operations unexpectedly due to a number of events, including:

 

   

unscheduled maintenance outages;

 

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prolonged power failures;

 

   

an equipment failure;

 

   

fires, floods, hurricanes or other catastrophes;

 

   

disruptions in the transportation infrastructure, including roads, bridges, railroad tracks and tunnels;

 

   

a chemical spill or release;

 

   

explosion of a boiler;

 

   

the effect of a drought or reduced rainfall on its water supply;

 

   

labor difficulties;

 

   

terrorism or threats of terrorism;

 

   

domestic and international laws and regulations applicable to our Company and our business partners, including joint venture partners, around the world; and

 

   

other operating problems.

Disease or fire could affect our forests and manufacturing processes and, in turn, adversely affect our business, financial condition, results of operations and cash flows.

Our operations are subject to various risks affecting our forests and manufacturing facilities, including disease and fire. Although to date certain pests and diseases afflicting radiata or taeda pine plantations in other parts of the world have not significantly affected the forestry industries in Chile, Argentina, Brazil and Uruguay, these pests or diseases do migrate and may appear in Chile, Argentina, Brazil or Uruguay in the future. Similarly, although forest fires have not significantly affected our plantations to date due to the broad geographic extension of our plantations and the varied ages and climatic conditions of our plantations, forest fires are always a risk, particularly during low rainfall conditions, and may affect our plantations in the future. We do not maintain insurance against pests, diseases or, in certain areas, fires that could affect our forests, and as a result our business, financial condition, results of operations and cash flows could be adversely affected if any of these risks were realized.

Climate change may negatively affect our business, financial condition, results of operations and cash flows.

A growing number of scientists, environmentalists, international organizations, regulators and other commentators maintain that global climate change has contributed, and will continue to contribute, to the increasing unpredictability, frequency and severity of natural disasters (including, but not limited to, hurricanes, droughts, tornadoes, freezes, other storms and fires) in certain parts of the world. As a result, a number of legal and regulatory measures as well as social initiatives have been introduced in numerous countries in an effort to reduce greenhouse gas and other carbon emissions, which some argue to be substantial contributors to global climate change. Such reductions in greenhouse gas emissions could result in increased energy, transportation and raw material costs and may require us to make additional investments in facilities and equipment. In addition, our plantations are located in regions which have ideal climatic conditions for a short growing cycle. Any climate changes that negatively affect such favorable climate conditions in central or southern Chile or in any region in which we benefit from favorable climate conditions could adversely affect the growth rate and quality of our plantations, or our production costs. Although we cannot predict the impact of changing global climate conditions, if any, nor can we predict the impact of legal, regulatory and social responses to concerns about global climate change, any such occurrences may negatively affect our business, financial condition, results of operations and cash flows.

 

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Risks relating to Chile

Adverse changes in Chile’s political and economic conditions could directly impact our business and the market price of our securities.

At December 31, 2010, 75.4% of our property, plant and equipment and forest assets were located in Chile, and in 2010, 73.8% of our revenues were attributable to our Chilean operations. Accordingly, our business, financial condition, results of operations and cash flows depend, to a considerable extent, upon economic conditions in Chile. Future changes in the Chilean economy could adversely affect our business, financial condition, results of operations and cash flows and may impair our ability to proceed with our strategic plan of business. In addition, such changes may impact the market price of our securities.

The Chilean government has exercised and continues to exercise a substantial influence over many aspects of the private sector. We have no control over and cannot predict how government intervention and policies will affect the Chilean economy or, directly and indirectly, our operations and revenues. Our operations and financial condition and the market price of our securities may be adversely affected by changes in policies involving exchange controls, taxation and other matters.

Chile has different corporate disclosure and accounting standards from those with which you may be familiar in the United States, and Chile’s securities laws may not afford you the same protections as U.S. securities laws.

The accounting, financial reporting and securities disclosure requirements applicable to foreign private issuers differ from those applicable to issuers domiciled in the United States in some important respects. Accordingly, the information about us available to you will not be the same as the information disclosed by a U.S. company required to file reports with the U.S. Securities and Exchange Commission.

In addition, although Chilean law imposes restrictions on insider trading and price manipulation, applicable Chilean securities laws and regulations are different from those in the United States, and some investors protections available in the United States may not be available in the same form, or at all, in Chile.

Inflation in Chile may disrupt our business and have an adverse effect on our business, results of operations, financial condition and cash flows.

Chile has experienced high rates of inflation in the past. The annual rates of inflation (as measured by changes in the consumer price index and as reported by the Chilean National Institute of Statistics) in 2005, 2006, 2007, 2008, 2009 and 2010 were 3.7%, 2.6%, 7.8%, 7.1%, -1.4% and 3.0%, respectively. High levels of inflation in Chile could adversely affect the Chilean economy and have a material adverse effect on our revenues, results of operations, financial condition and cash flows. Changes in the rate of inflation in Chile could continue in the future. Due to the competitive pressures we face in each of our product lines, we may not be able to increase prices in lock-step with inflation, which could materially and adversely affect our revenues, results of operations, financial and cash flows.

Currency fluctuations may have a negative effect on our financial results.

The Chilean peso has been subject to depreciations and appreciations in the past and may be subject to significant fluctuations in the future. We transact a significant portion of our business in U.S. dollars, and the U.S. dollar is the currency of the primary economic environment in which we operate. A significant portion of our operating costs, however, are denominated in Chilean pesos. An increase in the Chilean peso/U.S. dollar exchange rate increases our Chilean peso-denominated costs.

In addition, as an international company operating in Chile and several other countries, we transact a portion of our business and have assets and liabilities in Chilean pesos and other non-U.S. dollar currencies, such as the Argentine peso, the Uruguayan peso, the Brazilian reais, the Colombian peso and the Mexican peso, among others. To the extent that the Chilean peso depreciates against the U.S. dollar, our domestic sales revenues may be

 

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adversely affected when expressed in U.S. dollars. The same effects may occur for our domestic sales in Argentina and Brazil for products sold in each of the respective local currencies. As a result, fluctuations in the exchange rates of such foreign currencies to the U.S. dollar may have a material adverse effect on our business, results of operations, financial condition and cash flows.

Risks relating to Argentina

The economic conditions in Argentina may adversely affect our financial condition, results of operations and cash flows.

At December 31, 2010, 10.8% of our property, plant and equipment and forest assets were located in Argentina, and in 2010, 14.6% of our revenues were attributable to our Argentine operations. The financial condition and results of our Argentine operations, including the ability of our Argentine subsidiary Alto Paraná to raise capital, depend, to a certain extent, upon economic conditions prevailing in Argentina. See “Item 4. Information on the Company—Description of Business—History.”

From 1998 to 2002, the Argentine economy experienced an economic recession marked by reduced levels of consumption and investment and an elevated unemployment rate. The Argentine gross domestic product, or GDP, decreased by 0.8% in 2000, 4.0% in 2001 and 10.9% in 2002. Since 2003, the Argentine GDP increased by 8.8% in 2003, 9.0% in 2004, 9.2% in 2005, 8.5% in 2006, 8.7% in 2007 and 6.8% in 2008. Although in 2009, Argentina’s GDP growth slowed to 0.9% as a result of the global financial crisis, in 2010 it rose to 9.2%. Depending on the future development of the economy of Argentina, over which we have no control, our business, financial condition, results of operations and cash flows could be adversely affected.

In addition, the Argentine government has exercised and continues to exercise significant influence over many aspects of the Argentine economy and the private sector. Depending on the Argentine government’s actions, including, among others, actions with respect to inflation, interest rates, foreign exchange controls and taxes, our operations in Argentina could be adversely affected. We have no control over and cannot predict how government intervention and policies will affect the Argentine economy or our operations and revenues in Argentina.

Changes to the Argentine Central Bank’s currency exchange control measures may impair the ability of Alto Paraná, our Argentine subsidiary, to meet its obligations and transfer money abroad.

We guarantee a portion of Alto Paraná’s debt. We may be required to fulfill our obligation under our guarantees if the Argentine government were to restrict Alto Paraná’s ability to transfer funds abroad to service such debt. For a description of Alto Paraná’s debt which we guarantee see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources.”

Since 2001, the Argentine government has imposed a number of monetary and currency exchange control measures, which have included the obligation to repatriate foreign currency earned abroad and tight restrictions on transferring funds abroad, with certain exceptions for authorized transactions. Although current restrictions have not materially affected Alto Paraná’s business, financial condition, results of operations and cash flows, including its ability to service its debt, if in the future such payments are restricted, such restriction would be an obstacle to Alto Paraná’s ability to transfer money abroad, which may negatively affect its financial condition, results of operations and cash flows.

We are subject to a substantial tax claim in Argentina

On December 14, 2007, the Administración Federal de Ingresos Públicos, or AFIP, Argentina’s internal revenue service, notified our Argentine subsidiary, Alto Paraná S.A., or Alto Paraná, of a claim for unpaid taxes for fiscal years 2002, 2003 and 2004 in the aggregate amount of AR$418 million (or approximately U.S.$105 million) (including principal, interest and penalties accrued through such date), arising from a dispute regarding certain income tax deductions (related to debt issued by Alto Paraná in 2001 and repaid in 2007) taken by Alto Paraná and rejected by the AFIP. On February 8, 2010, Argentina’s tax court (Tribunal Fiscal de la Nación) issued an unfavorable administrative ruling requiring that Alto Paraná pay the AFIP’s claim in full.

 

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Alto Paraná appealed this unfavorable administrative ruling to the Court of Appeals and also filed an injunctive action requesting that the court stay Alto Paraná’s payment obligation until resolution of its pending appeal. On May 13, 2010, the Court of Appeals granted an injunction of Alto Paraná’s payment obligation in exchange for the posting of a surety bond in the amount of AR$633.6 million (or approximately U.S.$159 million). We have not established any reserve in respect of this contingency and can offer no assurance that the Court of Appeals will issue a ruling favorable to us. If the Court of Appeals upholds the decision of the Tribunal Fiscal de la Nación, Alto Paraná will be required to satisfy the abovementioned claim which would have an adverse effect on our financial condition and results of operations. See “Item 8. Financial Information—Legal Proceedings.”

Risks relating to Brazil

Economic conditions in Brazil may have a direct impact on our business, financial condition, results of operations and cash flows.

At December 31, 2010, 13.8% of our property, plant and equipment and forest assets were located in Brazil, and in 2010, 11.6% of our revenues were attributable to our Brazilian operations. During the first quarter of 2005, we acquired all of the shares of capital stock of LD Forest Products S.A. and of Placas do Paraná S.A., or Placas do Paraná, in Brazil, as well as 50% of the shares of capital stock of Dynea Brasil S.A., or Dynea Brasil, in Brazil. In April 2010, our subsidiary Arauco do Brasil S.A. acquired the other 50% of the shares of Dynea Brasil. As a result of this acquisition, we own 100% of the shares of Dynea Brasil.

In September 2007, our subsidiaries Placas do Paraná S.A. and Arauco Florestal S.A. entered into an agreement for the joint ownership of land with Stora Enso Oyj, or Stora Enso, a Finnish-Swedish multinational corporation. Pursuant to the agreement, we acquired 80% of the shares in Stora Enso Arapoti Empreendimentos Agrícolas S.A., now Arauco Florestal Arapoti S.A., which owns 50,000 hectares of land, including 25,000 hectares of pine and 5,000 hectares of eucalyptus plantations; 20% of the shares in Stora Enso Arapoti Indústria de Papel S.A., which owns a paper mill with an annual production capacity of 205,000 tons of light weight coated paper; and 100% of the shares of Stora Enso Arapoti Serraria Ltda., which owns a sawmill with an annual production capacity of 150,000 cubic meters per year. In August 2009, we acquired, through our Brazilian subsidiary Placas do Paraná, Tafisa Brasil S.A., or Tafisa Brasil, which has a panel production facility located in the city of Pien, Brazil, with an annual total installed capacity of 640,000 cubic meters, and which includes two production lines producing medium density fiberboard (MDF) and one production line producing particleboard. The facility also has added-value lines to produce products for the construction and furniture industries.

As a result of the foregoing, to a certain extent, our business, financial condition, results of operations and cash flows will be dependent on economic conditions in Brazil.

The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. Brazilian political and economic conditions have a direct impact on our business.

The Brazilian government has intervened the Brazilian economy and, occasionally, has made drastic changes in policy and regulations. The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, wage and price controls, currency devaluations, capital controls and limits on imports. The business, financial condition, results of operations and cash flows of our Brazilian subsidiaries may be adversely affected by such matters, changes in policy or regulation involving tariffs and exchange controls, as well as by factors such as:

 

   

currency fluctuations;

 

   

real estate ownership restrictions;

 

   

inflation;

 

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social instability;

 

   

price instability;

 

   

interest rates;

 

   

liquidity of domestic capital and lending markets;

 

   

tax policy; and

 

   

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

The Brazilian government’s actions have had and may continue to have a material effect on private sector entities, including our operations in Brazil. We have no control over and cannot predict how government intervention and policies will affect the Brazilian economy or, directly and indirectly, our operations and revenues.

Inflation and efforts by the Brazilian government to combat inflation may contribute significantly to economic uncertainty in Brazil and could harm the business of our Brazilian subsidiaries.

Brazil has, in the past, experienced high rates of inflation. More recently, Brazil’s rates of inflation were 3.1% in 2006, 4.5% in 2007, 5.9% in 2008, 4.3% in 2009 and 5.9% in 2010, as measured by the Brazilian consumer price index (Índice de Preços ao Consumidor-Amplo). In the past, inflation, governmental measures to combat inflation and public speculation about possible future actions have had significant negative effects on the Brazilian economy. Certain future measures, if taken by the Brazilian government, including interest rate increases, intervention in the foreign exchange market and actions to adjust or fix the value of the real may trigger increases in inflation, and consequently, have adverse economic impacts on the business, financial condition, results of operations and cash flows of our Brazilian subsidiaries could suffer.

Fluctuations in the value of Brazil’s currency against the value of the U.S. dollar may result in uncertainty in the Brazilian economy and the Brazilian securities market, which may adversely affect the financial condition, results of operations and cash flows of our recently acquired Brazilian subsidiaries.

The Brazilian real has historically suffered frequent devaluation. In the past, the Brazilian government has implemented various economic plans and exchange rate policies, including sudden devaluations, periodic mini-devaluations during which the frequency of adjustments has ranged from daily to monthly, floating exchange rate systems, exchange controls and dual exchange rate markets. Although over long periods, depreciation of the real generally is correlated with the differential in the inflation rate in Brazil versus the inflation rate in the United States, depreciation over shorter periods has resulted in significant fluctuations in the exchange rate between the real and the U.S. dollar and other currencies.

For example, the real appreciated by 34.4% against the U.S. dollar in 2009, and appreciated 3.9% during 2010. The exchange rate between the real and the U.S. dollar may continue to fluctuate and may rise or decline substantially from current levels.

Devaluation of the Brazilian real and currency instability may adversely affect our results of operation and financial condition in terms of U.S. dollars and could adversely affect the ability of our Brazilian subsidiaries to meet their foreign currency obligations in the future and could result in a monetary loss relating to these obligations.

Risks relating to Uruguay

Economic conditions in Uruguay may have a direct impact on our financial condition and results of operations.

In September 2009, we and our subsidiary, Arauco Internacional S.A., which has been subsequently renamed Inversiones Arauco Internacional Limitada or “Arauco Internacional”, executed a series of joint venture agreements with Stora Enso, pursuant to which Stora Enso Amsterdam B.V., a subsidiary of Stora Enso, agreed to

 

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transfer ownership of 100% of the shares of Stora Enso Uruguay S.A. to Forestal Cono Sur S.A. or “Forestal Cono Sur”, our subsidiary in Uruguay, in exchange for 50% of the shares of Forestal Cono Sur. As a consequence of this transaction, we and Stora Enso equally own and control all assets that both companies own in Uruguay, which includes 74,000 hectares owned by Stora Enso (including 17,300 hectares which are already planted with forests) and 39,000 hectares owned by us (of which 27,400 are already planted with forests).

In addition, in October 2009, our subsidiary Arauco International S.A. and a subsidiary of Stora Enso jointly acquired certain Uruguayan subsidiaries of the Spanish Grupo Empresarial ENCE S.A., or ENCE, which include (i) Eufores S.A., (ii) Celulosa y Energía Punta Pereira S.A., (iii) El Esparragal Asociación Agraria de Responsabilidad Limitada, (iv) Terminal Logística e Industrial M’Bopicuá S.A. and (v) Zona Franca Punta Pereira S.A. The principal assets of the acquired entities consist of an industrial site, 130,000 hectares of land (which includes, in part, 73,000 hectares of forestry plantation and 6,000 hectares under agreements with third parties) and the necessary environmental permits for the construction of a pulp mill, a river terminal and a nursery. For the purposes of this annual report, Stora Enso Uruguay S.A., Forestal Cono Sur, Eufores S.A., Celulosa y Energía Punta Pereira S.A., Zona Franca Punta Pereira S.A., El Esparragal Asociación Agraria de Responsabilidad Limitada and Terminal Logística e Industrial M’Bopicuá S.A. are jointly referred as the “Montes del Plata joint venture.” We own and operate these acquired assets jointly with Stora Enso as part of our Uruguayan joint venture. The aggregate value of the assets acquired as a result of this transaction was U.S.$335 million, of which we paid 50% (or approximately U.S.$167.5 million).

On January 18, 2011 Arauco and Stora Enso agreed to carry out the construction of a state of the art pulp mill with an annual guaranteed capacity of 1.3 million tons, a port and a power producing unit based on renewable sources, all located in Punta Pereira, department of Colonia, Uruguay. The total estimated investment is U.S.$1,900 million.

As a result of these significant recent investments we have made in Uruguay and the significant additional investments we are currently contemplating, our financial condition and results of operations may consequently depend, to a certain extent, on political and economic conditions in Uruguay. Certain future actions by the Uruguayan government including, among others, actions with respect to inflation, interest rates, foreign exchange controls and taxes, could have a material adverse effect on our operations in Uruguay.

Risks relating to other markets

Our business, earnings and prospects may be adversely affected by developments in other countries that are beyond our control.

Our business, financial condition, results of operations and cash flows depend, to a large extent, on the level of economic activity, government and foreign exchange policies and political and economic developments in our principal export markets. 94.9% of our total pulp sales in 2009 and 93.0% in 2010, as well as 60.5% in 2009 and 52.4% in 2010 of our total sales of forestry, wood and panel products were attributable to exports, principally to customers in Asia, the Americas and Western Europe. Our business, earnings and prospects, as well as our financial condition, results of operations, cash flows and the market price of our securities, may be materially and adversely affected by developments in these export markets relating to inflation, interest rates, currency fluctuations, protectionism, government subsidies, price and wage controls, exchange control regulations, taxation, expropriation, social instability or other political, economic or diplomatic developments. For example, certain target countries to which we export may impose buying restrictions in our industry, which may adversely affect our sales. We have no control over these conditions and developments which could adversely affect us and our business, financial condition, results of operations and cash flows or the price or market of our securities.

Developments in other emerging and developed markets may adversely affect the market price of our securities and our ability to raise additional financing.

Our financial condition and the market price of our securities may be adversely affected by declines in the international financial markets and world economic conditions. Chilean securities markets are, to varying degrees, influenced by general economic, political, social and market conditions in other emerging and developed market

 

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countries, especially those in the United States, China and Latin America. Although economic conditions are different in each country, investors’ reactions to developments in one country can affect the securities markets and the securities of issuers in other countries, including Chile. Negative developments in the international financial markets in the future could adversely affect the market price of our securities and impair Arauco’s ability to raise additional capital.

Risks Relating to Our Securities

The non-payment of funds by our subsidiaries could have a material and adverse effect on our business, financial condition, results of operations and ability to service our debt, including our securities

Our cash flow and our ability to service debt is dependent, in part, on the cash flow and earnings of our subsidiaries and the payment of funds by those subsidiaries to us, in the form of loans, interest, dividends or otherwise. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due under the terms of our securities or to make any funds available for such purpose. Furthermore, claims of creditors of our subsidiaries, including trade creditors, will have priority over our creditors, including holders of our securities, with respect to the assets and cash flow of the subsidiaries. Our right to receive assets of any of our subsidiaries upon their liquidation or reorganization (and the consequent right of the holders of our securities to participate in those assets) will be effectively subordinated to the claims of that subsidiary’s creditors.

Changes in Chilean tax laws could lead us to redeem our securities

Under current Chilean law and regulations, payments of interest made from Chile to holders of debt securities who are neither residents nor domiciled or organized in Chile for purposes of Chilean taxation will, generally, be subject to Chilean withholding tax at a rate of 4.0%. Subject to certain exceptions, we will pay additional amounts (as described in “Item 10. Additional Information—Taxation”) so that the net amounts received by the holder of the notes (including additional amounts) after such Chilean withholding tax will equal the amounts that would have been received in respect of the notes in the absence of such Chilean withholding tax. In the event of certain changes in Chilean tax laws requiring that we pay additional amounts that are in excess of the additional amounts that we would owe if payments of interest on our securities were subject only to a 4.0% withholding tax, we will have the right to redeem our securities.

 

Item 4. Information on the Company

DESCRIPTION OF BUSINESS

We believe that, as of December 31, 2010, we were one of Latin America’s largest forest plantation owner, and that we are Chile’s largest exporter of forestry and wood products in terms of sales revenue. We have industrial operations in Chile, Argentina and Brazil. As of December 31, 2010, we had approximately 1.0 million hectares of plantations in Chile, Argentina, Brazil and Uruguay. During 2010, we harvested 16.6 million cubic meters of sawlogs and pulplogs and sold 5.4 million cubic meters of wood products, including sawn timber (green and kiln-dried lumber), remanufactured wood products and panels (plywood, medium density fiber board, or MDF, particle board, or PBO, and high density fiber board, or HB).

Based on information published by Resource Information Systems, Inc., an independent research company for the pulp and paper industry, at December 31, 20010, we were one of the world’s largest producers of bleached and unbleached softwood kraft market pulp in terms of production capacity, with an estimated 7.8% share of the total world production of bleached softwood kraft market pulp and a 16.9% share of the total world production of softwood kraft market unbleached pulp. “Market pulp” is pulp sold to manufacturers of paper products, as opposed to pulp produced by an integrated paper producer for use in its paper production facilities. “Kraft pulp” is pulp produced using a chemical process.

 

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Based on information published by Resource Information Systems, Inc., we were also one of the world’s lowest-cost producers of softwood kraft market pulp. We believe that we are able to produce our products at a lower cost than our competitors because of the high growth rate and short harvest cycle of radiata and taeda pine compared to other commercial softwoods, the advanced genetic and silviculture techniques we apply in our forest management, our modern mill facilities and the proximity of our operations to Pacific coast ports.

History

Celulosa Arauco y Constitución S.A. is a corporation (sociedad anónima) organized under the laws of Chile and subject to certain rules applicable to Chilean public corporations (sociedades anónimas abiertas). Our principal executive offices are located at Avenida El Golf 150, 14th Floor, Las Condes, Santiago, Chile, and our telephone number is +56-2-461-7200.

We were formed on September 14, 1979 in a merger between Industrias de Celulosa Arauco S.A., or Industrias Arauco, and Celulosa Constitución S.A., or Celulosa Constitución. Our two predecessor companies were created in the late 1960s and early 1970s by Corporación de Fomento de la Producción, or Corfo, a Chilean government development corporation, to develop forest resources, improve soil quality in former farming areas and promote employment. As part of the Chilean government’s privatization program, Corfo sold Industrias Arauco to Compañía de Petróleos de Chile S.A., or Copec, in 1977 and Celulosa Constitución to Copec in 1979. In October 2003, Copec transferred all of its gasoline- and fuel-related business assets to a new subsidiary, and changed its legal name to Empresas Copec S.A., or Empresas Copec. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders.”

In 1996, we acquired Alto Paraná S.A., an Argentine company, which, at that time, owned plantations and other land in Argentina and manufactured and sold bleached softwood kraft pulp. With this acquisition, we expanded our market opportunities outside of Chile.

In 2000, we acquired 98% of the shares of Forestal Cholguán S.A., or Cholguán, and 50% of Trupán S.A., or Trupán, which permitted us to enter the MDF and HB markets, and in 2002, we began operations at two new MDF mills, one in Chile and one in Argentina.

In 2005, we expanded our presence in Chile, Argentina and Brazil through a series of acquisitions that increased our land holdings and the production capacity of various sectors of our business.

On June 30, 2006, through our subsidiaries Aserraderos Arauco S.A., Forestal Celco S.A., Bosques Arauco S.A. and Forestal Valdivia S.A., we acquired the forestry assets of Cementos Bío-Bío S.A. The acquisition represented an investment of U.S.$133.3 million. The acquired assets consisted of 21,000 hectares of pine plantations, one sawmill with an annual production capacity of approximately 250,000 cubic meters per year and a remanufacturing facility.

On September 27, 2007 we entered into an agreement for the joint ownership of land in Brazil with Stora Enso Oyj, a Finnish-Swedish multinational corporation. Pursuant to the agreement, we acquired 80% of the shares in Stora Enso Arapoti Empreendimentos Agrícolas S.A., now Arauco Florestal Arapoti S.A., which owns 50,000 hectares of land, including 25,000 hectares of pine and 5,000 hectares of eucalyptus plantations; 20% of the shares in Stora Enso Arapoti Indústria de Papel S.A., which owns a paper mill with an annual production capacity of 205,000 tons of light weight coated paper; and 100% of the shares of Stora Enso Arapoti Serraria Ltda., which owns a sawmill with an annual production capacity of 150,000 cubic meters per year. This alliance required an investment of U.S.$208.4 million, which was financed with our resources and commercial bank loans.

On May 17, 2009, our subsidiary Arauco International S.A. and a subsidiary of Stora Enso Oyj agreed through a joint venture partnership to acquire the Uruguayan subsidiaries of the Spanish Grupo Empresarial ENCE S.A., which acquisition was completed on October 16, 2009. The companies acquired by the joint venture partnership were Eufores S.A., Celulosa y Energía Punta Pereira S.A. and Zona Franca Punta Pereira S.A. The main assets of these subsidiaries include 130,000 hectares of land, of which 73,000 have forestry plantations, 6,000 hectares under agreements with third parties, an industrial site, the necessary environmental permits for the

 

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construction of a pulp mill, a river terminal, a chip producing mill and a nursery. The agreed value of these assets, pursuant to the aforementioned transaction, was U.S.$335 million, of which Arauco paid 50% (or U.S.$167.5 million). See “Item 5. Operating Financial Review and Prospects—Results of Operations—Negative Goodwill Immediately Recognized”.

On August 26, 2009, our subsidiary Placas do Paraná S.A. acquired 100% of the shares of Tafisa Brasil, by means of a share purchase agreement executed among SCS Beheer, B.V., Tafiber—Tableros de Fibras Ibéricos, S.L. (each of which is a subsidiary of Sonae Indústria, SGPS, S.A.) and Placas do Paraná S.A. Pursuant to the transaction, we paid a purchase price of approximately U.S.$227 million, of which U.S.$165.2 million was allocated to pay the value of the shares of Tafisa Brasil, with the balance corresponding to liabilities that the acquired company maintained. The primary asset of Tafisa Brasil (which has been renamed “Arauco do Brasil S.A.”) is a panel production facility located in the city of Pien, Brazil, which is in the state of Paraná. The facility has an annual total installed capacity of 640,000 cubic meters, which includes three production lines: two lines producing medium density fiberboard (MDF) and one line producing particleboard. The facility also has added-value lines to produce products for the construction and furniture industries.

On September 27, 2009, Arauco and its subsidiary Arauco Internacional, executed a series of joint venture agreements with Stora Enso, pursuant to which Stora Enso Amsterdam B.V. agreed to transfer ownership of 100% of the shares of Stora Enso Uruguay S.A. to Forestal Cono Sur. As a consequence of this transaction, Arauco and Stora Enso equally control all assets that both companies own in Uruguay, which includes 74,000 hectares owned by Stora Enso (including 17,300 hectares which are already planted with forests) and 39,000 hectares owned by Arauco (of which 27,400 are already planted with forests). These assets, and those that we acquired from Grupo Empresarial ENCE, S.A. in May of 2009, have helped to secure a strategic basis to consider the construction of a future pulp mill in Uruguay.

In addition, in October 2009, our subsidiary Arauco International S.A. and a subsidiary of Stora Enso acquired in equal parts Eufores S.A., Celulosa y Energía Punta Pereira S.A., El Esparragal Asociación Agraria de Responsabilidad Limitada, Terminal Logística e Industrial M’Bopicuá S.A. and Zona Franca Punta Pereira S.A., which were at that time Uruguayan subsidiaries of the Spanish Grupo Empresarial ENCE S.A., or ENCE, whose main assets include 130,000 hectares of land, of which 73,000 have forestry plantations, 6,000 hectares under agreements with third parties and one industrial site, along with the necessary environmental permits for the construction of a pulp mill, a river terminal and one nursery. We own and operate these acquired assets jointly with Stora Enso as part of the Montes del Plata joint venture. The aggregate value of the assets acquired as a result of this transaction was U.S.$335 million, of which we paid 50% (or approximately U.S.$167.5 million).

In April 2010, our subsidiary Arauco do Brasil S.A. acquired 50% of the shares of Dynea Brasil S.A. from Dynea AS for U.S.$15 million. As a result of this acquisition, we now own 100% of the shares of Dynea Brasil S.A.

On January 18, 2011 Arauco and Stora Enso agreed to carry out the construction of a state of the art pulp mill with an annual guaranteed capacity of 1.3 million tons, a port and a power producing unit based on renewable sources, all located in Punta Pereira, department of Colonia, Uruguay. The total estimated investment is U.S.$1,900 million. See “Item 5. Operating Financial Review and Prospects—Results of Operations—Other Profit (Loss)”.

Corporate Structure

We are substantially wholly owned by Empresas Copec S.A., a public company listed on the Santiago Stock Exchange, the Valparaíso Stock Exchange and the Chilean Electronic Stock Exchange. Empresas Copec is a holding company, the principal interests of which are in Arauco, gasoline and gas distribution, electricity, fishing and mining. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders.”

 

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The following table sets forth our ownership interests in our subsidiaries as of December 31, 2010.

 

     Country of
incorporation
   Total stock held  

Agenciamiento y Servicios Profesionales S.A. de C.V.

   Mexico      99.9986

Alto Paraná S.A.

   Argentina      99.9762   

Arauco Australia S.A.

   Australia      99.9986   

Arauco Bioenergía S.A.

   Chile      99.9985   

Arauco Colombia S.A.

   Colombia      99.9976   

Arauco Denmark ApS

   Denmark      99.9991   

Arauco Distribución S.A.

   Chile      99.9992   

Arauco do Brasil S.A.(ex-Placas do Paraná S.A.)

   Brazil      99.9986   

Arauco Ecuador S.A.

   Ecuador      99.9986   

Arauco Florestal Arapoti S.A.

   Brazil      79.9989   

Arauco Forest Brasil S.A.

   Brazil      99.9988   

Arauco Forest Products B.V.

   The Netherlands      99.9991   

Arauco Holanda Cooperatief U.A.

   The Netherlands      99.9990   

Arauco Perú S.A.

   Peru      99.9986   

Arauco Wood Products, Inc.

   U.S.A.      99.9986   

Araucomex S.A. de C.V.

   Mexico      99.9986   

Aserraderos Arauco S.A.

   Chile      99.9992   

Bosques Arauco S.A.

   Chile      99.9256   

Catan Empreendimentos e Participacoes S.A.

   Brazil      99.9934   

Controladora de Plagas Forestales S.A.

   Chile      59.6326   

Empreendimentos Florestais Santa Cruz Ltda. (ex-Lucchese Empreendimentos e Participacoes Ltda.)

   Brazil      99.9885   

Forestal Arauco S.A.

   Chile      99.9248   

Forestal Celco S.A.

   Chile      99.9256   

Forestal Cholguán S.A.

   Chile      97.4281   

Forestal Concepcion S.A.

   Panama      99.9986   

Forestal Los Lagos S.A.

   Chile      79.9405   

Forestal Nuestra Señora del Carmen S.A.

   Argentina      99.9987   

Forestal Valdivia S.A.

   Chile      99.9256   

Industrias Forestales S.A.

   Argentina      99.9987   

Inversiones Arauco Internacional Ltda. (ex-Arauco Internacional S.A.)

   Chile      99.9986   

Inversiones Celco S.L.

   Spain      99.9991   

Investigaciones Forestales Bioforest S.A.

   Chile      99.9256   

Leasing Forestal S.A.

   Argentina      99.9767   

Mahal Empreendimentos e Participacoes S.A.

   Brazil      99.9934   

Paneles Arauco S.A.

   Chile      99.9992   

Savitar (Forestal Talavera S.A.)

   Argentina      99.9985   

Servicios Logísticos Arauco S.A.

   Chile      99.9995   

Business Strategy

Our business strategy is to maximize the value of our forest plantations by pursuing sustainable growth opportunities in our core businesses and expanding into new markets and products. We are implementing our business strategy through the following initiatives:

 

   

We are improving the growth rate and quality of our plantations through advanced forest management techniques;

 

   

We are executing a capital expenditure plan designed to reinforce our competitive advantages through economies of scale and scope, improving the efficiency and productivity of our industrial activities and optimizing the use of our forests through biomass energy generation;

 

   

We continue to develop our facilities, transportation, shipping, storage and product distribution network that allow us to reach over 70 countries worldwide; and

 

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We are expanding internationally into new regions that we believe have comparative advantages in the forestry sector.

Domestic and Export Sales

The following table sets forth our sales revenue derived from exports and domestic sales for the years indicated.

 

     Year ended December 31,  
     2008      2009      2010  
     (in millions of U.S.$)  

Export Sales

        

Bleached pulp

   $ 1,508       $ 1,332       $ 1,448   

Unbleached pulp

     173         191         217   

Sawn timber

     390         234         359   

Remanufactured wood products

     223         170         131   

Plywood and fiber panels

     506         441         485   

Posts

     3         4         6   

Other

     4         0         1   
                          

Total export sales revenue

   $ 2,807       $ 2,372       $ 2,647   
                          

Domestic Sales

        

Bleached pulp

     107         69         94   

Unbleached pulp

     4         13         30   

Sawlogs

     72         46         98   

Pulplogs

     13         10         15   

Sawn timber

     82         68         105   

Remanufactured wood products

     24         22         19   

Chips

     10         17         29   

Electric power

     121         78         86   

Plywood and fiber panels

     441         390         624   

Other

     33         28         40   
                          

Total domestic sales revenue

   $ 907       $ 741       $ 1,141   
                          

Total sales revenue

   $ 3,714       $ 3,113       $ 3,788   
                          

The following table sets forth a geographic market breakdown of our export sales revenue for the years indicated.

 

     Year ended December 31,  
     2008      2009      2010  
     (in millions of U.S. dollars)  

North America

   $ 624       $ 482       $ 508   

Central and South America

     316         258         368   

Asia

     1,189         1,251         1,273   

Europe

     574         318         412   

Other

     104         63         85   
                          

Total

   $ 2,807       $ 2,372       $ 2,647   
                          

Forestry Activity

Radiata pine grows at the fastest rates within a narrow band of latitude and under certain climatic conditions. One of Chile’s main advantages in the forestry products industry lies in the short growing cycle of its radiata pine plantations. The faster growth rate of radiata pine trees in Chile allows harvesting of pulplogs and sawlogs 16 to 18 years after planting and of high quality sawlogs 25 years after planting. For most temperate softwood forests in the Northern Hemisphere this range is 18 to 45 years for pulplogs and 50 to 150 years for high

 

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quality sawn timber. Consequently, the Chilean forestry industry is a relatively low cost producer, since a Chilean producer generally requires less time and a smaller area to produce the same volume of pine as its North American or European competitors, who face lower forest growth rates and higher transportation and investment costs as a result of the larger tracts of forests necessary to produce equivalent yields of softwood. Accordingly, since the mid-1970s, we have focused our forest management toward the application of advanced genetic and silviculture techniques to increase productivity and the quality of our plantations.

Eucalyptus, which we began planting in 1989, grows well in the forest regions of Chile. Once planted, eucalyptus trees require no further forest management (other than fire control and reduction of weeds) until harvest. The average harvest cycle of eucalyptus plantations is approximately 12 years. Once harvested, Eucalyptus can be replanted or regrown.

Throughout our history, we have demonstrated a continued commitment to the improvement of our forest management policies. In particular, we have adopted environmentally sensitive policies towards our holdings of native forests, which are protected and preserved in their entirety. Our products come from our established plantations only; we do not sell any products derived from our native forests. We conduct our forestry operations in accordance with current legislative and environmental sustainability standards. Certain of our subsidiaries have received various environmental certifications as of the date of this annual report, which include, but are not limited to the following:

 

   

Sustainable Forest Management Certification: the Chilean certification of sustainable forest management, as determined since 2004 by the PEFC (Program for the Endorsement of Forest Certifications Schemes). PEFC is an international non-profit, non-governmental organization dedicated to promoting sustainable forest management;

 

   

Forest Stewardship Council (FSC) Certification: a forest management certification aimed at promoting forest management that is environmentally responsible, socially beneficial and economically viable for the world’s forests. FSC is a non-profit organization devoted to encouraging the responsible management of the world’s forests;

 

   

Chain of Custody Certification: a certification granted by the PEFC and designed to ensure that certified raw materials are used in finished product;

 

   

Chain of Custody and Controlled Wood Certification: a certification from FSC that is designed to ensure traceability of certified and uncertified wood from the forest to the finished product;

 

   

Environmental Management System ISO 14001: a certification issued by the International Standards Organization (ISO), awarded to organizations that comply with environmental legislation, monitor significant environmental impacts, prevent pollution and maintain a continuing program of environmental improvement. ISO is an international non-profit, non-governmental organization dedicated to developing international business standards;

 

   

Occupational Health and Safety Assessment Series (OHSAS) 18001: a certification awarded for the effective management of conditions and factors that may adversely affect the work environment of employees, temporary workers, contractors and other persons who are in the workplace.

Forest Plantations

At December 31, 2010, our planted forests consisted of 78% radiata and taeda pine and 22% mainly of eucalyptus. Radiata and taeda pine have a rapid growth rate and a short harvest cycle compared to other commercial softwoods. Radiata and taeda pine are sufficiently versatile for both the production of forestry and wood products and the production of long fiber pulp for sale to manufacturers of paper and packaging.

We seek to manage our forestry resources in a way that ensures that the annual growth of our forest is equal to or greater than the volume of resources harvested each year. In 2010, Arauco planted a total of 62,893 hectares

 

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and harvested a total of 42,480 hectares in Chile, Argentina, Brazil and Uruguay (which includes 50% of the total land owned in Uruguay by the Montes del Plata joint venture). We believe that we will reach a long-term sustainable equilibrium within the next five years, with annual harvests and plantations of approximately 64,200 hectares (including the Montes del Plata joint venture).

Our planted radiata pine forests are located in central and southern Chile, and most are located in close proximity to our major production facilities and to port facilities. The majority of our radiata pine is less than 16 years old.

At December 31, 2010, our aggregate radiata pine holdings comprised 42% of all Chilean radiata pine plantations, making us the country’s largest radiata pine plantation owner according to the Chilean Forestry Institute. At December 31, 2010, we owned approximately 1.1 million hectares of land in Chile, of which 0.7 million hectares are forest plantations.

At December 31, 2010, we owned 257,722 hectares of forest and other land in Argentina, 126,616 hectares of forest and other land in Brazil and 126,786 hectares of forest and other land that the Montes del Plata joint venture owns in Uruguay. Of the total land we own in these three countries, approximately 179,621 hectares of land is planted with taeda pine and elliotti pine, a species of softwood that has a growth rate similar to that of radiata pine. The balance includes plantations of other species of trees, land to be planted, protected areas and natural forests.

The following table sets forth the number of hectares and types of uses of our land holdings and rights, as of December 31, 2010.

 

     At December 31, 2010  
     Total      Distribution  
     (in hectares)      (percentage)  

Pine plantations(1)

     

0-5 years

     206,962         12.6

6-10 years

     171,933         10.5   

11-15 years

     188,895         11.5   

16-20 years

     136,982         8.3   

21+ years

     81,897         5.0   

Subtotal

     786,670         47.9   

Eucalyptus plantations(2)

     196,003         11.9   

Plantation of other species

     23,988         1.5   

Subtotal

     1,006,660         61.3   

Land for plantations

     60,520         3.7   

Land for other uses(3)

     575,166         35.0   
                 

Total(4)

     1,642,347         100.0
                 

 

(1) 

All years are calculated from the date of planting.

(2) 

Approximately 73% of our eucalyptus plantations are less than 10 years old.

(3) 

Includes roads, firebreaks, native forests and yards.

(4) 

Includes 100% of Alto Paraná-owned plantations, 80% of Forestal los Lagos S.A.-owned plantations, 80% of plantations owned by the Montes del Plata joint venture. Also includes 57,715 hectares for which we have the right to harvest but which we do not own, of which 49,487 hectares are in Chile, 7,923 hectares are in Uruguay and 305 hectares are in Argentina.

Land Acquisition and Afforestation

Our total land assets have increased from fewer than 170,000 hectares in 1980 to 1,642,347 hectares at December 31, 2010. That number does not include 12,184 hectares owned by third parties or the assets owned by Forestal Río Grande S.A. as to which we have harvesting rights. In the five years ending December 31, 2010, we purchased 261,587 hectares of land, of which 36,398 hectares were purchased in Chile, 16,156 in Argentina, 110,829 in Brazil and 119,311 in Uruguay.

 

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We expect to acquire additional land in Argentina, Uruguay (through the Montes del Plata joint venture) and Brazil (through minority investments in certain other companies that Arauco does not control), and to a lesser extent in Chile if we are presented with the opportunity to do so at a desired price or location. There can be no assurance that we would be able to acquire land at the desired price or location.

We plan to continue our policy of supplementing our pulplog production with purchases from domestic third parties. We believe that this policy is economically efficient, given the significant quantities of pulplog available from third parties and our increasing proportion of sawlogs yielded from our plantations. We believe that the aggregate of our existing plantations, land currently held by us that we intend to afforest and the third-party purchases we make in the ordinary course of our business will be sufficient to satisfy our anticipated future demand for sawlogs and pulplogs.

Chile

On January 6, 2005, through our subsidiary Forestal Valdivia S.A., we acquired 80% of Forestal Los Lagos S.A., which represented an investment of U.S.$21.4 million and included 9,234 hectares of land planted with eucalyptus in the Fourteenth Region of Chile.

On June 30, 2006, through our subsidiaries Aserraderos Arauco S.A., Forestal Celco S.A., Bosques Arauco S.A. and Forestal Valdivia S.A., we acquired the forestry assets of Cementos Bío-Bío S.A. The acquisition represented an investment of U.S.$133.3 million. The acquired assets consist of 21,000 hectares of pine plantations, one sawmill with an annual production capacity of approximately 250,000 cubic meters per year and a remanufacturing facility.

On October 11, 2006, the Bío Bío Investment Fund, a Chilean fund in which a group of Chilean insurance companies and other private investors participate, acquired the assets of Forestal Bío-Bío S.A. for U.S.$346 million, which included approximately 40,000 hectares of plantations. On that same date, Arauco entered into certain agreements with the Bío Bío Investment Fund pursuant to which Arauco became the administrator and exclusive buyer of these forestry assets. Arauco receives an annual fee for the administration of the forests. Arauco’s obligations under these agreements include the purchase of the fund’s forestry assets over a seven-year term beginning in 2006 and the purchase of the fund’s supply of timber during the same period. Arauco will pay a total of U.S.$461.6 million for the purchase of the fund’s forestry assets and timber supply over such seven-year term.

In January 2007, the Bío Bío Investment Fund transferred all of its assets and financial debt to Forestal Río Grande S.A., its newly created subsidiary. At the same time, the Bío Bío Investment Fund assigned all the administration and supply agreements it had entered into with Arauco to Forestal Río Grande S.A. Arauco has determined that Forestal Río Grande S.A. is a variable interest entity of which Arauco is the primary beneficiary. As a result, commencing on October 11, 2006, Arauco consolidates the assets and liabilities of Forestal Río Grande S.A. The indebtedness of Forestal Río Grande S.A. is neither secured by Arauco nor is Arauco liable for such indebtedness. See Note 1(c) to our audited consolidated financial statements.

In January 2007, through its subsidiary Bosques Arauco S.A., Arauco acquired 5,105 hectares of radiata pine plantation (excluding land) from Forestal Anchile Ltda. This acquisition represented an investment of U.S.$43.6 million.

In July 2008, through its subsidiary Forestal Valdivia S.A., Arauco acquired U.S.$14 million worth of plantations from Lafarge Chile S.A.

Argentina

In October 2005, through our Argentine subsidiary Industrias Forestales S.A., we acquired from Louis Dreyfus S.A.S. 100% of the stock of Ecoboard S.A.I.F. and Louis Dreyfus S.A.I.F. (subsequently renamed Ecoresine S.A.) in Argentina and, indirectly as a result of that purchase, 100% of the stock of Caif S.A. and LD Manufacturing S.A. (subsequently renamed Faplac S.A.) and 60% of the stock of Flooring S.A. As a result of these acquisitions, we own another 8,000 hectares of plantations in Argentina.

 

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In November 2006, through its subsidiary Arauco Internacional S.A., Arauco acquired La Señora del Milagro S.R.L. (subsequently renamed Forestal Nuestra Señora del Carmen S.A.), an Argentine forestry company, which owns approximately 4,000 hectares of land in Argentina, for U.S. $5.4 million.

In September 2007, Faplac S.A acquired 40% of the stock of Flooring S.A., from Fantoni SpA for U.S.$1.5 million.

In March 2008, Ecoboard SAIF, Ecoresine S.A. and CAIF S.A. merged with Industrias Forestales S.A.

In March 2008, Faplac S.A. acquired 20% of the stock of Savitar S.A. and El Oasis S.A., for U.S.$2.2 million, both Argentine forestry companies and owners of about 10,000 hectares of land. In 2009, Arauco acquired 80% of Savitar S.A. and El Oasis S.A. for U.S.$ 10.1 million.

In December 2008, Alto Paraná S.A. acquired 99.99% of the stock of the Brazilian company Lucchese Empreendimentos e Participações Ltda., which was subsequently renamed Empreendimientos Florestais Santa Cruz Ltda. and capitalized up to U.S.$39 million.

In January 2010, Faplac S.A. and Flooring S.A. merged into Alto Paraná S.A.

Brazil

In March 2005, through our Brazilian subsidiary Arauco do Brasil Ltda., we acquired from Louis Dreyfus S.A.S. 100% of the stock of LD Forest Products S.A. in Brazil and, indirectly as a result of that purchase, 100% of the stock of Placas do Paraná S.A. and 50% of the stock of Dynea Brasil S.A. As a result of these acquisitions, we acquired 25,800 hectares of plantations in Brazil.

In August 2006, through our subsidiary Arauco Forest Brasil S.A., we acquired from the Marchiori Group certain forestry land in Brazil. This investment of U.S.$39.6 million includes 14,715 hectares of land and plantations, mostly consisting of elliotti pine.

On September 27, 2007 Arauco entered into an agreement for the joint ownership of land in Brazil with Stora Enso Oyj, a Finnish-Swedish multinational corporation. Pursuant to the agreement, Arauco acquired 80% of the shares in Stora Enso Arapoti Empreendimentos Agrícolas S.A., now Arauco Florestal Arapoti S.A., which owns 50,000 hectares of land, including 25,000 hectares of pine and 5,000 hectares of eucalyptus plantations; 20% of the shares in Stora Enso Arapoti Indústria de Papel S.A., which owns a paper mill with an annual production capacity of 205,000 tons of light weight coated paper; and 100% of the shares of Stora Enso Arapoti Serraria Ltda., which owns a sawmill with an annual production capacity of 150,000 cubic meters per year. This alliance required an investment of U.S.$208.4 million, which was financed with Arauco’s resources and commercial bank loans.

Uruguay

On September 27, 2009, Arauco and its subsidiary Arauco Internacional, executed a series of joint venture agreements with Stora Enso, pursuant to which Stora Enso Amsterdam B.V. agreed to transfer ownership of 100% of the shares of Stora Enso Uruguay S.A. to Forestal Cono Sur, as part of the Montes del Plata joint venture. As a result of this transaction, Arauco and Stora Enso equally control all assets that both companies own in Uruguay, which includes 74,000 hectares owned by Stora Enso (including 17,300 hectares which are already planted with forests) and 39,000 hectares owned by Arauco (of which 27,400 are already planted with forests). These assets, and those that we acquired from Grupo Empresarial ENCE, S.A. in October of 2009, have helped to secure a strategic basis to consider the construction of a future pulp mill in Uruguay.

In addition, in October 2009, our subsidiary Arauco International S.A. and a subsidiary of Stora Enso acquired in equal parts Eufores S.A., Celulosa y Energía Punta Pereira S.A., El Esparragal Asociación Agraria de Responsabilidad Limitada, Terminal Logística e Industrial M’Bopicuá S.A. and Zona Franca Punta Pereira S.A., which were at that time Uruguayan subsidiaries of the Spanish Grupo Empresarial ENCE S.A., or ENCE, whose main assets include 130,000 hectares of land, of which 73,000 have forestry plantations, 6,000 hectares under

 

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agreements with third parties and one industrial site, along with the necessary environmental permits for the construction of a pulp mill, a river terminal and one nursery. We own and operate these acquired assets jointly with Stora Enso as part of the Montes del Plata joint venture. The aggregate value of the assets acquired as a result of this transaction was U.S.$335 million, of which we paid 50% (or approximately U.S.$167.5 million).

On January 18, 2011 Arauco and Stora Enso agreed to carry out the construction of a state of the art pulp mill with an annual guaranteed capacity of 1.3 million tons, a port and a power producing unit based on renewable sources, all located in Punta Pereira, department of Colonia, Uruguay. The total estimated investment is U.S.$1,900 million. For more information see “Item 5.Operating Financial Review and Prospects—Results of Operations—Negative Goodwill Immediately Recognized” and “—Other Profit (Loss)”.

Forest Management

For our pine plantations, our forestry management activities seek to increase sawlogs through advanced genetic techniques, planting and site preparation procedures, thinning and pruning. Managed forests can produce trees of larger diameter and, if pruned, a higher proportion of clear wood, which generally commands a higher price than knotted wood. Although some land is not suitable for the production of pruned logs, at December 31, 2010, over 64% of our pine forests in Chile were designed for clear wood production.

For our eucalyptus plantations, our forestry management activities seek to increase the amount of fiber production per hectare through advanced genetic techniques and planting and site preparation procedures. Eucalyptus is more expensive to plant than pine; however, after planting, eucalyptus requires minimal forest management, yields more fiber per hectare and has a shorter growth cycle and greater wood density than pine, resulting in a greater amount of pulp production per hectare.

As of December 31, 2010, we had nine nurseries in Chile, Argentina, Brazil and Uruguay, in which we grow seedlings using seeds and using cuttings from genetically selected trees. To achieve higher quality trees and an increased growth rate, we apply strict selection criteria to the trees from which seedlings are produced. We then plant the seedlings manually. Depending upon the species of tree to be planted and the nutrient and physical characteristics of the soil, we may also undertake a certain amount of ground preparation before planting. Our other principal forest activities are thinning, pruning and harvesting.

Thinning, or culling inferior trees from the plantation, occurs in the following two stages:

 

   

Thinning to waste. Thinning to waste occurs after four to six years and results in an average reduction of the number of trees per hectare from 1,250 to approximately 700.

 

   

Commercial thinning. Thinned trees are used in pulp production or, depending on the quality of the particular land, as sawlogs. Commercial thinning occurs at 10 to 12 years and results in an average reduction of the number of trees per hectare from 700 to approximately 450.

This high level of thinning benefits Arauco for the following reasons:

 

   

the cost of planting is relatively low,

 

   

the higher number of young trees provide each other with natural protection from the elements, and

 

   

the high degree of selection that thinning makes possible leaves only the highest quality trees to be harvested.

Pruning involves removing branches, the source of knots, which are the main defect in sawn timber. Pruning results in a high-quality clearwood sawlog of 5.3 meters from each tree, and is conducted three times:

 

   

at the time of the first thinning,

 

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two years later, when trees are six to eight years old, and

 

   

one year later, when trees are seven to nine years old.

Our eucalyptus plantations are neither thinned nor pruned.

Harvesting timber involves felling trees, removing branches from the logs, cutting the logs into appropriate sections and loading the logs onto trucks for transport to sawmills, panel mills or pulp mills. We use the lower section of the radiata pine, comprising the first 7 to 12 meters, in sawmills and plywood mills or it is exported as sawlogs. We use the mid-section of the radiata pine, comprising, on average, the next 8 to 13 meters, in either sawmills or pulp mills, depending on the diameter and quality of the pine. We use the top section of the tree for pulp and MDF production.

We monitor product demand and our current inventory levels, and we match harvests from sections of our plantations that will provide the optimal yield given our product requirements. This process involves the use of sophisticated operations research models and close communication between our different operating areas to ensure that the correct amounts of timber of the required characteristics are supplied. We replant as soon as practicable after harvesting, with an average period between harvesting and replanting of one year.

The following table illustrates, on a hectare basis, the extent of our thinning, pruning and harvesting activities in Chile during the periods indicated.

 

     Year ended December 31,  
     2008      2009      2010  
     (in hectares)  

Thinning

     18,562         19,246         11,570   

Pruning

     40,721         31,191         27,335   

Harvesting

     29,184         30,872         30,158   

We manage our forest activities, but we hire independent contractors to perform the bulk of our operations, including planting, maintenance, thinning, pruning, harvesting, transportation and access road construction. As of December 31, 2010, we had arrangements with more than 389 independent contractors that employed over 12,151 workers in Chile. Many of these contractors have long-standing relationships with us, but we award many contracts based on competitive bids. We believe that our arrangements with independent contractors provide greater flexibility and efficiency than performing these activities directly.

Our plantations are interspersed with native forest and farmland, and, as a result, they are naturally protected against the spread of certain diseases. In addition, our subsidiary Investigaciones Forestales Bioforest S.A., or “Bioforest”, has developed strategies to protect our forests from pests and diseases. During the last five years, radiata pine plantations have been affected by two health problems in particular: 1) the sirex noctilio, a wasp which attacks stressed trees, has caused a natural selection for thinning and 2) the disease produced by phytophthora pinifolia has reduced the growth rate of certain trees. To mitigate the effects of the sirex noctilio, Bioforest has implemented a biological control program under which it has released into the affected forests natural enemies of the sirex noctilio, including the nematode, the beddingia siricidicola and the parasitoid ibalia leucospoide. To control the spread of phytophthora pinifolia, Bioforest has begun genetically engineering our trees to be more tolerant to the disease and has also begun dispersing in our forests a fertilizer that further promotes resistance. For more information regarding certain risks to our forests presented by disease, see “Item 3. Key Information—Risk Factors—Disease or fire could affect our forests and manufacturing processes and, in turn, adversely affect our business, financial condition, results of operation and cash flows.”

We operate an extensive fire control organization that interacts with the fire control organizations of other forestry companies to ensure that any fire damage to our forests is minimal. The operation primarily consists of a system of spotter towers, manned 24 hours a day during the summer months, from which spotters report the direction of any fire observed to a central command post, where the fire’s exact location is determined and an appropriate ground and/or aerial response is formulated. Over the last five years, this system has limited fire damage to our forests to an average of 0.3% of the plantations per year.

 

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Forest Production

We harvested 16.6 million cubic meters of logs during the year ended December 31, 2010, consisting of 8.7 million cubic meters of sawlogs, 6.0 million cubic meters of radiata pine pulplogs and 1.9 million cubic meters of eucalyptus pulplogs and other logs. We did not export any pulplogs during 2010 because substantially all of the pulplogs from our forests were used in our pulp or panel mills. During 2010, our sawmills and panel mills used 6.5 million cubic meters of sawlogs, and no sawlogs were exported. We also sold 1.9 million cubic meters of sawlogs to unaffiliated domestic sawmills during 2010.

A log merchandising facility located at the same site as our Horcones I and Horcones II sawmills optimizes, cuts and classifies wood destined for our plywood facility, sawmills or pulp mills with an annual processing capacity of 1.7 million cubic meters of logs per year. The Nueva Aldea Complex also includes a log merchandising facility, with an annual processing capacity of 2.6 million cubic meters of logs per year.

Pulp

We believe that we were Chile’s largest producer of bleached and unbleached softwood market pulp in terms of production in 2010. For the year ended December 31, 2010, pulp sales were U.S.$1,790 million, representing 47.2% of our total sales revenue for the period.

Pulp obtained from wood fibers is used in the manufacture of printing and writing paper, hygienic and sanitary paper, board and packaging. Whether a specific kind of pulp is suitable for a particular end use depends not only on the type of wood but also on the process used to transform the wood into pulp. Pulp made from softwoods, such as radiata pine, has long fibers and is used to provide durability and strength to paper products. Bleached pulp is used primarily for printing and writing papers and for tissue. Unbleached pulp is used primarily for linerboard (a packaging material). Pulp made from hardwoods, such as eucalyptus, has short fibers and is used in combination with long fiber in manufacturing paper products.

We use a chemical process, known as the kraft process, in our pulp mills in Chile and Argentina. The raw wood is in the form of pulplogs and chips, which are combined in the production process to produce pulp. The pulplogs are first debarked and chipped. The chips are then screened, mixed and cooked with chemicals to separate the bulk of the lignin from the wood fibers. After the material is screened and washed, it is then passed to high-density tanks. For bleached pulp, the next step is a five-stage bleaching process using chemicals, primarily chlorine dioxide. At all of our pulp mills, the bleaching process is preceded by an oxygen delignification stage. Then, the fibers are subjected to a final stage where the sheets are formed and subsequently dried and baled for transport to customers. The lignin and bark produced during this process is used to fuel the boilers that produce steam, providing heat and generating electricity for the mill. Our bleached pulp is bleached to a 90+ brightness level, as measured by the ISO test procedure, which is one of the industry’s measurement methods.

Pulp Mills

At December 31, 2010, we owned and operated five pulp mills in Chile and one in Argentina, with an aggregate installed annual production capacity of approximately 3.2 million metric tons. Our six pulp mills produced 1.9 million metric tons of bleached pulp and 0.4 million metric tons of unbleached pulp in 2010.

All of our pulp mills in Chile except for the Nueva Aldea Mill and the Licancel Mill are ISO 9001:2000 and ISO14001:2004 certified. The Nueva Aldea Mill and the Licancel Mill were certified ISO 9001:2008 and ISO 14001:2004 in February 2010. The Alto Paraná Mill in Argentina is certified under ISO 9001:2000 and ISO14001:2004. No seasonal factors affect plant utilization, and the pulp mills generally run at full capacity throughout the year, with eight to ten days of maintenance scheduled every 12 months.

 

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The following table sets out bleached and unbleached kraft pulp production by plant for each of the years indicated.

 

     Year ended December 31,  
     2006      2007      2008      2009      2010  
     (in thousands of metric tons)  

Chile

              

Arauco Mill (bleached)

              

Arauco I

     295         279         281         286         231   

Arauco II

     494         475         507         505         84   

Valdivia Mill (bleached)

     440         436         488         540         493   

Constitución Mill (unbleached)

     338         331         320         333         252   

Nueva Aldea Mill (bleached)

     123         715         842         900         780   

Nueva Aldea Mill (unbleached)

                 9   
                                            

Licancel Mill (bleached)(1)

     141         53         118         51         28   
                                            

Licancel Mill (unbleached)(2)

     —           —           —           75         84   
                                            

Subtotal

     1,831         2,289         2,555         2,690         1,962   
                                            

Argentina

              

Alto Paraná Mill (bleached)

     348         336         343         310         329   

Total

     2,179         2,625         2,898         3,000         2,291   
                                            

 

(1) 

Operations at the Licancel Mill were temporarily suspended for approximately six months from June 2007 until January 2008.

(2) 

During 2009, the Licancel Mill produced unbleached pulp for a three-month period. During 2010, the Licancel Mill produced unbleached pulp for a nine–month period.

Chile

Arauco I. Arauco I, which was completed in 1972, is located at the Arauco Mill in the heart of a group of our radiata pine plantations in the Eighth Region of Chile. Arauco I produces elementary chlorine-free pulp, which does not use chlorine gas. Elementary chlorine-free pulp is also produced by a significant portion of our competitors in each of the world’s major pulp producing regions. The installed annual production capacity of Arauco I is approximately 290,000 metric tons of eucalyptus and pine bleached kraft pulp.

Arauco II. Also located at the Arauco Mill, Arauco II was completed in 1991. Arauco II’s pulping process is fundamentally the same as that of Arauco I, but it includes technological improvements in its production process and environmental design. Arauco II is also equipped to produce elementary chlorine-free pulp. The installed annual production capacity of Arauco II is approximately 500,000 metric tons of pine bleached kraft pulp.

As a consequence of the earthquake that occurred in Chile on February 27, 2010, the operations of Arauco II were temporarily suspended until February 2, 2011, when it resumed is operations.

Constitución Mill. The Constitución Mill is located in the heart of a group of our radiata pine forests in the Seventh Region of Chile. As of December 31, 2010, the Constitución Mill was the largest unbleached softwood market pulp mill in the world, with an installed annual production capacity of approximately 355,000 metric tons. In February 2006, the COREMA of the Seventh Region of Chile approved an environmental impact study for the construction of a new pipeline for the Constitución Mill, which commenced operations in February 2007. The Constitución Mill is equipped to produce elementary chlorine-free pulp.

Licancel Mill. We acquired the Licancel Mill in September 1999. It is located in Licantén, which is 250 kilometers south of Santiago. The mill has an installed annual production capacity of approximately 140,000 metric tons of eucalyptus kraft pulp and pine bleached and unbleached kraft pulp. The Licancel Mill is equipped to produce elementary chlorine-free pulp.

 

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In June 2007, our operations at the Licancel Mill became subject to environmental scrutiny by Chilean environmental regulators and the public, which arose in connection with the death of fish in the Mataquito River, approximately 15 kilometers downstream of the mill. As a result, Chilean authorities, including the health authorities and the Superintendencia de Servicios Sanitarios (Sanitary Services Superintendency), required that we suspend activities at the Licancel Mill and that we suspend any further discharges into the river. We estimate that the suspension of operations at the Licancel Mill resulted in a total loss of profits of U.S.$24 million. Several proceedings have been commenced regarding the events at the Licancel Mill and the death of fish at the Mataquito River. The mill resumed operations during January 2008. For further details in respect of the proceedings related to the 2007 suspension of operations at the Licancel Mill, see “Item 8. Financial Information—Legal Proceedings.”

In 2007, we invested U.S.$8 million in a new effluent treatment system for the Licancel Mill. However, we can offer no assurance that the Licancel Mill will be able to operate without further interruptions. Any future suspension of operations at the Licancel Mill may adversely affect our business, financial condition, results of operations and cash flows. See “Item 3. Environmental concerns led us to suspend our operations at the Licancel Mill, which adversely affected our business, financial condition, results of operations and cash flows” and “Item 8. Financial Information- Legal Proceedings.”

Valdivia Mill. We completed construction of the Valdivia Mill during the first quarter of 2004 and commenced operations in February 2004. The Valdivia Mill is located in Fourteenth Region of Chile (which was previously part of the Tenth Region of Chile), an area with significant radiata pine and eucalyptus plantations. The Valdivia Mill has an installed potential annual production capacity of approximately 550,000 metric tons of bleached pulp, consisting of softwood pulp and eucalyptus pulp. The Valdivia Mill is equipped to produce elementary chlorine-free pulp.

The Valdivia Mill has been subject to legal and administrative proceedings by the Chilean environmental regulators. Primarily, it has been alleged that the Valdivia Mill’s operations impacted the nearby Carlos Anwandter Nature Sanctuary and contributed to the migration and death of black-neck swans in an area downstream from the mill on the Cruces River. For a discussion of the administrative and litigation proceedings in which we have been involved as a result of our operations at the Valdivia Mill, see “Item 8. Financial Information—Legal Proceedings.”

On June 16, 2009, we submitted to the COREMA a request to increase our production at the Valdivia Mill by 20% from 550,000 metric tons to 660,000 metric tons per year, which request was rejected on July 20, 2009. Consequently, on May 28, 2010, we presented an environmental impact declaration to the COREMA pursuant to which we repeated our request to increase the production of the Valdivia Mill from 550,000 metric tons to 660,000 metric tons per year. As of the date of this annual report, this environmental impact declaration remains under the review of the COREMA.

Nueva Aldea Mill. Located in the Eighth Region of Chile, this mill was completed in 2006 and currently has a production capacity of 1,027,000 metric tons per year, half of which is for the production of pine bleached kraft pulp and the other half of which is for the production of eucalyptus bleached kraft pulp. The Nueva Aldea Mill is equipped to produce elementary chlorine-free pulp.

On February 20, 2006, the COREMA of the Eighth Region of Chile approved the environmental impact study for the construction and operation of the Nueva Aldea Mill Pipeline, which permits the mill to discharge certain liquid effluents into the ocean. The Nueva Aldea Mill pipeline’s startup and commissioning period (of 6 months) commenced in the first quarter of 2010. However, as result of damages to the pipeline caused by the earthquake that occurred in Chile on February 27, 2010, we needed to temporarily suspend our use of the pipeline and discharge the effluents of the Nueva Aldea Mill in the same place in which the mill’s wastewaters were discharged prior to our use of the pipeline. On July 31, 2010, our repairs to the damaged pipeline were completed and the startup and commissioning period was restarted. Since January 31, 2011, the pipeline has been fully operational.

On February 9, 2009, COREMA approved our request to increase the Nueva Aldea Mill’s production to 20% above the previously authorized level, which was 856,000 metric tons per year. The COREMA determined

 

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that it was not necessary for us to present an environmental impact study in connection with our request for increased production. As a result, our total annual authorized production capacity has been increased to 1,030,000 metric tons. Furthermore, on October 7, 2009 we presented an environmental impact declaration requesting an additional increase in the production capacity of the Nueva Aldea Mill from 1,030,000 metric tons to 1,200,000 metric tons per year. The COREMA approved this request on February 4, 2010. As of the date of this annual report, plans to carry out this increase in production capacity are underway.

Argentina

Alto Paraná Mill. Alto Paraná’s softwood pulp mill is located in the Province of Misiones, a region whose soil and climate are favorable for the rapid growth of pine trees. The Alto Paraná Mill is the only bleached softwood kraft market pulp facility in Argentina. The mill has an installed annual production capacity of 350,000 tons of pulp, of which approximately 67% is bleached softwood pulp, currently representing almost all of the total bleached softwood pulp production capacity in Argentina, and 33% is fluff pulp.

Production Costs

Based on information published by Resource Information Systems, Inc., our cash costs for softwood pulp production are significantly lower than the average costs of market pulp producers in Canada, the United States and Scandinavia, particularly with respect to timber and energy costs. While our modern facilities result in depreciation exceeding some of such Northern Hemisphere producers, our costs are still significantly lower than the average costs of our Northern Hemisphere competitors, on a total delivered cost basis. The following table compares our costs for the production of bleached softwood kraft market pulp to the average costs of market pulp producers in selected regions in the Northern Hemisphere for the year ended December 31, 2010.

 

     Bleached Softwood Kraft Pulp Producers’ Cost  
  

 

Arauco(1)

  

    
 

 

British
Columbia

Coast

  
  

  

    
 

 

British
Columbia

Interior

  
  

  

    
 

 

United
States

South

  
  

  

  

 

Sweden

  

  

 

Finland

  

                 
     (in U.S.$ per metric ton for the year ended December 31, 2010)  

Wood

     172         263         193         172         283         295   

Total chemicals

     64         74         80         74         60         63   

Labor

     48         79         73         41         45         51   

Others(2)

     86         209         178         139         88         67   
                                                     

Total cash cost

     369         625         524         426         476         476   

Depreciation

     37         58         35         65         67         88   
                                                     

Total mill cost

     406         683         559         491         543         564   

Transportation(3)

     83         67         104         65         34         41   
                                                     

Total delivered cost

     488         750         663         556         577         605   
                                                     

 

(1) 

Excludes Alto Paraná production costs.

(2) 

Includes energy, materials and other production costs.

(3) 

Delivered in Northern Europe.

Source: Resource Information Systems, Inc. World Pulp Annual Historical Data, December 2010, except Arauco information, which is furnished by Arauco.

Sales

The total production of bleached kraft market pulp in the global market during the year ended December 31, 2010 was 52.6 million metric tons. Based on information published by Resource Information Systems, Inc., we believe that our production represented 5.5% of this market in 2010. During the year ended December 31, 2010, we sold 93.9% of our bleached pulp in our export markets, principally to customers in Asia and Western Europe.

Integrated manufacturers dominate the world production of unbleached softwood pulp, which leaves non-integrated companies that sell market pulp, like us, with only a small percentage of total production. “Market pulp”

 

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is pulp sold to manufacturers of paper products, as opposed to pulp produced by an integrated paper producer for use in its paper production facilities. With a total world production of unbleached softwood kraft pulp of 2.1 million metric tons for 2010, according to Resource Information Systems, Inc., our Constitución Mill was the world’s largest single producer of unbleached softwood market pulp, with 16.9% of the total market in 2010. During the year ended December 31, 2010, 87.7% of our total unbleached market pulp sales consisted of export sales. While for the last five years Asia has been our principal export market for unbleached market pulp, we continually seek niche markets for our products in Western Europe and the United States. Historically, our sales in the Chilean market have been less than 10.6% of our total unbleached pulp sales revenue.

The following table sets forth, by region, the sales volumes of bleached and unbleached pulp for the years indicated.

 

     Year ended December 31,  
     2008      2009      2010  
     (in metric tons)  

Bleached Pulp

        

North and South America

     364,231         333,781         349,058   

Europe

     671,062         484,406         456,922   

Asia

     1,335,029         1,865,318         1,169,398   

Other

     40,467         23,962         23,496   
                          

Total

     2,410,789         2,707,467         1,998,874   
                          

Unbleached Pulp

        

North and South America

     56,673         51,012         67,858   

Europe

     25,590         13,931         13,441   

Asia

     225,542         344,941         263,145   

Other

     0         0         0   
                          

Total

     307,805         409,884         344,444   
                          

While there are many grades and varieties, pulp is a commodity that is marketed primarily on the basis of price and service. In marketing our pulp, we seek to establish long-term relationships with non-integrated end users of pulp by providing a competitively priced, high-quality, consistent product and excellent service. The consistency of our pulp derives from our high-quality mills and our use of a single species of tree, in contrast to pulp producers in some of the world’s major softwood pulp producing regions that mix different species, depending on availability and seasonality. Our bleached pulp is marketed under the brand names “Arauco” and “Alto Paraná,” and our unbleached pulp is marketed under the brand name “Celco.”

Prices for bleached softwood kraft market pulp produced from radiata pine generally fluctuate depending on prevailing world prices, which historically have been cyclical. The fluctuations generally depend on worldwide demand, world production capacity, business strategies adopted by major forestry, pulp and paper producers and the availability of substitutes. See “Item 5. Operating and Financial Review and Prospects—Management’s Discussion and Analysis of Financial Conditions, Results of Operations and Cash Flows—Overview” and “—Prices.”

 

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The following table sets forth our average bleached and unbleached pine pulp prices per metric ton at the indicated dates, for the years indicated.

 

     2008      2009      2010  
     (U.S.$ per metric ton)  

Bleached Pulp

        

March 31

     727         446         724   

June 30

     738         486         840   

September 30

     675         556         782   

December 31

     472         637         767   

Unbleached Pulp

        

March 31

     572         392         678   

June 30

     577         416         775   

September 30

     551         552         735   

December 31

     452         598         748   

In accordance with customary pulp market practice, we do not have long-term sales contracts with our customers (except for in a few limited cases); rather we maintain long-standing relationships with our customers with whom we periodically reach agreements on specific volumes and prices. We have a diversified customer base located throughout the world and totaling, as of December 31, 2010, more than 460 clients. As of December 31, 2010, we employed more than 13 sales agents to represent us in more than 40 countries. We manage this worldwide sales network from our headquarters in Chile.

Plywood and Fiberboard Panels

Our panel products consist of plywood and fiberboard panels. At December 31, 2010, we owned two plywood mills and one HB-MDF mill in Chile, one MDF mill and one PBO mill in Argentina, and one MDF mill, one PBO mill and one MDF-PBO mill in Brazil. For the year ended December 31, 2010, sales of panels were U.S.$1,109.0 million, representing 29.3% of our total sales revenues.

Exports, which include sales to countries other than Chile, Argentina and Brazil, accounted for 43.7% of our total sales revenues of plywood and fiberboard panels for the year ended December 31, 2010. We sell plywood and fiberboard panels primarily to customers in North America, Europe, Brazil, Chile, Argentina and other countries in Latin America.

On March 9, 2005, we acquired from Louis Dreyfus S.A.S. 100% of the stock of LD Forest Products S.A. in Brazil and, indirectly as a result of that purchase, 100% of the stock of Placas do Paraná S.A. and 50% of the stock of Dynea Brasil S.A. We paid an aggregate purchase price for these acquisitions of U.S.$168.0 million. With these acquisitions, we acquired an MDF mill with installed annual production capacity of approximately 250,000 cubic meters, a particleboard mill with installed annual production capacity of approximately 320,000 cubic meters, an impregnated paper mill and a formaldehyde and resin plant.

On October 31, 2005, we acquired from Louis Dreyfus S.A.S. 100% of the stock of Ecoboard S.A.I.F. and Louis Dreyfus S.A.I.F. in Argentina and, indirectly as a result of that purchase, 100% of the stock of CAIF S.A. and LD Manufacturing S.A. and 60% of the stock of Flooring S.A. As a result of these acquisitions, we own a particleboard mill with installed annual production capacity of approximately 260,000 cubic meters, a chemical plant that produces resins used for the production of wood panels, and an MDF and particleboard-based wood floor mill with installed annual production capacity of approximately two million square meters. We paid an aggregate purchase price of U.S.$55.0 million for this acquisition. As discussed in “Item 4. Description of Business—History”, we have expanded our panel production capacity in Brazil. On August 26, 2009, we acquired Tafisa Brasil. Tafisa Brasil’s primary asset is a panel production facility, located in Pien, Brazil, which produces both MDF and particleboard and has an annual total installed capacity of 640,000 cubic meters.

 

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The following table sets forth, by category, our plywood and fiberboard panel sales to unaffiliated third parties for each of the years indicated.

 

     Year ended December 31,  
     2006      2007      2008      2009      2010  
     (in thousands of cubic meters)  

Total plywood and fiberboard panels

     2,397         2,455         2,353         2,630         3,032   

Chile

Trupán-Cholguán Mill. This mill has an installed annual production capacity of approximately 575,000 cubic meters of panels. It has three production lines, one produces hardboard with a capacity of 60,000 cubic meters and the other two lines produce MDF with a production capacity of 165.000 and 350.000 cubic meters, respectively.

Arauco Mill. This mill has an installed annual production capacity of approximately 350,000 cubic meters of plywood panels. It has two production lines with respective production capacities of 140,000 and 210,000 cubic meters.

Nueva Aldea Mill. This mill has an installed annual production capacity of approximately 450,000 cubic meters of plywood panels distributed between two lines, each with a production capacity of 225,000 cubic meters.

Argentina

Piray Mill. This mill has an installed annual production capacity of approximately 300,000 cubic meters of panels and produces MDF.

Zárate Mill. This mill has an installed annual production capacity of approximately 260,000 cubic meters of panels and produces PBO.

Brazil

Jaguariaiva Mill. This mill has an installed annual production capacity of approximately 315,000 cubic meters of panels and produces MDF. In April 2011, a project to expand the Jaguariaiva Plant was approved. This project will include the construction of a productive line that will manufacture panels and MDF boards with an estimated installed capacity of 500,000 cubic meters of finished product per year, as well as the construction of a decorative paper impregnation line and melamine press.

Curitiba Mill. This mill has an installed annual production capacity of approximately 260,000 cubic meters of panels and produces PBO.

Pien Mill. This mill has an installed annual production capacity of approximately 670,000 cubic meters of panels distributed in two production lines with a production capacity of 400,000 cubic meters of MDF and 270,000 cubic meters of PBO.

Wood Products

Our wood products consist of sawn timber (green, kiln-dried lumber and flitches) and remanufactured wood products. For the year ended December 31, 2010, revenue from sales of wood products was U.S.$620.8 million, representing 16.4% of our total sales revenues for the period.

 

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The following table sets forth, by category, our wood products sales to unaffiliated third parties for each of the periods indicated:

 

     Year ended December 31,  
     2006      2007      2008      2009      2010  
     (in thousands of cubic meters)  

Sawn timber

     2,512         2,650         2,522         1,952         2,098   

Remanufactured wood products

     430         389         348         279         316   

Aserraderos Arauco S.A. was established in 1993 to centralize management and control production in our sawmill and remanufacturing operations. Our sawmills and remanufacturing facilities in Chile are currently operated by independent contractors that are paid sawing service fees calculated on a fixed and variable basis depending on productivity, with price renegotiations in the event of material changes in costs or productivity. Each of our 12 independent contractors operates exclusively for us and only with respect to one sawmill or remanufacturing facility. We believe that our arrangements with independent contractors provide us with greater flexibility and efficiency than performing such activities on our own. We operate our sawmill and remanufacturing facilities in Argentina.

As of December 31, 2010, we had nine sawmills in operation, eight in Chile and one in Argentina, with aggregate installed annual processing capacity of approximately 5.3 million cubic meters of sawlogs and an aggregate installed annual production capacity of approximately 2.8 million cubic meters of lumber. Contractors that are not related to us or to each other operate our eight sawmills in Chile. We operate our sawmills in coordination with our forestry and sales operations, since our sawn timber is generally produced in accordance with customer specifications. All of our sawmills are located near our pine plantations.

As of December 31, 2010, we also own five remanufacturing facilities, four in Chile and one in Argentina, that reprocess sawn timber into remanufactured wood products, such as moldings, jams and pre-cut pieces that end users require for doors, furniture and door and window frames. These facilities produced 463,000 cubic meters of remanufactured wood products in 2010.

During 2008, the decrease in demand of sawn timber products, due primarily to the credit crisis and the continued downturn in the real estate market in the United States, resulted in our decision to close the following facilities (indicating the date of closure and the annual lumber production capacity of each facility):

 

   

the Arapoti sawmill (closed on March 31, 2008 with an annual production capacity of 250,000 cubic meters),

 

   

the Lomas Coloradas sawmill (closed on August 9, 2008 with an annual production capacity of 250,000 cubic meters),

 

   

the Coronel sawmill (closed on November 17, 2008 with an annual production capacity of 150,000 cubic meters), and

 

   

the Coelemu sawmill (closed on December 30, 2008 with an annual production capacity of 80,000 cubic meters).

In November 2009 production at the Horcones II sawmill was suspended. However, due to favorable market conditions and in order to restore jobs in a region that was seriously affected by the earthquake, Horcones II sawmill resumed operations June 2010 with an annual production capacity of 225,000 cubic meters.

 

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The following is a brief description of our sawmills and remanufacturing facilities and their production capacity, as of December 31, 2010.

Chile

Cholguán Sawmill and Remanufacturing Facilities 1 and 2. This sawmill was acquired in March 2000 and has installed annual production capacity of approximately 330,000 cubic meters of lumber, as well as drying kiln facilities and two remanufacturing facilities with installed annual production capacity of approximately 70,000 cubic meters of remanufactured wood products. The Cholguán sawmill also has a special facility for making laminating beams with installed annual production capacity of approximately 11,200 cubic meters and drying facilities with installed annual production capacity of approximately 252,000 cubic meters.

Colorado Sawmill. This sawmill has installed annual production capacity of approximately 320,000 cubic meters of lumber and produces “green” sawn timber (or sawn timber that is not kiln dried) for the Chilean, Japanese and Middle Eastern markets. It also has drying facilities with installed annual production capacity of approximately 181,000 cubic meters.

El Cruce Sawmill. This sawmill has installed annual production capacity of approximately 85,000 cubic meters of lumber.

Horcones I Sawmill and Remanufacturing Facility. This sawmill has installed annual production capacity of approximately 360,000 cubic meters of lumber. It also has drying kilns with installed annual production capacity of approximately 412,000 cubic meters and a remanufacturing facility with installed annual production capacity of approximately 136,000 cubic meters of remanufactured wood products.

Horcones II Sawmill (reopened in 2010). This sawmill was closed in November 2009 due to unfavorable market conditions, however it resumed operations in June 2010 with an annual production capacity of approximately 225,000 cubic meters of lumber.

Nueva Aldea Sawmill. This sawmill has installed annual production capacity of approximately 430,000 cubic meters of sawn timber. It is also equipped with drying kilns with installed annual production capacity of approximately 355,000 cubic meters.

Valdivia Sawmill and Remanufacturing Facility. This sawmill has installed annual production capacity of approximately 340,000 cubic meters of lumber. It also has drying facilities with installed annual production capacity of approximately 345,000 cubic meters and a remanufacturing facility with installed annual production capacity of approximately 72,000 cubic meters of remanufactured wood products.

Viñales Sawmill and Remanufacturing Facility. This sawmill has installed annual production capacity of approximately 360,000 cubic meters of lumber. It is also equipped with drying kilns with installed annual production capacity of approximately 231,000 cubic meters and a remanufacturing facility with installed annual production capacity of approximately 120,000 cubic meters of remanufactured wood products.

Mutrún Sawmill (closed in 2010). This sawmill had installed annual production capacity of approximately 130,000 cubic meters of lumber. It was equipped with drying kilns with installed annual production capacity of approximately 90,000 cubic meters. In February 2010, the Mutrún Sawmill was destroyed by the earthquake and tsunami in Chile and will not be reopened.

Argentina

Bossetti Sawmill (closed in 2010). Alto Paraná S.A. acquired this sawmill in 2004 as part of its purchase of the forestry assets of Pecom Energía S.A. in Argentina. This mill had installed annual production capacity of approximately 150,000 cubic meters of lumber. It also had drying facilities with installed annual production capacity of approximately 180,000 cubic meters. In December 2010, the Bossetti Sawmill was closed due to unfavorable market conditions.

 

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Piray Sawmill and Remanufacturing Facility. This sawmill, previously known as the Misiones Sawmill, was completed in 2000. It has installed annual production capacity of approximately 320,000 cubic meters of lumber. It is also equipped with drying kilns with installed annual production capacity of approximately 320,000 cubic meters and a remanufacturing facility with installed annual production capacity of approximately 65,000 cubic meters of remanufactured wood products.

Forestry Products

Our forestry products are sawlogs, pulplogs, posts and chips. As a result of our forest management policies and the increasing maturity of our plantations, our plantations are yielding increasing volumes of forestry products, particularly clear wood. As the volume of clear wood has grown, we have broadened our range of forestry products. For the year ended December 31, 2010, sales of forestry products were U.S.$150.2 million, representing 4.0% of our sales revenues for such year.

The following table sets forth, by category, forestry product sales to unaffiliated third parties for each of the years indicated.

 

     Year ended December 31,  
     2006      2007      2008      2009      2010  
     (in thousands of cubic meters)  

Sawlogs

     1,474         1,562         1,745         1,117         1,802   

Pulplogs

     239         149         457         309         612   

Posts

     34         4         15         19         24   

Chips

     178         150         96         293         501   

Sustainable Development

As of December 31, 2010, we had registered four electricity co-generation power plants as projects of the Clean Development Mechanism (CDM) within the Kyoto Protocol. Three of them were registered during 2006—Trupán, Nueva Aldea (first phase) and Nueva Aldea (second phase)—and a fourth one was registered in 2009, the Valdivia biomass power plant. Each of these power plants generate electricity through forestry biomass (meaning forestry and wood industrial sub-products, including the woodpulp by-product called “black liquor”), which is a renewable resource, and replace fossil fuel energy from the electricity grid.

In connection with the CDM in 2007, we sold 482,129 Certified Emission Reductions (CERs or “carbon credits”). With this issuance, we became the first Chilean forestry company to issue CERs through the CDM of the Kyoto Protocol. The following table presents the total amount of CERs sold by Arauco for each of the years indicated.

 

     Year ended December 31,  
     2008      2009      2010  

CERs sold

     255,592         333,067         0   

During the second half of 2010, we began operations at the Horcones complex of a new biomass co-generation plant, which consists of a power boiler with capacity to produce 210 tons of steam per hour and a 31 Megawatt co-generating steam turbine. We expect this plant to provide 24 Megawatts of additional power to the Chilean Central Interconnected System (SIC), which distributes electrical power along the Central and Southern Regions of Chile. This biomass plant was registered as a CDM project during early 2011.

In early 2010, we began construction of the Viñales biomass power plant, which is located alongside the Viñales sawmill in the Seventh Region of Chile. The new plant will include a biomass-fueled power boiler with capacity to produce 210 tons of steam per hour and a 40 Megawatt steam turbine. We expect to complete construction and begin operations by the beginning of 2012.

 

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In January 2009, we announced plans to complete a Carbon Footprint Assessment (CFA) in order to determine the amount of carbon dioxide stored in our wood products and, to calculate the carbon dioxide emissions resulting from our plantation business. The results of the assessment were obtained in July 2009.

Competition

We experience substantial worldwide competition in each of our geographical markets and in each of our product lines.

Pulp

In general, our competitors in the pulp market vary depending on the geographical region and variety of pulp involved. CMPC Celulosa S.A. and Fibria Cellulose S.A. are our main competitors in most geographical regions. While Fibria produces hardwood pulp only, CMPC produces both softwood and hardwood pulp. In Asia, we also face competition from Canadian, Brazilian, Russian and Indonesian producers. In Europe, we also face competition from Brazilian, Scandinavian and American producers. Our main competitors with respect to unbleached softwood pulp are from Canada and Russia.

Plywood and fiberboard panels

Arauco’s principal competitors in the plywood markets are located in the United States, Finland and Russia. In some regions, Arauco also competes with hardwood plywood produced in China, Africa and other regions of the world.

Arauco’s main competitors in the MDF market are: in Latin America, Duratex S.A., Masisa S.A. and other large South American producers; in North America, local producers such as Flakeboard Company Limited and Roseburg Forest Products Co.; in Asia, producers from Malaysia and China, and in the Middle East, European producers.

For sales of PBO, we focus on the Latin American market, where we compete with Duratex S.A., Masisa S.A., Berneck S.A. and Fibraplac S.A.

Wood Products

For remanufactured wood products, our main competitors are located in Chile, Brazil, and the United States. For sawn timber, our main competitors are located in Europe, New Zealand, Canada, and Chile. Arauco believes that its operating efficiencies, competitive logistics costs, ability to serve customers with multiple specifications, geographical presence in thirty eight countries and the versatility of its radiata and taeda pine allow it to compete effectively in the world market for wood products.

Transportation, Storage and Distribution

To remain competitive worldwide, we ship our products to various distribution centers around the world from which final delivery to the customer is made. Historically, we and other Chilean forestry products producers have coordinated our transportation requirements to achieve larger lots to fill specially designed forestry products ships and thus obtain competitive freight rates.

The following are the principal Chilean ports that we use, each of which are operational as of the date of this annual report:

 

   

Coronel. A private port located between Concepción and the Arauco Mill, which we constructed as a member of a consortium with five other companies and in which we have an equity interest of 50%. We shipped 33.9% of our aggregate export volume through this port in 2010;

 

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Lirquén. A private port in Concepción in which we have an equity interest of 20.1% and through which we shipped 35.6% of our aggregate export volume during 2010; and

 

   

San Vicente and Talcahuano. State-owned ports near the city of Concepción through which we shipped 30.5% of our aggregate export volume during 2010.

The ports we use in Chile are approximately 55 kilometers from the Arauco Mill, 330 kilometers from the Constitución Mill, 390 kilometers from the Licancel Mill, 100 kilometers from the Nueva Aldea Mill, and 410 kilometers from the Valdivia Mill. We do not own pulp storage warehouses in any of these ports.

We ship pulp to various ports in Europe, North and South America and Asia and, as is customary in the pulp industry, we store some stock in those ports. We use 11 foreign ports that have warehouse facilities available, and standard storage terms provide that we are entitled to a certain period of storage free of charge. We seek to ensure that it does not exceed the free storage period for each shipment. At December 31, 2010, we had 96,569 air dry metric tons of pulp in storage in warehouses at foreign ports.

We believe that our shipping costs are comparable to those of our international competitors, notwithstanding Chile’s greater distance from Europe, because of the proximity of our plantations and mills to the Pacific coast and the economies of scale we achieve through the volume of our exports.

In Argentina, timely and competitively priced delivery of finished products to our customers is an important factor in our ability to compete effectively, and we ship most orders either by truck or railway almost immediately after they are produced.

In Brazil, our efficient distribution system, which delivers finished products to almost two thousand customers in over 250 cities, many of which are separated by long distances, is a key component to our competitiveness.

Description of Property

Our principal properties consist of land and production plants and facilities, the majority of which are located in Chile. At December 31, 2010, we owned 1,101,963 hectares of land in Chile, over 737,939 hectares of which consist of forest plantations, and 540,384 hectares of land in Argentina, Brazil and Uruguay, of which 268,721 consist of forest plantations. In addition, at December 31, 2010, we owned various plants and facilities, including five pulp mills, three panel mills, eight sawmills and five remanufacturing facilities in Chile; one pulp mill, one sawmill, one MDF mill, one PBO mill and one remanufacturing facility in Argentina; and one MDF mill, one PBO mill and one MDF-PBO mill in Brazil. In Brazil, the Arapoti sawmill was closed on March 31, 2008. In Chile, the Lomas Coloradas sawmill, the Coronel sawmill and the Coelemu sawmill were closed in 2008. In 2009 Horcones II sawmill was temporarily closed, with operations restarting in June 2010. In February 2010, the Mutrún sawmill was destroyed as a result of the earthquake and will not be reopened. In December 2010, the Bossetti sawmill in Argentina was closed as a result of unfavorable market conditions.

Insurance

Consistent with industry practice, we maintain fire insurance coverage for all our Chilean forest holdings and nurseries but do not insure against pests or disease. Depending on the age of the trees affected, our insurance covers timber loss, either at replacement cost or commercial value. In Argentina we maintain fire insurance for 8,520 hectares of timber assets located in the Campana region, near Buenos Aires. For the rest of our Argentine operations we do not maintain fire insurance for our timber assets because we believe that the risk of damage from fire is low because Argentina receives significant amounts of rainfall, particularly during the summer months. We do not carry fire insurance for our forests in Brazil because the risk of damage from fire does not justify the costs of carrying insurance.

We also carry insurance, consistent with industry practice, covering our production plants, facilities and equipment. This insurance provides coverage, in the event of fire, explosion, machinery breakdown or natural

 

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disaster, which includes earthquakes and tsunamis. The insurance covers up to an amount of U.S.$650 million per loss, which includes physical damage and business interruption of up to 12 months (or 18 months in the case of a boiler explosion in our pulp mills). The deductibles for physical damage are US$ 3 million for damages caused by earthquakes, boiler explosions and machinery breakdowns and US$ 1 million for damages arising from all other contingencies. Deductibles for business interruption are 30 days for boiler explosions, 21 days for earthquakes and 15 days for interruptions caused by all other contingencies. All of our insurance policies covering our forest holdings and production plants, facilities and equipment in Chile and Argentina are carried by the RSA group, Mapfre S.A., Chartis S.A. and Ace Group.

The forestry insurance for plantations located in Chile is carried by the RSA Group and Penta Security Compañía de Seguros SA. Our insurance policies for some plantations located in Delta del Paraná, Argentina, are carried by Federación Patronal. Our MDF and particleboard mills in Brazil are insured by Itaú XL Seguros Corporativos and Allianz Seguros S.A., and these policies cover fire, explosions, electrical damage, equipment damage and loss of profit.

CAPITAL EXPENDITURES

To utilize our increasing volume of forest production, we have added to, expanded and modernized our processing facilities. For the year ending December 31, 2011, we have planned capital expenditures of U.S.$803.4 million, which principally include U.S.$300.0 million in maintenance of our existing mills, U.S.$383 million in our new panel mill projects and capital contributions for the Montes del Plata project in Uruguay and U.S.$120.0 million in maintenance of biological assets.

On January 18, 2011 Arauco and Stora Enso agreed to carry out the construction of a state of the art pulp mill with an annual guaranteed capacity of 1.3 million tons, a port and a power producing unit based on renewable sources, all located in Punta Pereira, department of Colonia, Uruguay. The total estimated investment is U.S.$1,900 million. The project will be financed 40% by Montes del Plata’s shareholders (50% from our part, 50% from Stora Enso) and 60% by long-term debt financing.

For the year ended December 31, 2010, our aggregate capital expenditures were U.S.$595.5 million, consisting primarily of U.S.$483,2 million in internal projects and U.S.$112.3 million in acquisition of biological assets.

GOVERNMENT REGULATION

Environment

In each country where we have operations, we are subject to numerous national and local environmental laws, regulations, decrees and municipal ordinances concerning, among other things, health, the handling and disposal of solid and hazardous waste, discharges into the air, soil and water and other environmental impacts. Some of these laws require us to conduct environmental impact studies of future projects or activities (or major modifications thereto). Under these laws, our operations may be subject to specific approvals, consents and regulatory requirements, and emissions and discharges may be required to meet specific standards and limitations. We have made and will continue to make substantial expenditures to comply with such environmental laws, regulations, decrees and ordinances.

Chile

The Chilean legislation to which we are subject includes the Chilean Environmental Law (Ley Sobre Bases Generales del Medio Ambiente) and related regulations. The Chilean Environmental Law created the National Environmental Commission (Comisión Nacional del Medio Ambiente), or CONAMA, which includes under its organization the various Regional Environmental Commissions (the COREMAs). As discussed below, these institutions were replaced in 2010 by the Ministry of Environment, the Service of Environmental Evaluation and the Evaluation Commissions (Comisiones de Evaluación) and a new Superintendency of Environment.

 

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The Ministry of the Environment is under the direct supervision of the President of Chile and it is responsible for, among other things, creating and/or proposing environmental public policies and environmental regulations. The Service of Environmental Evaluation and the Evaluation Commissions administer the Environmental Impact Evaluation System (“SEIA”) and evaluate environmental impact studies or declarations of environmental impact. Under the Chilean Environmental Law, we are required to conduct environmental impact studies or declarations of environmental impact of any future projects or activities (or their significant modifications) that may affect the environment. These and other regulations also establish procedures for private citizens to object to the plans or studies submitted by project owners.

The Evaluation Commissions and other governmental agencies may also participate in the oversight of the implementation of projects in accordance with their environmental impact studies or declarations of environmental impact. Under the Chilean Environmental Law and other regulations, affected private citizens, public agencies and local authorities can sue to enforce environmental compliance. Enforcement remedies include temporary or permanent closure of facilities and fines. The application of these environmental laws and remedies may adversely affect the manner in which we seek to implement our business strategy and our ability to realize our strategy.

On January 26, 2010, Law No. 20,417 was published in the Official Gazette. This new law replaced the former CONAMA and COREMA with a new set of public institutions: the Ministry of the Environment (aimed at developing national environmental policy), the Service of Environmental Evaluation (in charge of administering the environmental assessment system) and the Superintendency of Environment (in charge of supervising and auditing environmental compliance). While the Ministry of the Environment and the Service of Environmental Evaluation and the Evaluation Commissions have been operating since October 1, 2010, the authority to begin operations at the Superintendency of Environment is still pending the passage of certain legislation by the Chilean Congress. As a result, the supervision and auditing of Chile’s environmental laws is currently the responsibility of the Evaluation Commissions and some other public authorities. Although certain provisions of the Law N°20,417 are already in force, including minor procedural modifications to the SEIA, others are still subject to the publication of an administrative decree by the President of Chile. This decree is expected to be published and to become effective during 2011.

We recently faced, and continue to face, certain environmental proceedings in connection with certain of our pulp mills. For a description of these proceedings, see “Item 8. Financial Information Litigation Proceedings.”

Argentina

Our operations in Argentina are subject to Argentine environmental legislation, including regulation by municipal, provincial and federal governmental authorities.

Argentine environmental legislation includes the requirement that water used or recovered in the production process be treated and purified before being returned to the Paraná River at the proper temperature. All gaseous emissions must be scrubbed to ensure satisfactory levels of waste particle recovery and odor removal. Regular testing of river and air quality is used to monitor the ultimate impact of the mill on the environment.

We believe that we are currently in material compliance with all applicable local and national environmental regulations governing our operations in Argentina.

 

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Brazil

Our Brazilian operations are subject to environmental legislation, including municipal, regional and federal governmental laws, regulations and licensing requirements. Law No. 6,938 establishes strict liability for environmental damage, mechanisms for enforcement of environmental standards and licensing requirements for activities that are damaging or potentially damaging to the environment. A violation of environmental laws and regulations may result in:

 

   

fines,

 

   

partial or total suspension of activities,

 

   

forfeiture or restriction of tax incentives or benefits, or

 

   

forfeiture or suspension of participation in credit lines with official credit establishments.

As a result, we may become liable for environmental damages caused by management of our materials, including damages caused during the transportation, treatment and disposal of our industrial waste, even where third parties manage such activities on our behalf.

Law No. 9,605 provides that individuals or entities whose conduct or activities cause harm to the environment are subject to criminal and administrative sanctions and are liable for any costs to repair the damages resulting from such harm. For individuals who commit environmental crimes, criminal sanctions range from fines to imprisonment; for legal entities, criminal sanctions may include fines, partial or total suspension of activities, restrictions on participation in government contracts and, in cases of bad faith, dissolution. In addition, Law No. 9,605 also establishes that the corporate structure of a company may be disregarded if the structure impedes the recovery for harm caused to the environment. We are not aware of any successful assertion of claims against shareholders under this provision of Law No. 9,605.

We believe we are currently in material compliance with all applicable local and national environmental regulations governing our operations in Brazil.

Forestry Regulation

Chile

The management and exploitation of forests in Chile is regulated by the Forests Law of 1931, as amended, and Decree-Law No. 701 of 1974, as amended. The Forests Law and Decree-Law No. 701 impose a variety of restrictions on the management and exploitation of forests. Forestry activities, including thinning, on land that is designated as preferably suited for forests or that has natural or planted forests, are subject to management plans that require the approval of the CONAF (National Forest Service). In addition, the Forests Law and Decree-Law No. 701 impose certain standards for the prevention of forest fires, as well as fines for the harvesting or destruction of trees and shrubs in violation of the terms of a forest management plan. We believe that we are in material compliance with the Forests Law and Decree-Law No. 701.

Law No. 20,283, published in the Official Gazette on July 30, 2008, provides a new policy for the management and conservation of native tree forests and forest development. Its purposes are the protection, recovery and improvement of native forests in order to guarantee both forest sustainability and environmental policy. This law establishes a fund for the conservation and sustainable management of native forests. According to the new law, owners of native forests are able to exploit them so long as they have a “management plan” approved by the National Forestry Corporation. Depending on the owner’s approved plan, as well as other factors, the subsidy provided by the fund may vary between U.S.$200 and U.S.$400 per hectare. The law also prohibits the harvesting of native trees in certain areas and under certain conditions. Management believes that this law will not have a material effect on our business. In compliance with applicable regulations, we have adopted environmentally sensitive policies towards our holdings of native forests, which are protected and preserved in their entirety.

 

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Our products come from established plantations only; we do not sell any products derived from our native forests. Arauco’s forestry operations adhere to our international control systems, which are all in accordance with current legislative and environmental sustainability standards. Certain of our subsidiaries have received various environmental certifications as of the date of this annual report. See Item 4. “Description of Business—Forestry Activity.”

All of our forest activities are ISO 14001 certified since 2001. During 2003, we obtained CERTFOR Forest Management Certification in Chile. In 2004, PEFC (the Programme for the Endorsement of Forest Certification) undertook its first audit of our operations and confirmed that we complied with international PEFC requirements. See “Item 4. Information on the Company—Description of Business—Forestry Activity.”

In 2005, CERTFOR certified the chain of custody of the Arauco, Constitución, Licancel and Valdivia pulp mills and Arauco and Nueva Aldea plywood mills, pursuant to the Sustainable Forestry Management practices, which require that sources used for production are not endangered or that their use is not otherwise prohibited. The National Regulatory Institute (Instituto Nacional de Normalización) also accredited the effluent laboratories of the Constitución and Arauco wood mills in accordance with the strict requirements of Chilean environmental standards.

In 2009, Arauco began the pre-assessment process for FSC (Forest Stewardship Council) forest management certification. This pre-evaluation allowed us to identify the Company’s position regarding FSC principles and criteria, allowing it to better prepare for the FSC’s official assessment. This pre-assessment process covered all of Arauco’s forest operations in Chile and was conducted by Woodmark, a Soil Association certification body.

Argentina

The management and exploitation of forests in Argentina is regulated by National Law 13,273, National Law 25,080, and National Law 26,432, National Decree 710, Provincial Law No. 854, Provincial Law No. 3,426 and other regulations promulgated thereunder, which collectively constitute the regulatory framework. The regulatory framework imposes a variety of restrictions on the management and exploitation of forests in Argentina. The regulatory framework regulates the replanting of land after harvesting. We believe that our Argentine operations are in material compliance with the regulatory framework.

Brazil

Environmental laws and regulations relating to the management and exploitation of forests and the protection of Brazilian plant and wildlife govern our Brazilian forestry operations. Under this regulatory framework Brazilian authorities establish forest preservation areas and regulate replanting of forests after harvesting. We believe that our Brazilian operations are in material compliance with the regulatory framework.

 

Item 5. Operating and Financial Review and Prospects

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION, RESULTS OF OPERATIONS AND CASH FLOWS

The following discussion is based on and should be read in conjunction with our audited consolidated financial statements and the notes thereto, included elsewhere in this annual report. Our consolidated financial statements are prepared in U.S. dollars in accordance with IFRS.

Overview

We derive our sales revenue from the sale of bleached and unbleached pulp, plywood and fiberboard panels, wood products such as sawn timber and remanufactured wood products, and forestry products such as sawlogs and pulplogs. Export sales constituted 76.2% of our total sales revenue for the year ended December 31, 2009, and 69.9% of our total sales revenue for the year ended December 31, 2010. Sales of pulp

 

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constitute the single largest component of our sales revenue. As with many commodities, pulp is subject to significant cyclical price fluctuations determined by global supply and demand. Accordingly, our sales revenue is subject to cyclical fluctuations. World prices for plywood and fiberboard panels, wood products and forestry products, which are generally viewed as commodities, also fluctuate significantly.

Although prices tend to have the most significant effect on our results of operations, sales volume and product mix, production costs and exchange rate fluctuations also can have a substantial impact on our results.

Our business, results of operations and cash flows depend, to a large extent, on the level of economic activity, on government and foreign exchange policies and on political and economic developments in our principal export markets. In 2010, we exported our products to Asia, to North, Central and South America, to Europe and, to a lesser extent, to Africa and the Middle East. In 2009 and 2010 94.9% and 93.0%, respectively, of our total pulp sales were attributable to exports, and 60.5% and 52.4%, respectively, of our total panels, wood products and forestry product sales were attributable to exports. Our business, earnings and prospects may be materially and adversely affected by developments in these export markets with respect to inflation, interest rates, currency fluctuations, protectionism, government subsidies, price and wage controls, exchange control regulations, taxation, expropriation or social instability, as well as by political, economic or diplomatic developments.

At December 31, 2010, 75.4% of our property, plant, equipment and forest assets were located in Chile, 10.8% were located in Argentina and 13.8% were located in Brazil. In 2010, 73.8% of our consolidated sales revenue was derived from our operations in Chile, 14.6% of our consolidated sales revenue was derived from our operations in Argentina, and 11.6% of our consolidated sales revenue was derived from our operations in Brazil. Accordingly, our financial condition, results of operations and cash flows depend, to a significant degree, upon economic conditions in Chile, Argentina and Brazil.

Despite growth in the 1980s and 1990s, the Chilean economy has remained smaller than that of certain other Latin American countries. In 2004, GDP growth was stronger than previous years, reaching 6.1% and 5.7% in 2005. The GDP grew at a slower rate in subsequent years (4.6% in 2006, 4.6% in 2007 and 3.7% in 2008). In 2009, the Chilean GDP contracted 1.5%, mainly due to the global financial crisis. See “Risk factors—Risks relating to Chile.”

From late 1998 to 2002, the Argentine economy went through an economic recession marked by reduced levels of consumption and investment and an elevated unemployment rate. Argentine GDP decreased by 0.8% in 2000, 4.0% in 2001 and 10.9% in 2002. In December 2001, amid public demonstrations and the resignation of the Argentine president, Argentina declared a suspension on payment of its foreign debt. In early 2002, the government released the Argentine peso from its one-to-one peg to the U.S. dollar and allowed the exchange rate to float, resulting in a 49.6% devaluation of the Argentine peso from January 1, 2002 to December 31, 2002. From 2003 to 2008, economic indicators showed signs of recovery, and the Argentine GDP increased by 8.8% in 2003, 9.0% in 2004, 9.2% in 2005, 8.5% in 2006, 8.7% in 2007 and 6.8% in 2008. Due to the global financial crisis, Argentina’s GDP grew by only 0.9% in 2009. In 2010, Argentina’s GDP growth rose to 9.2%. The future economic, social and political developments in Argentina, over which we have no control, could impair our and Alto Paraná’s business, financial condition or results of operations. See “Risk factors—Risks relating to Argentina.”

Brazil’s GDP decreased by an estimated 0.2% in real terms in 2009, compared to a growth rate of 4.8% in 2008 and 5.4% in 2007. This decrease is mainly explained by the financial crisis. Brazilian GDP decreased 0.5% in 2003, mainly due to uncertainty arising from the presidential election held that year and the new economic policies to be implemented by the newly elected government of President Luis Ignacio Lula da Silva. The Brazilian real/U.S. dollar exchange rate also experienced turbulence during that period. During 2001, the Brazilian real declined in value by 18.7% against the U.S. dollar, and in 2002, it further devalued by 52.3%, closing at R$3.533 to U.S.$1.00 on December 31, 2002. Those concerns dissipated during 2003, resulting in an appreciation of the Brazilian real by 18.2% against the U.S. dollar in that year. During 2004, the Brazilian real continued to recover against the U.S. dollar, with an 8.8% appreciation. The Brazilian real appreciated 20.7% in 2007. In 2008, the real depreciated against the dollar by 32.2% and in 2009 and 2010, the real appreciated against the dollar by 34.4% and 3.9% respectively. See “Risk factors—Risks relating to Brazil.”

 

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During the last quarter of 2008, the prices of our products decreased substantially as a result of the global financial crisis. Prices began to show a slight recovery during the second quarter of 2009. The recovery in the pulp market was confirmed during the fourth quarter of 2009 and the year 2010, during which time pulp prices grew strongly, reaching near pre-crisis levels. We expect this positive trend to continue throughout the first half of 2011, especially with respect to prices of long fiber. However, future developments in the Chilean, Argentine and Brazilian economies may impair our ability to proceed with our strategic plan or our business, financial condition or results of operations. Our financial condition, results of operations and cash flows could also be materially and adversely affected by changes in political, economic, regulatory or other policies of the Chilean, Argentine and Brazilian governments, which have exercised substantial influence over many aspects of the private sector in these countries, or other political or economic developments in Chile, Argentina and Brazil, as well as regulatory changes or administrative practices of Chilean authorities, over which we have no control.

Prices

In recent years, our sales revenue has been affected by price level volatility in the export market. The prices for each of our pulp, panels, wood and forestry products depend on the markets in which they are sold. While prices are generally similar for a given product on a global basis, regionalized market conditions affect prices in markets such as Asia, Europe and the United States.

The following table sets forth, for the periods indicated, average unit sales prices for our products.

 

     Year ended December  31,(1)  

Product(2)

   2009      2010  
     (U.S.$ per metric ton)(3)  

Pulp

     

Bleached pulp

     517.4         771.6   

Unbleached pulp

     497.7         717.7   
     (U.S.$ per cubic meter)(3)  

Wood Products

     

Sawn timber

     154.7         221.1   

Remanufactured wood products

     687.6         476.4   

Panels

     

Plywood and fiberboard panels

     315.9         365.7   

Forestry Products

     

Sawlogs

     41.4         54.6   

Pulplogs

     33.3         24.4   

Posts

     201.6         261.2   

 

(1) 

Calculated as average unit prices for the year based on our internally collected data.

(2) 

Each category of product contains different grades and types and the shipping terms vary with the product, as well as the customer.

(3) 

We generally quote our prices in U.S. dollars for export sales and in Chilean pesos, Argentine pesos or Brazilian reals for domestic sales.

Pulp Prices

Historically, world pulp prices have been subject to significant fluctuations over relatively short periods of time. Pulp prices mainly depend on worldwide demand, world production capacity, worldwide pulp and paper inventory levels and availability of substitutes, and in general terms, are directly related to global economic growth. All of these factors are beyond our control.

Prices for bleached grades of hardwood pulp, including eucalyptus, generally follow the same cyclical pattern as prices for Norscan Bleached Softwood Kraft market pulp, or NBSK, which is the benchmark for softwood

 

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bleached pulp. However, the latter historically has had higher prices mainly due to lower global supply. Moreover, during the last five years, the majority of the added global pulp production capacity has been dedicated to the production of hardwood pulp, particularly eucalyptus pulp.

Prices for unbleached softwood market pulp also follow cyclical patterns related to worldwide demand, stock levels and supply. Unbleached softwood market pulp represents about 3.5% of the total wood pulp market. The majority of such pulp is sold in Asia, and its price does not necessarily follow the cycle of prices for NBSK or Bleached Eucalyptus Kraft Pulp (“BEKP”).

During 2010, pulp prices for all grades increased with respect to 2009, which was mainly explained by a recovery from the global financial crisis that began during the second half of 2008. This recovery brought as a consequence lower average inventory levels and higher demand for pulp, which are key drivers for price increases.

The market price for NBSK was U.S.$730.0 per ton at December 31, 2006, which represented an increase of 21.9% as compared to December 31, 2005. The price for NBSK was U.S.$869.30 at December 31, 2007, which represented an increase of 19.1% when compared to December 31, 2006. The price for NBSK was U.S.$641.51 at December 31, 2008, a 26.2% decrease as compared to December 31, 2007. The price of U.S.$798.77 per ton recorded at December 31, 2009 represented an increase of 24.5% as compared to December 31, 2008. The market price for NBSK was U.S.$948.92 per ton at December 31, 2010, an 18.8% increase when compared to December 31, 2009.

The market price for BEKP was U.S.$671.6 per ton at December 31, 2006, which represented a 14.0% increase over the price at December 31, 2005. The price for BEKP at December 31, 2007 reached U.S.$775.20, which represented a 15.4% increase over the price at December 31, 2006. At December 31, 2008, the price for BEKP was U.S.$584.54, which represented a 24.6% decrease as compared to December 31, 2007. The price for BEKP at December 31, 2009 reached U.S.$700, which represented a 19.8% increase of over the price at December 31, 2008. The market price for BEKP was U.S.$751.85 per ton at December 31, 2010, a 24.6% increase when compared to December 31, 2009.

The market price for unbleached kraftwood pulp, or UKP, reached U.S.$586.9 per ton at December 31, 2006, which represented an increase of 27.5% over the price at December 31, 2005. The price at December 31, 2007 reached U.S.$598.5, which represented a 19.8% increase over the price at December 31, 2006. The price at December 31, 2008 dropped to U.S.$455.76, which represented a decrease of 23.8% as compared to December 31, 2007. The price at December 31, 2009 was U.S.$603.65, which represented a 32.4% increase over the price at December 31, 2008. The market price for UKP was U.S.$751.85 per ton at December 31, 2010, a 24.6% increase as compared to December 31, 2009.

Forestry, Wood Product, Plywood and Fiberboard Prices

Over the last five years, the average prices for our forestry and wood products have fluctuated significantly, reflecting the effect on demand of global economic developments.

In spite of strong international growth and demand for wood products in 2005, prices in the U.S. declined during the first three quarters of 2005 due to excess inventories of panel and remanufactured wood products at distributors. This trend affected the average prices for wood products during 2005. By the end of 2005, the average prices for wood products demonstrated signs of recovery. However, the continued weakening of the construction sector in the United States caused a decrease in the price and demand for wood, particularly moldings, during 2006.

The continued weakening of the construction sector in the United States throughout 2006 caused a decrease in the price and demand for wood, especially in moldings in that market. Along with the markets in Asia, the Middle East and Central America have been strengthening and Europe registered strong demand and prices for wood throughout 2006. The prices of plywood in the United States and Canada slightly decreased during 2006, while the other markets maintained levels comparable to those for 2005. The demand for products directed at furniture markets in Latin America remained strong during the year, and sales of medium-density fiberboard (MDF) panels also experimented important improvements due to the high demand in all the markets in which Arauco participates, which are concentrated in North, Central and South America.

 

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The complications related to the United States construction and real estate markets continued throughout 2007. The construction sector has continued to be affected by a significant stock of unsold houses, which caused construction to fall 30% in the United States during 2007. This negatively affected the sales volume of wood. Prices of moldings and wood continued to decrease. From a commercial point of view, 2007 was marked by an increase in the demand in virtually all markets for panels. In Europe, consumer trends favoring products with a sustainable forestry management certification increased demand for the entire range of Arauco’s panels. In the United States, the strong contraction of the real estate sector adversely affected the sale of MDF moldings. This was offset, however, by the strong increase in the demand for MDF boards in Latin America. In the case of Arauco’s plywood panels, the demand benefited from a decrease in the supply from other manufacturers and by the highly diversified applications of these products unrelated to the construction sector.

The slowdown in the global growth markets during 2008 continued to affect the demand for timber in all markets. The construction sector continued to decline in the United States. In particular, the construction of houses declined to a rate of approximately 550,000 houses per year by December 2008, which negatively compares with the 2 million homes built in the United States during 2006. This decline negatively affected the sales volume and prices of wood and moldings, which reached their lowest levels during the last quarter of 2008. During most of 2008 there was a consistent demand for panels, which resulted in an increase in price in most of the products produced by Arauco. During the latter part of 2008, however, demand lowered, which negatively affected sales volume and prices of plywood and MDF in most markets, especially in the United States and Europe.

The fiscal year 2009 was challenging for the panels business due to low demand and a weak dollar. However, Arauco was able to sell all panels production without any plant shutdown despite the decline in demand. This was due to Arauco’s geographic diversification, with sales in over forty countries, and to Arauco’s broad product portfolio.

During 2010, average sales prices in our sawn timber segment increased when compared with 2009, mainly due to higher average sales prices of green sawn timber in the Asian market and remanufactured products in United States. Regarding our panel segment, in 2010 our sales in U.S. dollars increased in 33.5%, representing an increase of 15.3% in our average sales as compared to 2009. Average sales prices of Plywood, which was the most negatively impacted product line in terms of margin erosion during 2009, increased during 2010, especially in Latin America, Europe and United States. Average sales prices of MDF, HB and MDF moldings also increased during 2010.

Prices for our pulp, panel, forestry and wood products may decline in the future. Our results of operations may be materially adversely affected if the prices of our products were to decline from current levels.

Costs

Our major costs of sales are the following:

 

   

the cost of timber,

 

   

costs related to harvesting (forestry works),

 

   

maintenance costs,

 

   

chemical costs,

 

   

the cost of sawmill processing,

 

   

depreciation, and

 

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energy and fuel costs.

Our major administrative and selling expenses are wages and salaries, traffic, shipping and freight costs, insurance expenses and commissions.

IAS 41 requires that biological assets, such as standing trees, are shown on the balance sheet at fair value. Our forests are thus accounted for at fair value less estimated point-of sale costs at harvest, considering that the fair value of these assets can be measured reliably.

The recovery of forest plantations is based on discounted cash flow models, which means that the fair value of biological assets is calculated using cash flows from continuing operations discounted on the basis of our sustainable forest management plans and the estimated growth of our forests. This recovery is performed on the basis of each stand identified and for each type of tree species.

These discounted cash flows require estimates in growth, harvest, sales prices and costs. It is therefore important that management make appropriate estimates of future levels and trends for sales and costs, as well as administer regular surveys of the forests to establish the volumes of wood available for harvesting and their current growth rates.

Our property, plant and equipment are depreciated on a straight-line basis over the remaining useful lives of the underlying assets. However, the amount of such depreciation that relates to our fixed production assets, such as pulp mills and sawmills, is allocated to finished goods held as inventories and accumulates until charged to cost of sales when the finished goods are sold. Forests and land are not depreciated.

Selling expenses consist primarily of per ton fees we paid to our selling agents. Traffic, shipping and freight costs are the costs of carrying the product to the destination.

During 2009, cost of sales decreased by 7.7% as a result of lower sawn timber sales volume as well as lower unit costs of wood, chemicals and energy, reflecting Arauco’s stringent cost management and favorable market conditions for raw materials.

Cost of sales increased 6.8% during 2010, mainly due to higher cost of sales of our forestry operations and an increase in other raw materials and indirect costs, partially offset by lower maintenance costs.

Exchange Rate Fluctuations

The Chilean peso has been subject to devaluation in the past and could be subject to significant fluctuations in the future. During 2010, the value of the Chilean peso relative to the U.S. dollar increased 8.4% in nominal terms and 13.2% in real terms, based on the observed exchange rates on December 31, 2009 and December 31, 2010. The observed exchange rate on June 21, 2011 was Ch$472.95 to U.S.$1.00. For information regarding historical rates of exchange in Chile from January 1, 2005 see “Item 3. Key Information—Exchange Rates.”

We generally price our exports in U.S. dollars, whereas our domestic sales in Chile are priced in Chilean pesos; domestic sales in Brazil are priced in reals and domestic sales in Argentina are priced in Argentine pesos except for pulp sales, which are priced in U.S. dollars. To the extent that the Chilean peso depreciates against the U.S. dollar, our domestic sales revenues may be adversely affected when expressed in U.S. dollars. The same effects may occur for our domestic sales in Argentina and Brazil for products sold in each of the respective local currencies. The effect of exchange rate fluctuations is partially offset by the fact that certain of our operating expenses are denominated in U.S. dollars (such as our freight costs and selling expenses in the form of commissions paid to our sales agents abroad) and a significant part of our indebtedness is denominated in U.S. dollars. As of December 31, 2010, our U.S. dollar-denominated indebtedness was U.S.$2.7 billion. In addition, as the U.S. dollar appreciates against the local currency in any of our export markets, we must from time to time price our sales in that local currency to compete effectively.

 

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Critical Accounting Policies

A summary of our significant accounting policies is included in Note 1 to our audited consolidated financial statements, which are included in this annual report. The preparation of consolidated financial statements in accordance with IFRS requires management to make subjective estimates and assumptions that affect the amounts reported. Estimates are based on historical experience and various other assumptions that are believed to be reasonable, though actual results and timing could differ from the estimates. Management believes that the accounting policies below take into account those matters that require the exercise of judgment, but acknowledge that different judgments could result in substantially different results. The most critical accounting policies and estimates are described below.

Property, Plant and Equipment

Property, plant and equipment are stated at cost and are depreciated using the straight-line method based on the estimated useful lives of the assets. The amount of such depreciation that relates to our fixed production assets, such as pulp mills and sawmills, is allocated to finished goods held as inventories and accumulates until charged to cost of sales when the finished goods are sold. Forests and lands are not depreciated.

In estimating the useful lives we have primarily relied upon actual experience with the same or similar types of equipment and recommendations from the manufacturers. Useful lives are based on the estimated amount of years an asset will be productive and are revised periodically to recognize potential impacts caused by new technologies, changes to maintenance procedures, changes in utilization of the equipment, and changing market prices of new and used equipment of the same or similar types.

Property, plant and equipment assets are evaluated for possible impairment. Factors that would indicate potential impairment may include, but are not limited to, significant decreases in the market value of a long-lived asset, a significant change in a long-lived asset’s physical condition and operating or cash flow losses associated with the use of a long-lived asset. This process requires our estimate of future cash flows generated by each asset or group of assets. For any instance where this evaluation process indicates impairment, the appropriate asset’s carrying values are written down to net realizable value and the amount of the write-down is charged against the results of continuing operations.

Expenditures that substantially improve and/or increase the useful life of facilities and equipment are capitalized. Other maintenance or repair costs are charged to income as they are incurred.

Fair Value of Financial Instruments

The Company recognizes financial assets and liabilities on its balance sheet at fair value, which is the value that the Company estimates would be attributable to such asset or liability in an arms-length transaction. As of the date of the initial recognition, the management of the Company classifies its financial assets at fair value through (i) income or (ii) collectible credits and accounts, depending on the purpose for which the financial assets were acquired.

The fair value of financial instruments that are not traded in an active market is determined by using valuation techniques. Arauco uses its judgment to select a variety of methods and make assumptions that are mainly based on market conditions existing at each balance sheet date.

The doubtful provision of trade receivables is established when there is evidence that Arauco will not receive payments under the original terms of sale. Provisions are made when the client is a party to a bankruptcy court agreement or cessation of payments, or when Arauco has exhausted all levels of recovery of debt in a reasonable time. See Note 23 to our consolidated financial statements.

Biological Assets

IAS 4A requires that biological assets, such as standing trees, are shown on the balance sheet at fair value. Our forests are thus accounted for at fair value less estimated point-of sale costs at harvest, considering that the fair value of those assets can be measured reliably.

The recovery of forest plantations is based on discounted cash flow models, which means, that the fair value of biological assets is calculated using cash flows from continuing operations, the basis of sustainable forest management plans and considering the potential growth of forests. This recovery is performed on the basis of each forest stand identified and for each type of tree species.

 

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These discounted cash flows require estimates in growth, harvest, sales prices and costs. It is therefore important that management make appropriate estimates of future levels and trends for sales and costs, as well as administers regular surveys of the forests to establish the volumes of wood available for harvesting and their current growth rates. The principal considerations used to calculate the valuation of forest plantations are presented in Note 20 to our audited consolidated financial statements.

Lawsuits and Contingencies

Arauco and its subsidiaries are subject to certain ongoing lawsuits, the future effects of which need to be estimated by the management of the Company in collaboration with its legal advisors. Arauco seeks to evaluate the reports of its legal advisors and make appropriate contingency estimates in each balance sheet based on such reports. Arauco also makes contingency estimates and/or adjustments to prior contingency estimates upon the occurrence of material changes to the nature or underlying facts of such lawsuits.

Results of Operations

The following discussion is based on and should be read in conjunction with our audited consolidated financial statements, including the notes thereto, as of December 31, 2009 and 2010 included elsewhere herein. The audited consolidated financial statements included herein are prepared in U.S. dollars and in accordance with IFRS.

The following table provides a breakdown of our financial results of operations and sales volumes as of and for the year ended December 31, 2009 and 2010.

 

     For the year ended December 31,  
     2009      2010  
     Sales      %     Volume      Sales      %     Volume  
     (in millions of U.S.$, except where indicated)  

Revenue

               

Pulp

               

Bleached pulp(1)

   U.S.$ 1,400.8         45.0     2,707       U.S.$ 1,542.4         40.7     1,999   

Unbleached pulp(1)

     204.0         6.6        410         247.2         6.5        344   
                                                   

Total

     1,604.8         51.6        3,117         1,789.6         47.2        2,343   

Plywood and Fiberboard panels

               

Plywood and Fiberboard panels

     831.0         26.7        2,630         1,108.7         29.3        3,032   

Other

             0.3         0.0     

Total

     831.0         26.7        2,630         1,109.0         29.3        3,032   

Wood Products

               

Sawn timber(2)

     301.9         9.7        1,952         463.8         12.2        2,098   

Remanufactured wood products(2)

     191.9         6.2        279         150.4         4.0        316   
                                                   

Other

             6.6         0.2     
                                       

Total

     493.8         15.9        2,231         620.8         16.4        2,414   

Forestry Products

               

Sawlogs (net)(2)

     46.3         1.5        1,117         98.3         2.6        1,802   

Pulplogs(2)

     10.3         0.3        309         14.9         0.4        612   

Posts

     3.8         0.1        19         6.2         0.2        24   

Chips

     16.7         0.5        293         29.3         0.8        501   

Other

     4.6         0.1        148         1.5         0.0        124   
                                 

Total

     81.7         2.6        1,886         150.2         4.0        3,062   

Energy

     77.9         2.5           86.0         4.3     

Other

     23.9         0.8           32.8         0.9     
                                 

Total revenue

     3,113.0         100        3,788.4         100  

Cost of sales, exclusive of depreciation

               

Timber

     630.2              613.5        

Forestry labor costs

     353.2              470.3        

Maintenance costs

     284.3              207.2        

Chemical costs

     261.4              240.9        

Depreciation

     190.9              187.2        

Other costs of sales

     432.5              579.1        
                           

 

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     For the year ended December 31,  
     2009      2010  
     Sales     %     Volume      Sales     %     Volume  
     (in millions of U.S.$, except where indicated)  

Total cost of sales

     2,152.5             2,298.2       

Gross income

     960.5        30.9        1,490.2        39.3  

Other operating income

     181.4             378.2       

Distribution costs

     (388,5          (379.6    

Administrative expenses

     (249,3          (323.9    

Other operating expenses

     (59.7          (50.6    

Other income (loss)

     64.1             (0.3    

Financial income

     19.3             22.1       

Financial costs

     (193.9          (213.9    

Participation in profit (loss) in affiliates and joint ventures through equity method

     6.6             (7.7    

Exchange rate differences

     17.6             (16.3    

Income before income taxes

     358.1             898.8       

Income tax

     (53.5          (198.0    
                         

Net income

     304.6             700.7       

 

(1) 

Volumes measured in thousands of metric tons.

(2)

Volumes measured in thousands of cubic meters.

Year ended December 31, 2009 compared to year ended December 31, 2010

The following discussion is based on and should be read in conjunction with our audited consolidated financial statements and the notes thereto, included elsewhere in this annual report. Our consolidated financial statements are in accordance with IFRS and presented in U.S. dollars.

Revenue

Revenue increased 21.7% from U.S.$3,113.0 million in 2009 to U.S.$3,788.4 million in 2010, primarily as a result of:

 

   

a 33.5% increase in revenue from plywood and fiberboard panels;

 

   

a 11.5% increase in revenue from pulp;

 

   

a 25.7% increase in revenue from wood products; and

 

   

a 83.8% increase in revenue from forestry products.

Pulp

Revenue from bleached and unbleached pulp increased 11.5% from U.S.$1,604.8 million in 2009 to U.S.$1,789.6 million in 2010, reflecting a 48.3% increase in average prices, partially offset by a 24.8% decrease in sales volume. Sales of bleached pulp increased 10.1% due to a 49.1% increase in average prices, partially offset by a 26.2% decrease in sales volume. Revenue from unbleached pulp increased 21.2% due to a 44.2% increase in average prices, partially offset by a 16.0% decrease in sales volume.

When comparing to 2009, the increase in revenues in 2010 was primarily driven by higher average pulp prices which reflected a recovery in global demand for pulp and paper after the global financial crisis that led to a substantial decrease in the prices of our products during the last quarter of 2008 and the first quarter of 2009.

The decrease in pulp sales volume was primarily a result of the interruption of operations at our Chilean pulp mills in March, April and May, 2010 as a result of the earthquake that hit the South-Central Region of Chile on February 27, 2010.

 

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Plywood and fiberboard panels

Revenue from plywood and fiberboard panels increased 33.5% from U.S.$831.0 million in 2009 to U.S.$1,109.0 million in 2010. This increase in revenues was primarily due to a 15.3% increase in sales volume and a 15.8% increase in average prices.

Our sales volume increased in 2010 primarily as a result of our acquisition of Tafisa Brasil in August 2009, which added 640,000 cubic meters of annual production capacity to our panels business, partially offset by the loss in production caused by the interruption of our operations in Chile due to the February 27, 2010 earthquake.

Our average prices increased in 2010 primarily as a result of higher demand for our products during the year compared to 2009, when prices for plywood, medium-density fiberboard, particleboard and hardboard deteriorated due to a decrease in global demand for these products.

Wood products

Revenue from sawn timber and remanufactured wood products increased 25.7% from U.S.$493.8 million in 2009 to U.S.$620.8 million in 2010, primarily as a result of a 8.2% increase in sales volume and a 16.2% increase in average prices. During 2010, our offer for sawn timber products increased largely due to reconstruction efforts in Chile after the February 27, 2010 earthquake. Also, the real estate and construction markets in the United States showed signs of modest improvement during the year 2010, but still remain at their lowest levels in 50 years. Homebuilding levels in the United States improved in 2010 reaching approximately an average of 588,000 units per year, compared to an average of 554,000 units per year during 2009. All of these factors described favored demand for our sawn timber and remanufactured wood products, increasing sales volume, partially offset by the interruption of our sawmills and the permanent closure of our Mutrún mill, after the February 27, 2010 earthquake.

Forestry products

Revenue from forestry products increased 83.8% from U.S.$81.7 million in 2009 to U.S.$150.2 million in 2010. This increase was primarily the result of increased demand for our sawlogs and chips, revenues of which increased 112.5% and 75.6% respectively, in 2010.

Demand for our forestry products increased in 2010 as a result of the recovery from the global financial crisis, which triggered a significant increase in demand for pulplogs, sawlogs, chips and posts.

Other revenue

Revenue from other sources, consisting principally of sales of energy and chemicals, increased 16.7% from U.S.$101.8 million in 2009 to U.S.$118.8 million in 2010. This increase is explained by higher sales of energy of U.S.$8.1 million and an increase in sales of chemicals by U.S.$6.6 million.

Cost of sales

Cost of sales increased 6.8% from U.S.$2,152.5 million in 2009 to U.S.$2,298.2 million in 2010, primarily as a result of higher forestry production costs by 33.2%, from U.S.$353.2 million in 2009 to U.S.$470.3 million in 2010 and an increase in raw materials costs, which increased 74.3%, from U.S.$146.7 million in 2009 to U.S.$255.8 million in 2010, partially offset by lower maintenance costs which decreased 27.1 %, from U.S.$284.3 in 2009 to U.S.$207.2 in 2010. As of December 31, 2010, average costs of pulp have increased when compared to December 31, 2009. BSKP or bleached softwood kraft pulp unitary costs increased by 10.5%, BHKP or bleached hardwood kraft pulp unitary costs slightly increased by 1.0% and UKP or unbleached kraft pulp unitary costs were 10.1% higher.

 

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Gross margin

Our gross margin increased from 30.9% for 2009 to 39.3% for 2010, primarily as a result of a 21.7% increase in sales revenue mainly as a result of higher average prices of almost all our products, partially offset by a 6.8% increase in cost of sales.

Other operating income

Other operating income increased 108.5% from U.S.$181.4 million in 2009 to U.S.$378.2 million in 2010, mainly as a result of a U.S.$66.0 million increase in the fair value of our biological assets due to higher sales margin in 2010 compared to 2009 and a net gain of U.S.$107.7 million attributable to insurance claims related to the February 27, 2010 earthquake.

Distribution costs

Distribution costs for all markets decreased 2.3% from U.S.$388.5 million in 2009 to U.S.$379.6 million in 2010, primarily as a result of a 9.5% decrease in shipping and freight costs due to a 24.8% reduction in pulp sales volume.

Administrative expenses

Administrative expenses increased 29.9% from U.S.$249.3 million in 2009 to U.S.$323.9 million in 2010, primarily as a result of a U.S.$50.2 million increase in administrative expenses attributable to our consolidation of the labor costs of Tafisa Brasil, which we acquired and began to consolidate in August 2009. As a percentage of revenue, administrative expenses increased from 8.0% in 2009 to 8.6% in 2010.

Financial costs

Interest expenses increased 10.3% from U.S.$193.9 million in 2009 to U.S.$213.9 million in 2010. This increase is explained primarily by higher accrued interests of U.S.$15.0 million, of which U.S.$8.0 million came from our two bond offerings made in September 2010 and a higher negative impact of change in fair value of derivatives of U.S.$5.0 million.

Exchange rate differences

We recorded exchange rate difference gains of U.S.$17.6 million in 2009 compared to exchange rate difference losses of U.S.$16.3 million in 2010, primarily as a result of foreign exchange losses attributable to our financial debt denominated in currencies that appreciated against the U.S. dollar, partially offset by foreign exchange gains attributable to money market investments, deposits and accounts receivables denominated in such currencies which appreciated against the U.S. dollar. The exchange rate losses can be explained largely by the depreciation of the U.S. dollar against the Euro and the depreciation of the U.S. dollar against the Chilean peso, which caused a loss of U.S.$28.4 million in total liabilities, partially offset by a gain of U.S.$12.1 million in total assets.

Income tax expenses

We had tax expenses of U.S.$53.5 million in 2009 compared to tax expenses of U.S.$198.0 million in 2010. This increase was principally attributable to a higher income before taxes as a result of our 55.1% increase in gross profit in 2010 compared to 2009. Our effective tax rate increased from 14.9% in 2009 to 22.0% in 2010, mainly due to higher profits coming from our subsidiaries in Argentina and Brazil, which have higher tax rate than our local subsidiaries, and the tax effect of income received from insurance related to the earthquake of February 27, 2010.

On July 30, 2010 Law N. 20.455 for national reconstruction financing was published in the Chilean Official Gazette (Diario Oficial de Chile). One of the most important changes such law introduced was the increase in the First Category Taxes for revenues received and /or accrued during commercial years 2011 and 2012, with rates of 20% and 18.5%, respectively.

 

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Net profit

Net consolidated profit in 2010 increased 130.0% from U.S.$304.6 million in 2009 to U.S.$700.7 million in 2010, primarily as a result of higher gross profits in almost all of our business segments due to improved market conditions, partially offset by exchange rate difference losses and higher income tax expenses.

Year ended December 31, 2008 compared to year ended December 31, 2009

Net Sales

Net sales decreased 16.2%, from U.S.$3,713.9 million in 2008 to U.S.$3,113.0 million in 2009, mainly as a result of a decreases of (i) 10.5% in pulp sales, (ii) 12.4% in panels sales, (iii) 19.6% in forestry products sales and (iv) 31.3% in wood products sales.

Pulp Sales

Sales revenue of bleached and unbleached pulp decreased from U.S.$1,792.8 million in 2008 to U.S.$1,604.8 million in 2009, as a result of a 21.9% decrease in average prices, which was partially offset by a 14.7% increase in sales volume. Sales revenue from the sale of bleached pulp decreased by 13.3% due to a 22.8% decrease in average prices, which was partially offset by a 12.3% increase in sales volume. Sales revenue from the sale of unbleached pulp increased by 15.7%, principally due to a 33.2% increase in sales volume of unbleached pulp, which was partially offset by a reduction in overall prices of unbleached pulp by 13.1%. The increase in sales volume mainly results from the increase in production capacity of pulp at the Nueva Aldea Mill from 856,000 to 1,027,000 tons per year as of March 2009.

Wood Products Sales

Sales of wood products, including sawn timber and remanufactured products decreased by 31.3%, from U.S.$718.3 million in 2008 to U.S.$493.8 million in 2009, reflecting a 22.3% decrease in sales volume and a 11.5% decrease in average prices. Sawn timber sales revenue decreased 36.0%, from U.S.$471.6 million in 2008 to U.S.$301.9 million in 2009, due principally to a 22.6% decrease in the sales volume of wood products and a decrease of 17.3% in average prices. Sales of remanufactured wood products decreased 22.2% from U.S.$246.6 million in 2008 to U.S.$191.9 million in 2009, due to a 2.9% decrease in average prices and a 19.9% decrease in sales volume. The decrease in the sales volume of wood products sales was mainly attributable to the closure of four of our sawmills during 2008. These closures were directly related to the weakening of the construction sector in the United States and Latin America in 2008 as a result of the global financial crisis.

Plywood and Fiberboard Panels Sales

Sales of plywood and fiberboard panels decreased 12.2%, from U.S.$946.9 million in 2008 to U.S.$831.0 million in 2009. This decrease was primarily due to an average price decrease of 21.1%, which was partially offset by an 11.2% increase in sales volume. The decrease in prices, which has affected the majority of our panel product lines, resulted from the weakening of the construction sector in 2009, particularly in Latin America and the United States, and an oversupply of panels in the Brazilian market, which added downward pressure to the prices of panels during the second half of 2009. The increase in sales volume is largely attributable to our acquisition of Tafisa in August 2009, which added 640,000 cubic meters of annual capacity to our panels business. See “Item 4. Description of Business—History.”

 

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Forestry Sales

Sales revenue from forestry products decreased by 19.6%, from U.S.$101.6 million in 2008 to U.S.$81.7 million in 2009. This decrease is mainly due to a decrease in sales volume of 31.0% of sawlogs, pulplogs and chips, which was partially offset by a 16.6% increase in the average prices of forestry products as compared to 2008.

Cost of Sales

Cost of sales decreased by 7.7% from U.S.$2,331.9 million for 2008 to U.S.$2,152.5 million for 2009, primarily due to an overall decrease in the per unit cost of production for most of our products. In particular, we saw an annual decrease in our timber, forestry labor and chemicals costs of 14.0%, 14.3% and 22.9% respectively. These decreases were partially offset by both an increase in our maintenance costs and depreciation.

Gross Margins

Gross margins decreased from 37.2% for 2008 to 30.9% for 2009, primarily due to decreases in average sales prices, which was partially offset by a decrease in the per unit cost of sales.

Other Operating Income

Other operating income increased 75.8% from U.S.$104.3 million in 2008 to U.S.$183.3 million in 2009, primarily as a result of an increase in the fair value of our biological assets. This increase in fair value is mainly explained by the higher price of wood, an increase in volume of our forests and an older average age of the trees in 2009 compared to 2008.

Distribution Costs

The distribution costs for all markets decreased from U.S.$455.2 million in 2008 to U.S.$388.5 million in 2009, mainly due to a decrease in the per unit freight cost of our exports. This decrease in our freight costs was a result of the global financial crisis and the oversupply of shipment capacity.

Administrative Expenses

In 2009, administrative expenses were similar to those of 2008, slightly decreasing from U.S.$247.0 million to U.S.$242.2 million.

Financial Costs

Financial costs increased 10.6% from U.S.$175.2 million in 2008 to U.S.193.9 million in 2009, primarily due to an increase in interest expense of 13.5%, partially offset by a decrease in other financial costs of 1.9% as compared to 2008. Our interest expense increased as result of higher levels of long-term debt; in particular, this increase was the result of U.S.$142.0 million in long-term debt we issued in March 2009 in the local market and U.S.$500 million we issued in July 2009 in the U.S. market.

Exchange Rate Differences

We recorded foreign exchange gains of U.S.$17.6 million in 2009 compared to losses of U.S.$67.8 million in 2008. During 2009, the Chilean peso appreciated 20.3% against the U.S. dollar compared to 2008, which positively impacted our sales and other accounts receivables positions recorded in Chilean Pesos. In the same period the Brazilian Real depreciated 34.2% against the U.S. dollar in 2009, which also positively impacted our related party payables position recorded in Brazilian Reals.

Negative Goodwill Immediately Recognized

Negative goodwill immediately recognized increased to U.S.$36.9 million in 2009 from zero in 2008. This increase is a result of our purchase of ENCE’s main assets in Uruguay at a purchase price below market value, which allowed us to recognize negative goodwill. See “Item 4. Description of Business—History.”

 

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Other Profit (Loss)

In 2009, we earned other profit of U.S.$27.2 million, as compared to the other losses we incurred in 2008 of U.S.$0.4 million. This increase was primarily due to the gain that we recorded as a result of our contribution of 50% of our equity in Forestal Conosur to the Montes de Plata joint venture. This contribution resulted in a change in control of Forestal Conosur S.A., which allowed us to recognize the assets and liabilities contributed to the joint venture at fair value under the equity method rather than at book value on a consolidated basis which resulted in a gain for Arauco. See “Item 4. Description of Business—History.”

Income Tax

In 2009, we incurred income tax expenses of U.S.$53.5 million, which is a decrease of U.S.$44.5 million from the income tax expenses of U.S.$98.0 million in 2008. This decrease was principally due to our lower profit before income tax and to the increase in non-taxable items.

Net Profit

Net profit decreased 33.0% from U.S.$405.0 million in 2008 to U.S.$304.6 million in 2009. The main cause of this decrease was the global financial crisis that continued to negatively affect the construction sector throughout 2009, which resulted in decreases in both our prices and total sales revenues.

Liquidity and capital resources

Our primary sources of liquidity are funds from operations, domestic and international borrowings from commercial and investment banks and debt offerings in the domestic and international capital markets.

Cash flow from operating activities

Our net cash flow provided by operating activities was U.S.$1,137.3 million in 2010 and U.S.$751.0 million in 2009. The increase of net cash provided by operating activities in 2010 as compared to 2009 was principally due to an increase of U.S.$308.4 million in the collection of trade accounts receivable as a result of increasing sales of our products, and an increase of U.S.$292.4 million received from insurance claims mostly related to the earthquake of February 27, 2010. This result was partially offset by higher payments to suppliers for goods and services by U.S.$91.4 million and an increase of U.S.$72.3 million of payments to and on behalf of employees.

Cash flow used in investing activities

Our net cash used in investing activities was U.S.$669.4 million in 2010 and U.S.$717.3 million in 2009. This decrease was principally due to lower amounts used in business combinations by U.S.$286.5 million, partially offset by higher capital expenditures for property, plant and equipment by U.S.$240.9 million.

Cash flow from financing activities

Our net cash used in financing activities was U.S.$33.9 million in 2010 compared to U.S.$302.4 million obtained from financing activities in 2009. This decrease was mainly due to lower funds obtained by debt financing of U.S.$356.7 million, partially offset by a lower amount used to repay loan obligations by U.S.$112.4 million.

In accordance with customary practice in the pulp industry, we do not have long-term sales contracts with our customers; rather, we maintain relationships with our customers, with whom we reach agreements from time to time on specific volumes and prices.

We believe that cash flow generated by operations, cash balances, borrowings from commercial banks and debt offerings in the domestic and international capital markets will be sufficient to meet our working capital, debt service and capital expenditure requirements for the foreseeable future. See “Item 4—Information on the Company—Capital Expenditures.”

 

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Contractual obligations

The following table sets forth certain contractual obligations as of December 31, 2010, and the period in which the contractual obligations come due.

 

     Payments Due by Period  
     Less than 1
year
     1-3 years      3-5 years      More than
5 years
     Total  
    

(in millions of U.S. dollars)

 

Debt obligations(1)

     504,2         722,7         845,3         2.286,8         4.359,0   

Forestal Río Grande debt obligations(2)

     35,6         69,1         —           —           104,7   

Purchase obligations(3)

     31,7         —           —           —           31,7   

Capital (finance) lease obligations

     0,3         0,0         —           —           0,4   

Operating lease obligations

     —           —           —           —           —     

Other contractual obligations(4)

     —           —           —           —           —     
                                            

Total

     571,8         791,8         845,3         2.286,8         4.495,7   

 

(1)

Includes estimated interest payments related to long-term debt obligations.

(2) 

Forestal Río Grande S.A. is a special purpose entity, which we control but do not own. As a result, we include the financial information of Forestal Río Grande S.A. in our financial statements, including its long term debt obligations.

(3) 

Excludes contracts entered into with independent contractors to perform operations on our behalf. Our payment obligations under such contracts are not pre-determined, but rather depend on the performance of certain variables. Accordingly, we cannot quantify our contractual obligations under such contracts.

(4) 

Excludes our obligations to purchase wood, plantations and land from Forestal Río Grande S.A. because those obligations are already included in our consolidated financial statements as part of our indebtedness.

Investment activities

During 2010, our principal investment activities were as follows:

In April 2010, our subsidiary Arauco do Brasil S.A. acquired 50% of the shares of Dynea Brasil from Dynea AS for U.S.$15 million. As a result of this acquisition, we now own 100% of the shares of Dynea Brasil.

Financing activities

During 2010, our principal financing activities were as follows:

 

   

On June 17, 2010, we prepaid U.S.$22.8 million of U.S.$270.5 million of our 8.675% notes due 2010.

 

   

On August 16, 2010, we paid at maturity U.S.$247.7 million of the balance of our 8.675% notes due 2010.

 

   

On September 2, 2010, we issued one series of bonds for U.S.$210 million in the Chilean local market. This series of bonds with an aggregate principal amount of 5,000,000 UF was issued at 3.25% with a final maturity of 10 years.

 

   

On September 21, 2010, we issued bonds for U.S.$400 million in the U.S. market at 5.00% with a final maturity of 10 years.

 

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As of December 31, 2010, our short-term bank debt was U.S.$103.2 million of which %87.9 was U.S. dollar-denominated.

As of December 31, 2010, our total long-term bank, export credit agency and multilateral lending agency debt (including the current portion of such debt) was U.S.$294.8 million of which 96.7% was U.S. dollar-denominated. As of December 31, 2010, we also had total capital markets borrowings (including the current portion of such debt) of U.S.$3,051,6 million, 77.8% of which was U.S. dollar-denominated. As of December 31, 2010, the weighted average maturity of our long-term debt was 7.0 years. The interest rate on our variable rate debt is determined principally by reference to the London inter-bank offered rate (LIBOR), and as of December 30, 2010, the average interest rate for our U.S. dollar floating rate debt over nine-month LIBOR was 0.66%. As of December 30, 2010, the average interest rate for our U.S. dollar fixed rate debt was 6.34%. These average rates do not reflect the effect of swap agreements and subsequent unwinds effective as of December 30, 2010.

The instruments and agreements governing our bank loans and local bonds set limits on our incurrence of debt and liabilities through the use of financial covenants. The principal financial covenants contained in the bank loan agreements are as follows:

 

   

Our debt to equity ratio must not exceed 1.2:1; and

 

   

Our interest coverage ratio must not be less than 2:1.

The principal financial covenant contained in the local bond agreements is:

 

   

Our debt to equity ratio must not exceed 1.2:1.

We were in compliance with these covenants for both bank loans and local bonds agreements as of December 31, 2010.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any material off-balance sheet arrangements.

TREASURY MANAGEMENT

We manage the treasury activities of all of our Chilean subsidiaries on a centralized basis. Our Chilean subsidiaries borrow from or lend money to us in accordance with their daily cash requirements or surplus, maintaining their cash balance close to zero. Our policy is not to allow our Chilean subsidiaries to invest in financial instruments and other transactions. We make decisions regarding short-term loans, short-term investments, currency transactions and other transactions on a consolidated basis. Treasury activities are governed by our cash and deposits policy, which is approved by the board of directors. The main principles of our cash and deposits policy are as follows:

 

   

investments must be in fixed income instruments;

 

   

we do not invest in stocks;

 

   

investments must be in instruments from the Central Bank of Chile or from internationally recognized financial institutions; and

 

   

transactions must be carried out only with banks or bank subsidiaries.

Our Argentine and Brazilian subsidiaries manage their treasury activities independently from us. Their activities are governed by cash and deposit policies that are approved by their chief executive officers. These policies are based on the same principles underlying our cash and deposits policy.

 

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HEDGING

We periodically review our exposure to risks arising from fluctuations in foreign exchange rates and interest rates and make a determination, on a case-by-case basis, at our senior management level whether or not to hedge such risks. As a result, from time to time we enter into currency and interest rate swaps with respect to a portion of our borrowings. See Note 23 to our audited consolidated financial statements.

We have two offsetting interest rate swap agreements outstanding, each in a notional amount of U.S.$130 million, with respect to the interest rate on our 7.75% Notes due 2011. These interest rate swaps settle semiannually and terminate in 2011. The net effect of our interest rate swap agreements is that we pay fixed interest at a rate of 5.506% and receive fixed interest at a rate of 7.75%. See Note 23 to our audited consolidated financial statements.

The Bío Bío Investment Fund, with which we entered into certain agreements pursuant to which we became the administrator and exclusive buyer of the forestry assets acquired from Forestal Bío Bío S.A., entered into one interest rate swap agreement, in an initial notional amount of U.S.$240 million with amortizations during the life of the swap in the same amount and dates of the amortizations of the credit agreement the Bío Bío Investment Fund obtained on October 6, 2006, with interest rate settled quarterly and with a final maturity in October 2013. The net effect of this interest rate swap agreement is that the Bío Bío Investment Fund pays fixed interest rate at a rate of 5.256% and receives a floating rate at 3 months LIBOR. In January 2007, the Bío Bío Investment Fund transferred all of its assets and financial debt to Forestal Río Grande S.A.

We have outstanding the following cross currency swap agreements to hedge our local bonds issued in UF:

 

   

A cross currency swap agreement with Banco de Chile for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 2.25% and pays semi-annual interest based on the notional amount of U.S.$35,700,986.39, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 4.99%. This swap matures in March 2014.

 

   

A cross currency swap agreement with JPMorgan Chase Bank for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 2.25% and it pays semi-annual interest based on the notional amount of U.S.$35,281,193.28, which is the equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 4.94%. This swap agreement matures in March 2014.

 

   

A cross currency swap agreement with Barclays Bank PLC for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 4.25% and it pays semi-annual interest based on the notional amount of U.S.$38.38 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.86%. This swap agreement matures in October 2014.

 

   

A cross currency swap agreement with Banco de Chile for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 4.25% and it pays semi-annual interest based on the notional amount of U.S.$37.98 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.79%. This swap agreement matures in April 2014.

 

   

A cross currency swap agreement with Deutsche Bank for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 4.25% and it pays semi-annual interest based on the notional amount of U.S.$37.98 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.8%. This swap agreement matures in October 2014.

 

   

A cross currency swap agreement with Deutsche Bank for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 4.25% and it pays semi-annual interest based on the notional amount of U.S.$37.62 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.79%. This swap agreement matures in October 2014.

 

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A cross currency swap agreement with Barclays Bank PLC for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 4.25% and it pays semi-annual interest based on the notional amount of U.S.$38.42 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.62%. This swap agreement matures in October 2014.

 

   

A cross currency swap agreement with Corpbanca for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 3.25% and it pays semiannual interest based on the notional amount of U.S.$42.86 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.20%. This swap agreement matures in September 1, 2020.

 

   

A cross currency swap agreement with BBVA for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 3.25% and it pays semiannual interest based on the notional amount of U.S.$42.86 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.20%. This swap agreement matures in September 1, 2020.

 

   

A cross currency swap agreement with Deutsche Bank for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 3.25% and it pays semi-annual interest based on the notional amount of U.S.$42.86 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.25%. This swap agreement matures in September 1, 2020.

 

   

A cross currency swap agreement with Banco Santander for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 3.25% and it pays semi-annual interest based on the notional amount of U.S.$42.87 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.17%. This swap agreement matures in September 1, 2020.

 

   

A cross currency swap agreement with BBVA for UF 1,000,000. Under this agreement, we receive semi-annual interest based on the notional amount of UF 1,000,000 at a rate of 3.25% and it pays semi-annual interest based on the notional amount of U.S.$42.87 million, which is equivalent to UF 1,000,000 at the currency exchange rate at the date of the agreement, at a rate of 5.09%. This swap agreement matures in September 1, 2020.

These cross currency swap agreements allow us to address uncertainties regarding exchange rates. Through these agreements, we receive cash flows in UF, which allow us to comply with the terms of the bonds and pay fixed amounts in dollars, the currency in which a significant amount of our assets are denominated.

On June 4, 2010, we entered a six month Then-on-the-Run Treasury Hedge with J.P. Morgan Securities Inc. Under this agreement, we locked the 10-year U.S. Treasury bond at a 3.4925% rate based on a notional amount of U.S.$300.0 million. This hedge agreement matured on December 6, 2010.

We have also analyzed our exposure to risks associated with fluctuations in prices of commodities, including pulp, but have, thus far, not entered into any material hedging transactions with respect to such risks.

RESEARCH AND DEVELOPMENT

We spent U.S.$6.1 million for the year ended December 31, 2010 on research and development. We conduct our principal research and development programs through our subsidiary Investigaciones Forestales Bioforest S.A., which concentrates its efforts on applying and implementing advanced technologies to the specific characteristics of our forests and mills.

 

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We are continuously researching and attempting to develop different strains of long-fiber pine trees to improve their quality and to shorten their average harvest cycle. Additionally, we maintain close relations with certain international research institutes, equipment suppliers and the scientific and engineering community involved with our industry.

TREND INFORMATION

On February 27, 2010, an earthquake measured at a magnitude of 8.8 on the Richter scale occurred in the South-Central Region of Chile and was followed by a tsunami that affected parts of the Chilean coastline. The affected area is a location where we maintain a substantial portion of our Chilean industrial operations. Immediately after the earthquake, all of our production units applied their contingency plans, which involved shutting down operations and evaluating the damage caused to each facility by the earthquake. As a result of the earthquake and the subsequent tsunami, our Mutrún sawmill was destroyed. Our other operations that were adversely affected by the earthquake and tsunami reopened gradually, the last of which being line two of the Arauco Pulp Mill (Arauco II), which reopened on February 2, 2011. As of today, all of our operations have reopened and are currently operating at full operational capacity, except for the Mutrún sawmill, which was destroyed and will not be reopened. The Mutrún sawmill represented 6% of our sawn timber production capacity in Chile.

Pulp sales reached U.S. $533.3 million during the fourth quarter of 2010, a 13.6% increase compared to the same quarter of the previous year. This increase is mainly explained by higher average prices of 23.6%, partially offset by lower sales volume of 9.2%. The lower sales volume is largely explained by the interruption of operations at our pulp mills mainly in the first half of 2010 as a result of the earthquake that hit the central and southern regions of Chile on February 27, 2010.

The global financial crisis that affected the world paper market, especially in Europe and North America, led to a substantial decrease in the prices of our products during the last quarter of 2008. Prices began to show a slight recovery during the second quarter of 2009, and then continued increasing for the rest of the year, almost reaching pre-crisis levels in the last quarter of 2009. The recovery in the pulp market was confirmed during the fourth quarter of 2009 and the year 2010, during which time pulp prices have grown strongly, reaching near pre-crisis levels. We expect this positive price trend to continue throughout the first half of 2011, especially in long fiber, although at a slower pace than that of the year 2010. In February 2011, we began to see strong rises in prices of long fiber while short fiber prices continued stable, causing a spread between the prices of long and short fibers of U.S.$100 or more.

Inventory levels decreased slightly at the end of the fourth quarter of 2010, as compared to 2009 levels. World stock levels were 28 days for long fiber and 43 days for short fiber as of February 2011, which were higher than the world stock levels measured as of February 2010, which were 25 and 34 days, respectively.

Notwithstanding the strong recovery in the overall quantity of our shipments to Europe during 2010, the European paper market is still facing challenging circumstances. Local producers have not been able to transfer the higher global pulp prices to paper products, consequently suffering decreases in margin due to the higher costs of raw material. Also, the sovereign debt crisis in Greece that occurred in the first months of 2010 has impacted the value of the euro against the US dollar, which increased European pulp-buyer prices in euro terms. The status of the overall European economy is uncertain in the short term, and the pulp market may be negatively impacted if the crisis spreads to other European countries, as there is a close relationship between the health of the economy of a region and its pulp and paper demand.

During the last quarter of 2010, the market in general was very strong in Asia, particularly in China, showing an upward trend in long fiber prices and price stability for short fiber. During the early months of 2011, Asian countries, including China in particular, continued to have strong demand for pulp, leading to pulp price increases throughout the region. Although paper prices remain under pressure and shipments to China are higher than consumption, paper production is still very strong for local consumption and exports.

 

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Our sawn timber and panels business is strongly related to the real estate and construction industries. The real estate and construction markets in the United States are still at their lowest in 50 years. During the early months of 2011, homebuilding levels decreased to approximately 480,000 units per year, as compared to an average of 585,000 units during 2010. During 2010 and the early months of 2011, home sales in the Chilean market were higher than in 2009, which increase was largely the result of the reconstruction efforts in the central and southern regions of Chile following the earthquake of February 27, 2010.

 

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Item 6. Directors, Senior Management and Employees

DIRECTORS AND EXECUTIVE OFFICERS

Directors

A board of directors manages our business. Our by-laws (estatutos) require that the board of directors consist of nine directors. Our directors cannot also be our executives. The entire board is elected every three years and can be re-elected for any number of periods. The current board was elected in April 2010, and their terms will expire in 2013. The board may appoint replacements to fill any vacancies that occur during periods between elections; however, at the annual shareholders’ meeting following any such replacement, an election of the entire board must take place. Scheduled meetings of the board of directors are, generally, held once a month. Extraordinary board meetings are called when summoned by the Chairman or when requested by at least two directors.

We do not have an audit committee or compensation committee.

Our current directors are listed below.

 

Name

   Years as
Director
   Position    Age

José Tomás Guzmán

   25    Chairman    81

Roberto Angelini

   25    First Vice-Chairman    62

Manuel Bezanilla

   25    Second Vice-Chairman    66

Jorge Andueza

   17    Director    62

José Rafael Campino

   1    Director    58

Carlos Croxatto

   25    Director    96

Alberto Etchegaray

   17    Director    65

Eduardo Navarro

   3    Director    45

Timothy C. Purcell

   6    Director    51

Included below are brief biographical descriptions of each of our directors.

José Tomás Guzmán became a Director on April 30, 1986 and became Chairman of the board of directors on May 4, 2007. He served as Chairman of the board of directors from April 18, 1991 to January 4, 2005, when he voluntarily resigned, and as First Vice-Chairman of the board of directors from January 27, 2005 to May 4, 2007. He is a partner of the law firm Portaluppi, Guzmán y Bezanilla, is a Vice-Chairman of COPEC, Empresas Copec and AntarChile, is Chairman of the board of directors of Forestal Arauco, Inversiones Siemel S.A. and Compañía de Seguros de Vida Cruz del Sur S.A., and serves as a member of the boards of directors of Industrias Forestales S.A., Sigma S.A., Servicios Corporativos Sercor S.A., Corpesca S.A. and Astilleros Arica S.A. Mr. Guzmán holds a law degree from the Catholic University of Chile.

Roberto Angelini became a Director on April 30, 1986 and became First Vice-Chairman of the board of directors on May 4, 2007. He served as Vice-Chairman of the board of directors from April 18, 1991 to January 4, 2005, when he voluntarily resigned, and as Second Vice-Chairman of the board of directors from January 27, 2005 to May 4, 2007. He serves as Chairman of the board of directors of Empresas Copec, COPEC, AntarChile, Corpesca S.A., Pesquera Iquique-Guanaye S.A., Astilleros Arica S.A. and Servicios Corporativos Sercor S.A. He also serves as a member of the boards of directors of Forestal Arauco, Industrias Forestales S.A., Empresa Pesquera Eperva S.A., Orizon S.A., Compañía de Seguros de Vida Cruz del Sur S.A., Inversiones Siemel S.A. and Sigma S.A. Mr. Angelini holds a degree in civil engineering from the Catholic University of Chile.

Manuel Bezanilla became a Director on April 30, 1986. He was appointed as Second Vice-Chairman of the board of directors on May 4, 2007. He is also a partner of the law firm Portaluppi, Guzmán y Bezanilla and serves as a member of the boards of directors of Forestal Arauco, Pesquera Iquique-Guanaye S.A., AntarChile and Inversiones Siemel S.A. Mr. Bezanilla holds a law degree from the Catholic University of Chile.

 

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Jorge Andueza became a Director on April 11, 1994. He is also the Chief Executive Officer of AntarChile and serves as a member of the boards of directors of COPEC, Empresas Copec, Empresa Pesquera Eperva S.A., Corpesca S.A., Compañía de Seguros de Vida Cruz del Sur S.A., Inversiones Siemel S.A., Astilleros Arica S.A., Pesquera Iquique-Guanaye S.A., Orizon S.A., Organización Terpel S.A., Servicios Corporativos Sercor S.A. and Sigma S.A. Mr. Andueza holds a degree in electronic civil engineering from Federico Santa María Technical University.

José Rafael Campino became a Director on March 23, 2010. He is currently Chairman of the board of directors and Chief Executive Officer of Forestal del Sur S.A., a member of the boards of directors of Forestal Los Lagos S.A. and Forestales Regionales S.A., Managing Partner of Forestal Atlántico Sur S.A.R.L. in Montevideo, Uruguay and former President of the Corporación Chilena de la Madera (Chilean Forestry Association). Mr. Campino holds a degree in civil engineering from the Catholic University of Chile and Master of Science degree in management from Stanford University.

Carlos Croxatto became a Director on April 30, 1986. He also serves as a member of the boards of directors of Forestal Arauco and Industrias Forestales S.A. Mr. Croxatto holds a degree in civil engineering from the University of Chile.

Alberto Etchegaray became a Director on April 11, 1994 and served as Chairman of the board of directors from January 4, 2005 to May 4, 2007, when he voluntarily resigned. He is also a partner of Domet Ltda., the Chairman of the board of directors of Invesco Internacional S.A., Salfacorp S.A., Red Salud S.A and Habitaria S.A.. He served as the Chilean Minister of Housing for four years. Mr. Etchegaray holds a degree in civil engineering from the Catholic University of Chile.

Eduardo Navarro became a Director on September 25, 2007. He is also the Chief Executive Officer of Empresas Copec S.A., the Chief Executive Officer of Pesquera Iquique-Guanaye S.A., and serves as a member of the boards of directors of COPEC, Abastecedora de Combustibles S.A., Sociedad Nacional de Oleoductos S.A., Empresa Eléctrica Guacolda S.A., Corpesca S.A., Orizon S.A., Compañía Minera Can-Can S.A., Metrogas S.A. and Colbún S.A. Mr. Navarro holds degrees in commercial engineering and economics, and a master’s degree in economics, all from the Catholic University of Chile.

Timothy C. Purcell became a director on April 26, 2005. He is also Managing Partner of Linzor Capital Partners, LP. Mr. Purcell currently serves as a member of the boards of directors of Compañía de Seguros de Vida Cruz del Sur S.A., Cruz del Sur Administradora General de Fondos S.A., Isapre Cruz Blanca S.A., BOPP Holdings, Parque Arauco S.A. and Corporación Santo Tomás. He is also a Trustee of International House in New York. Mr. Purcell received an undergraduate degree with distinction in Economics from Cornell University, as well as a Masters Degree in International Studies from the University of Pennsylvania and a master’s degree in business (MBA) from Wharton Business School.

 

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Executive Officers

Our executive officers are appointed by the board of directors and hold office at its discretion. Our current principal executive officers and the directors of each area or department are listed below.

 

Name

   Years with
Arauco
    

Position

   Age  

Matías Domeyko(1)

     22       President and Chief Executive Officer      49   

Gianfranco Truffello

     16       Chief Financial Officer      43   

Robinson Tajmuch

     20       Comptroller Director      54   

Franco Bozzalla

     21       Wood Pulp Area Managing Director      48   

Jorge Garnham(2)

     34       Corporate Management Director      57   

Cristián Infante(2)

     15       Corporate Management & Development Director      44   

Charles Kimber

     25       Corporate Affairs & Marketing Director      49   

Antonio Luque

     19       Sawn Timber Area Managing Director      54   

Alvaro Saavedra

     19       Forestry Area Managing Director      55   

Gonzalo Zegers

     3       Panels Area Managing Director      50   

Felipe Guzman

     2       General Counsel      41   

 

(1) 

Matías Domeyko worked at Arauco from 1987 to 1994. He rejoined Arauco in 1997.

(2) 

As of March 31, 2010, Jorge Garnham voluntarily resigned as Corporate Management Director and was replaced by Cristián Infante.

Included below are brief biographical descriptions of each of our executive officers and the directors of each area or department.

Matías Domeyko is the President and Chief Executive Officer of Arauco. Mr. Domeyko is also a member of the board of directors of Puerto Lirquén S.A. He worked at Arauco from 1987 to 1994. He rejoined in 1997 and served as our Chief Financial Officer until 2005. He previously served as the Director of Development of Copec. Mr. Domeyko holds a degree in commercial engineering from the University of Chile.

Gianfranco Truffello is the Chief Financial Officer of Arauco. He joined Arauco in 1994 and was previously our Finance Manager. He also served as the Chief Financial Officer of Alto Paraná S.A. Mr. Truffello holds a degree in civil engineering from the Catholic University of Chile and a master’s degree in business administration from the Massachusetts Institute of Technology.

Robinson Tajmuch is the Comptroller Director of Arauco. He joined Arauco in 1991 and was previously our Comptroller. Before joining Arauco, he served as Auditing Manager at Price Waterhouse. Mr. Tajmuch holds a degree in accounting and auditing from the Santiago University of Chile.

Franco Bozzalla is the Woodpulp Area Managing Director. He joined Arauco in 1990. He was formerly a sales representative of Forestal Arauco and the Panels Area Managing Director. Mr. Bozzalla holds a degree in civil engineering from the Catholic University of Chile.

Jorge Garnham was the Corporate Management Director of Arauco until March 31, 2011 when he voluntary resigned and was replaced by Cristián Infante. He joined Arauco in 1978. He was formerly the Managing Director of Alto Paraná S.A., Chief Accounting Officer, Manager of Forestry Sales of Arauco and Woodpulp Area Managing Director. Mr. Garnham holds a degree in civil engineering from the Catholic University of Chile.

Cristián Infante is currently the Corporate Management & Development Director of Arauco since April 1, 2011. Previously, he was the Atlantic Region Managing Director. He joined Arauco in 1996 as a woodpulp sales representative, where he worked for two years. In 1998, Mr. Infante was appointed sales manager for industrial lumber and remanufactured products of Forestal Arauco, where he worked until 1999, at which time he moved to Centromaderas S.A., where he worked for two years. Mr. Infante holds a degree in civil engineering from the Catholic University of Chile.

 

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Charles Kimber is the Corporate Affairs & Marketing Director of Arauco. Mr. Kimber also supervises the Environmental Area, Andrés Camaño. He graduated from the Catholic University of Chile with a degree in Commercial Engineering and joined Arauco in 1986, where he has held several positions in sales. He was previously Managing Director of Arauco Wood Products Inc.

Antonio Luque is the Sawn Timber Area Managing Director of Arauco and has held that position since 1993. Before joining Arauco, he was the General Manager of Cabildo S.A. and a research engineer at Compañía Industrial. Mr. Luque holds a degree in civil engineering from the University of Chile.

Alvaro Saavedra is the Forestry Area Managing Director of Arauco. He joined Arauco in 1991. Previously, he was the Director of Development of Forestal Arauco. He holds a degree in civil engineering from the University of Chile and a masters degree in science from the University of London.

Gonzalo Zegers is the Panels Area Managing Director of Arauco. He joined Arauco in 2008. Before joining the Company, he was the general manager of Agrofruta S.A. from 1991 to 1995, Chief Financial Officer (1995-1996) and Chief Executive Officer (1996-2005) of MASISA, and Chief Executive Officer of ATC Panels Inc. (USA) until 2008. Mr. Zegers holds a degree in commercial engineering from the Santiago University of Chile.

Felipe Guzmán is the General Counsel of Arauco. He joined Arauco in December 2008. Before joining the Company, he worked at the law firm Portaluppi, Guzmán & Bezanilla (1996-2008), and he spent a year as an International Associate at Simpson, Thacher & Bartlett in New York (2000-2001). Mr. Guzmán holds a law degree from Finis Terrae University, and a Master of Law from Duke University.

Compensation

For 2010, the aggregate compensation of all our directors and executive officers and senior managers paid or accrued in that year for services in all capacities, including salaries and compensation for their service to those executive officers who serve as directors, was U.S.$47.7 million. We do not maintain any pension or retirement programs or incentive compensation plans for our directors or executive officers. We also do not maintain any plans providing for benefits upon termination of employment. The following table sets out the compensation of our directors for their services as directors in the years provided.

 

     2009      2010  

Roberto Angelini

   U.S.$ 184,113         186,031   

José Tomás Guzmán

     211,335         215,223   

Carlos Croxatto

     231,062         236,860   

Manuel Bezanilla

     128,503         141,030   

Jorge Andueza

     54,453         60,019   

Jorge Bunster

     54,453         14,651   

José Rafael Campino

     —           45,368   

Alberto Etchegaray

     54,453         60,019   

Eduardo Navarro

     54,453         60,018   

Juan Cambiaso

     48,000         36,000   

Antonio Luque

     28,754         30,952   

Matías Domeyko

     131,190         126,960   

René Katz

     11,414         12,462   

Manfred Mayer

     11,414         12,462   

Jorge Garnham

     22,754         24,952   

Eduardo Zañartu

     11,340         60,018   

Alvaro Saavedra

     28,754         30,952   

Franco Bozzalla

     22,754         24,952   

Cristián Infante

     13,997         18,462   

Gonzalo Zegers

     17,340         18,489   

Robinson Tajmuch

     22,754         24,952   

Charles Kimber

     22,754         24,951   

Timothy C. Purcell

     54,453         60,018   
                 

Total compensation

   U.S.$ 1,420,497         1,478,273   
                 

 

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Employees

The following table provides a breakdown of our employees by main category of activity as of the end of each year in the three-year period ended December 31, 2009.

 

     As of December 31,  
     2008      2009      2010  

Pulp mill employees

     2,288         2,286         2,347   

Other industrial employees

     3,445         3,398         3,912   

Forestry employees

     1,185         1,347         1,823   

Administrative employees

     897         873         952   
                          

Total

     7,815         7,904         9,034   
                          

As of December 31, 2010, we had contracts with 1,096 contractors, who employed 26,670 employees. Contractors that are not affiliated with us or with each other operate our eight sawmills and five remanufacturing facilities in Chile. The 12 independent contractors that operate our Chilean sawmills had 2,822 employees at December 31, 2010. The independent contractors that operate our Chilean remanufacturing facilities had 1,991 employees at December 31, 2010 and the independent contractor that operates the laminating beams line employed 99 employees at December 31, 2010.

Under Chilean labor legislation, we are secondarily liable for the payment of labor and the social security obligations owed to employees of our contractors. In the event that we do not exercise the rights granted to us by the labor laws regarding the supervision of our contractors in their compliance of their labor and social security obligations, then our responsibility is elevated from secondary to joint and several, thus enabling an employee of a contractor to bring a claim relating to these obligations against both the contractor and to us, as the party hiring such contractor, although the contractor would remain primarily liable for such obligations. Furthermore, we are also responsible for some of the health and safety conditions of the contractors’ workers, and we are obligated to supervise the compliance by our contractors with all obligations related to such conditions while such workers are performing activities for us within our corporate purpose.

21.7% of our employees in Chile, 50.1% of our employees in Argentina and 14.7% of our employees in Brazil were unionized at December 31, 2010. We negotiate collective bargaining agreements of two or three years’ duration with unionized employees.

We have stable employee relations in Chile, Argentina and Brazil. Our Chilean operations have not experienced any work stoppages in the last five years other than (i) a ten-day work stoppage in November 2009 at our Constitución and Valdivia pulp mills, our Trupán-Cholguán panel mill, and our Nueva Aldea and Horcones complexes, (ii) a three-day work stoppage in September 2009 at our Constitución and Valdivia pulp mills, our Trupán-Cholguán panel mill, and our Nueva Aldea and Horcones complexes; and (iii) a six-day work stoppage in May 2007 at our Horcones complex (which includes the Arauco pulp mill, a panel plant and two sawmills), each of which was caused by the employees of our third party forestry contractors at each of the respective facilities.

In Argentina, during January 2008, the chemical mill in Argentina experienced three days of work stoppage, but these strikes were limited to two hours per shift and did not materially affect operations. In addition, in January and February 2007, we experienced (i) a 12-day stoppage at the Faplac mill due to problems with the labor union of its chemical division and (ii) a six-day suspension of operations at our Alto Paraná mill as a result of a strike by a group of approximately 150 power saw operators.

 

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During the last five years, there have been no strikes or other material work stoppages at our Brazilian subsidiaries.

SHARE OWNERSHIP

Our former director, Anacleto Angelini, who passed away on August 28, 2007, owned 20.8% of the partnership rights in Inversiones Angelini y Compañía Limitada, or Inversiones Angelini, which is the principal shareholder of AntarChile. He directly owned 0.9% of AntarChile. Through his direct and indirect interests in Inversiones Angelini, AntarChile and Empresas Copec, Anacleto Angelini beneficially owned 8.3% of our shares. Mr. Angelini’s estate was divided among his heirs through a public deed in January 2010, and as a result Mr. Angelini’s ownership of partnership rights in Inversiones Angelini was distributed among his widow, Mrs. María Noseda Zambra, who received 15.3%, his nephew Mr. Roberto Angelini, who received 3.1%, and his niece Mrs. Patricia Angelini Rossi, who received 2.3%.

Our First Vice-Chairman, Roberto Angelini, owns 15.3% of Inversiones Angelini. He directly owns 0.2% of AntarChile. Through his direct and indirect interests in Inversiones Angelini, AntarChile and Empresas Copec, Roberto Angelini beneficially owns 6.1% of our shares.

Our Chairman, José Tomás Guzmán, owns 1.9% of Inversiones Angelini. Directly and indirectly through Agroforestal e Inversiones Maihue S.A., he owns 4.1% of AntarChile and 2.6% of Empresas Copec. Through his interests in Inversiones Angelini, AntarChile and Empresas Copec, José Tomás Guzmán beneficially owns 2.6% of our shares.

None of our other directors or executive officers beneficially owns 1% or more of our shares.

 

Item 7. Major Shareholders and Related Party Transactions

MAJOR SHAREHOLDERS

Our only outstanding voting securities are shares of common stock of a single series, without nominal (par) value. The following table sets forth certain information concerning ownership of our common stock, as of June 21, 2011, with respect to each shareholder known by us to own more than 5% of the outstanding shares of our common stock and all of our directors and executive officers, as a group.

 

     Number of
Shares Owned
     Percentage
Ownership
 

Empresas Copec

     113,127,605         99.98   

Directors and executive officers of the Company, as a group

     —           —     

Through its ownership of our Common Stock, Empresas Copec currently has voting control over us.

Empresas Copec is a Chilean public company listed on the Santiago Stock Exchange, the Valparaíso Stock Exchange and the Chilean Electronic Stock Exchange. It is a holding company, the principal interests of which are in Arauco, gasoline distribution, electricity, gas distribution and fishing. Before October 1, 2003, Empresas Copec’s legal name was Compañía de Petróleos de Chile S.A. As of that date, Compañía de Petróleos de Chile S.A. transferred all its gasoline- and fuel-related business assets to a new subsidiary, Compañía de Petróleos de Chile COPEC S.A., which we call COPEC, and changed its legal name to Empresas Copec S.A. In May 2005, AntarChile purchased 3.1 million shares of COPEC, increasing its ownership to 60.4% of Empresas Copec. At December 31, 2010, AntarChile owned 60.8% of Empresas Copec.

Through its ownership in Empresas Copec, AntarChile beneficially owned 60.8% of our shares at December 31, 2010. As of June 21, 2011, AntarChile beneficially owns 60.8% of our shares.

 

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Inversiones Angelini y Compañía Limitada (“Inversiones Angelini”) in turn owns 63.4% of AntarChile’s shares, and certain other related investors own an additional 13.3% of AntarChile. Inversiones Angelini and such other investors are defined herein as the “Angelini Group.”

The principal equity owners of interest in Inversiones Angelini are Mrs. María Noseda Zambra with 31.2%, Mr. Roberto Angelini Rossi with 15.3%, and Mrs. Patricia Angelini Rossi with 14.5%.

As of December 31, 2010, the Angelini Group controls Arauco through the ownership structure described above.

RELATED PARTY TRANSACTIONS

We engage in a variety of transactions in the ordinary course of business with related parties. Related parties include, among others, directors, officers and affiliates of the Company. The new Title XVI, or “Title XVI”, of the Chilean Companies Act, which was included by Law Nº 20,382 published in the Official Gazette on October 20, 2009, amended among others, articles 44 and 89 of the Chilean Companies Act, establishing the applicable norms for transactions with related parties by and among public corporations and their subsidiaries. Title XVI requires that our transactions with related parties contribute to the company’s interest and be on a market basis or on terms similar to those prevailing in the market. In addition, Title XVI provides that related party transactions must be approved by an informed majority of the disinterested members of the board of directors. If a majority of the disinterested directors abstains from voting on a particular transaction, the transaction must be approved by a unanimous vote of the non-abstaining disinterested directors or by a two-thirds of the shares with voting rights. Resolutions approving any such transactions must be reported to our shareholders at the next annual shareholders’ meeting.

Notwithstanding the above, in accordance with Article 147 of the Chilean Companies Act, our Board has resolved that the following transactions with related parties do not need to follow the procedure set forth in the previous paragraph: (i) transactions which do not involve material amounts; (ii) transactions with affiliates in which we control 95% or more of the equity; and (iii) transactions that are considered by our Board to be performed in the ordinary course of our business in accordance with our general policy of customary dealings, which was approved by our Board on December 29, 2009 and is available to shareholders at our main office and is published on our website, at www.arauco.cl.

Article 146 of the Chilean Companies Act defines related party transactions as negotiations, acts, contracts or transactions between the company and any other person or entity that involve the following:

 

   

directors or officers of a corporation (or their respective spouses and certain other relatives) acting on their own;

 

   

directors or officers of a corporation who have a direct or indirect ownership interest of at least 10% of the equity shares of the other company or are also directors or officers of such other company;

 

   

persons who have been in the last 18 months previous to the transaction, directors or officers of the corporation; and

 

   

“related persons” of the corporation, as defined in article 100 of the Chilean Securities Markets Law.

Article 100 of the Chilean Securities Markets Law establishes that the following are “related persons” to a company: (i) the entities of the corporate group (grupo empresarial) to which such company belongs; (ii) the entities that are either parent company, subsidiary, owners of at least 10% of the equity of a company or other companies in which the company owns at least 10%; (iii) directors or officers of a company (or their respective spouses and certain other relatives); (iv) any person who, individually or with other persons under a voting agreement can designate at least one member of the management of the company or control at least 10% of the capital of such company; and (v) any other person who is indicated as such by the Chilean Superintendencia de Valores y Seguros, in accordance with certain parameters established by the abovementioned Article 100.

 

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Our transactions with affiliates include the following:

 

   

We purchase goods and services that may also be provided by other suppliers. Among the most significant are our fuel purchases from COPEC, a subsidiary of Empresas Copec, our majority shareholder; and

 

   

We purchase port services from our 20.1% affiliate Puerto de Lirquen S.A. and our 50.0% affiliate Compañía Puerto de Coronel S.A.;

 

   

We purchase from EKA Chile, a chlorate sodium supplier, which is 50% controlled by Arauco, and we provide EKA Chile with electricity;

 

   

We purchase from Dynea Brasil, a chemicals and melamine supplier, which, as of April 2010, is now 100% controlled by Arauco, and we provide Dynea Brasil with fuel and services; and

 

   

We obtain legal services from Portaluppi, Guzmán y Bezanilla, a law firm of which two of our directors, José Tomás Guzmán and Manuel Bezanilla, are partners.

Financial information concerning transactions with affiliates is included in Note 11 to our audited consolidated financial statements.

On June 11, 2007, in order to refinance the notes (obligaciones negociables) issued by Alto Paraná S.A. in 2001 (the “APSA Notes”) and other existing debt and to finance capital expenditures in the ordinary course of business, Alto Paraná S.A. issued U.S.$270 million of 6.375% Notes due 2017 in the form of Rule 144A/Regulation S notes sold in the local and international capital markets. Arauco fully and unconditionally guaranteed these notes. Alto Paraná paid down the APSA Notes with the proceeds of the 6.375% Notes.

 

Item 8. Financial Information

See “Item 17—Financial Statements.”

EXPORT SALES

Export sales constituted 76.2% of our sales revenue for the year ended December 31, 2010. Our total export sales revenue for 2010 was U.S.$2,647 million. Our principal overseas markets are Asia, North America and Western Europe. See “Item 4. Information on the Company—Description of Business—Domestic and Export Sales.”

LEGAL PROCEEDINGS

We have been and continue to be subject to environmental proceedings related to allegations by the Chilean environmental regulators and private parties. We are also subject to certain other legal proceedings arising from the ordinary course of our business. For more information regarding the environmental proceedings and other legal proceedings arising from the ordinary course of business, see Note 19 to our audited consolidated financial statements.

Since the end of 2004, we have been subject to various criminal proceedings relating to alleged violations of several environmental laws in Chile, each of which has been either terminated or abandoned by the prosecutor (decisión de no perseverar) as of the date of this annual report. For instance, on October 18, 2010, in a public hearing held before the San José de la Mariquina’s Criminal Court, the prosecutor in charge of the investigation announced its decision to terminate the investigation due to a lack of information or evidence that could support any theory of criminal liability. Such decision has not been challenged.

 

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While Chilean law in general provides that only individuals can be convicted in criminal actions, Chilean Law Nº 20,393, which was published in the Official Gazette on December 2, 2009, provides an exception to this general rule, under which criminal responsibility of legal entities can be established for criminal offenses related to the financing of terrorism, asset laundering or bribery. We do not have knowledge of any fact that could result in such criminal responsibility for the Company.

Valdivia Mill

Our operations at the Valdivia Mill have been subject to continued environmental scrutiny by Chilean environmental regulators and the Chilean public since the mill began its operations in 2004. A variety of concerns and claims have been raised regarding the mill’s potential environmental impacts in the area.

The COREMA for the Tenth Region of Chile evaluated claims regarding the migration and death of black-neck swans, whose habitat in the nearby Carlos Anwandter Nature Sanctuary is downstream from the mill on the Cruces River. There have been allegations of a causal connection between the migration and death of black-neck swans and the operations at the Valdivia mill, and in a study dated April 18, 2005, researchers at the Austral University in Valdivia concluded that wastewater discharges from the Valdivia Mill had significantly altered the quality of the Cruces River. The study also concluded that the effluent discharges were a significant contributing factor in the death or migration of a large population of the black-necked swans in the Carlos Anwandter Nature Sanctuary downstream from the Valdivia Mill. The National Defense Council instituted an action seeking reparations, damages and indemnification from us for environmental harm allegedly caused by the discharges from the Valdivia Mill. In response, we have argued to the court that this action should be rejected, as several studies have demonstrated that there is no relationship between the alleged damages and the operation of the Valdivia Mill.

On June 8, 2005, we voluntarily suspended operations at the Valdivia Mill pending the receipt of legal and technical guidance from the applicable regulatory authorities. We estimate this voluntary suspension resulted in a loss of sales of approximately U.S.$1.0 million per day and a loss of profits of approximately U.S.$250,000 per day. Pursuant to the decision of our board of directors, based on certain clarifications provided by the Environmental Regional Commission (Comisión Regional del Medio Ambiente), or COREMA, of the Tenth Region of Chile, the mill resumed operations on August 12, 2005 at 80% of its authorized production capacity after 64 days of suspended operations. In order to achieve the full production capacity authorized by applicable permits, the mill had to fulfill certain new requirements established by the COREMA. On January 18, 2008, the COREMA authorized the Valdivia Mill to return to its annual authorized production capacity of 550,000 metric tons. The mill gradually increased its production over a four-month period starting in March 2008 and reached full capacity in June 2008. The suspension of operations at the Valdivia Mill adversely affected our business, financial condition, results of operations and cash flows. Any future suspension of operations at the Valdivia Mill or at any other of our significant operating plants can be expected to have similar adverse effects. We offer no assurance that the Valdivia Mill will be able to operate without further interruption. See “Item 3. Key Information—Risk Factors—Risks Relating to Arauco and the Forestry Industry—Environmental concerns led us to temporarily suspend our operations at the Valdivia Mill, which adversely affected, and in the future may continue to adversely affect, our business, financial condition, results of operations and cash flows” and “Item 4. Information on the Company—Description of Business—Pulp—Pulp mills—Chile—Valdivia Mill.”

In June 2007, we submitted to the COREMA of the Tenth Region of Chile an environmental impact study for the implementation of substantial technological improvements on the quality of the effluents generated by the Valdivia Mill. On June 30, 2008, the COREMA approved that environmental impact study. However, the approval was subject to certain conditions that, in the opinion of Arauco, affected the feasibility of the project. For such reason, Arauco filed an appeal (recurso de reclamación) before the Directive Council (Consejo Directivo) of the Environmental National Commission (Comisión Nacional del Medio Ambiente), or CONAMA, challenging the conditions. Such appeal (recurso de reclamación) was partially accepted by the CONAMA. However, some of the conditions that affect the feasibility of the project were maintained. As a consequence, on September 17, 2009, we presented another appeal (recurso de reclamación) before the ordinary courts of justice, which appeal has not been resolved as of the date of this annual report.

 

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On February 19, 2009, we submitted to the COREMA of the Fourteenth Region of Chile an environmental impact study for the construction of a pipeline to discharge the Valdivia Mill’s wastewater in the Pacific Ocean near Punta Maiquillahue, that is, in a body of water other than the Cruces River, the Carlos Anwandter Nature Sanctuary or their sources. The pipeline would transport the wastewaters of the Valdivia mill through an extension of 37 kilometers from the Valdivia mill to Punta Maiquillahue and would finally discharge the wastewater two kilometers inside the Pacific Ocean. Such environmental impact study was approved with certain conditions by the COREMA by resolution dated February 24, 2010. We have challenged some of these conditions before the Directive Council (Consejo Directivo) of the CONAMA. As of the date of this annual report, the Directive Council of the CONAMA has not resolved the action presented by us. As stated in the environmental impact study, the construction of this pipeline will commence once (i) the COREMA approves the environmental impact study in its final form, and (ii) all necessary permits for the construction of the pipeline have been issued by the competent authorities. In the environmental impact study, we estimated that the construction of the pipeline will take 24 months. Once the construction of the pipeline has been completed, we will conduct a 6-month trial phase of the pipeline and will then begin normal operations.

Approvals by the COREMA and the judicial courts, as well as the construction and operation of the pipeline are each subject to many environmental, regulatory, engineering and political uncertainties. As a result, we cannot provide any assurances that the projects will be finally approved as requested or completed. If our request for the necessary permits for the construction of the pipeline is rejected, or if the installation of the pipeline is delayed for reasons attributable to us, we may face sanctions that include warnings, fines or the revocation of the Valdivia Mill’s environmental permit for operation. Alternatively, if any rejections or delays are attributable to reasons beyond our control (such as a force majeure or the acts of a third party), we believe that the Chilean environmental authorities should extend the applicable deadlines for the completion of these projects. However, we can provide no assurances that any deadline extensions would be granted, even if we comply with all the requirements that may be set forth by those authorities. See “Item 3. Key Information—Risk Factors—Risks Relating to Arauco and the Forestry Industry—Environmental concerns led us to temporarily suspend our operations at the Valdivia Mill, which adversely affected, and in the future may continue to adversely affect, our business, financial condition, results of operations and cash flows” and “Item 4. Information on the Company—Description of Business—Pulp—Pulp mills—Chile—Valdivia Mill.”

As part of the environmental resolution that modified the Valdivia Mill environmental permit in 2005, the COREMA of the Tenth Region asked CONAF to elaborate an Integral Environmental Management Plan for the wetland, which was completed in 2006. The plan concluded that there was a need to develop a Conceptual Ecosystem Model for the wetland. CONAF selected the Science Faculty of the University of Chile to conduct this study.

The study indicated in its second progress report that the disappearance of the “luchecillo,” a water weed that was an important food source of black-necked swans, was likely related to natural causes. Specifically, the study proposed that the disappearance of the “luchecillo” was caused by the convergence of three factors in May 2004: (i) low levels of precipitation, (ii) low levels of water flow in the rivers and the wetland and (iii) three instances in which temperatures reached zero degrees Celsius or lower. According to the study, the simultaneous occurrence of these factors was likely responsible for the disappearance of the “luchecillo” which, in turn, lead to the death and migration of the swans. This second progress report was followed by a final report issued by the Science Faculty of the University of Chile, which was not approved by CONAF.

Nueva Aldea

In January 2001, we obtained environmental approval for the Nueva Aldea Project that included the construction of a pulp mill with an annual production capacity of 550,000 metric tons. After obtaining approval, we determined that we could increase the annual production capacity of the mill to 856,000 tons without an additional environmental impact study. However, the COREMA for the Eighth Region of Chile determined that it was necessary to formally review the difference in capacity before we proceeded with construction, and in August 2004,

 

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we submitted a new environmental impact study that considered the higher capacity. In September 2004, while this new study was under consideration, we began construction of the pulp mill according to the parameters approved in 2001. The COREMA for the Eighth Region of Chile disagreed with our decision and, on January 12, 2005, initiated an administrative proceeding and ordered suspension of construction of the mill until the new environmental impact study was approved.

On March 10, 2005, the COREMA for the Eighth Region of Chile unanimously approved the new study and expressly authorized construction of the mill with installed annual capacity of 856,000 metric tons. We promptly resumed the construction of the pulp mill. The COREMA for the Eighth Region of Chile’s new approval requires submission of a new environmental impact study of the discharge of wastewater through a pipeline into the sea. On February 20, 2006, the COREMA of the Eighth Region of Chile approved this new environmental impact study.

Licancel Mill

In June 2007, our operations at the Licancel Mill, a pulp mill located in the Seventh Region of Chile, became subject to environmental scrutiny by Chilean environmental regulators and the public. On June 5, 2007, in connection with the death of fish in the Mataquito River, approximately 15 kilometers downstream of the mill, we suspended our operations in the Licancel Mill as a preventive measure. In addition, Chilean authorities, including the health authorities and the Superintendencia de Servicios Sanitarios (Sanitary Services Superintendency), required that we suspend activities at the Licancel Mill and that we suspend any further discharges into the river. On June 18, 2007, as a result of a pipe leakage in the effluent treatment system currently in place at the Licancel Mill, an estimated 50 cubic meters of effluents reached the Mataquito River. On that same date, we decided to close the mill indefinitely and informed the Sanitary Services Superintendency of the incident. On October 3, 2007, we requested to the health authority (Autoridad Sanitaria) of the Seventh Region of Chile that it remove the suspension of activities at the Licancel Mill. On October 22, 2007, the health authority of the Seventh Region of Chile removed the suspension and imposed certain conditions relating to our activities in the mill consisting primarily of the implementation of certain emergency detection and control programs and systems, with which we have complied. Furthermore, on November 12, 2007 the Sanitary Services Superintendency removed the suspension regarding the release of discharges by the Licancel Mill. The mill resumed operations during January 2008, using the new effluent treatment system in which we invested U.S.$8 million during 2007.

On September 7, 2007, the National Defense Council instituted a civil lawsuit seeking reparations, damages and indemnification from us for environmental harm allegedly caused by the Licancel Mill. The National Defense Council agreed to terminate this lawsuit pursuant to an agreement with Arauco dated January 29, 2010. However, the resolution that approved the agreement and declared the lawsuit terminated was challenged by certain third parties, which challenge was rejected by the court. Several other proceedings have been commenced as a result of the event at the Licancel Mill, including one proceeding arising from the death of fish at the Mataquito River.

Tax Litigation in Argentina

On December 14, 2007, Argentina’s internal revenue service (AFIP), notified our Argentine subsidiary, Alto Paraná S.A., of a claim for unpaid taxes in the amount of approximately AR $418 million (including principal, interest and penalties), arising from a dispute regarding certain income tax deductions taken by Alto Paraná S.A. in connection with certain debt service payments made beginning in 2001 in respect of outstanding bonds. On February 8, 2010, Argentina’s Tribunal Fiscal de la Nación issued an unfavorable administrative ruling requiring that Alto Paraná S.A. satisfy the abovementioned claim.

Alto Paraná’s legal and tax advisors continue to believe that this claim lacks merit, and as a result, Alto Paraná has appealed the decision to the Court of Appeals. Alto Paraná also filed an injunctive action requesting that the court stay the company’s payment obligation until the appeal has been fully resolved. On May 13, 2010, the Court of Appeals granted the request in exchange for a guarantee by Alto Paraná until the final judgment has been issued.

 

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Tax Litigation in Chile

On August 25, 2005, the Chilean Servicio de Impuestos Internos (the “Chilean IRS”) issued tax calculations No. 184 and No. 185 of 2005 objecting to certain capital reduction transactions effected by Arauco on April 16, 2001 and October 31, 2001, and furthermore, requested reimbursement from the Company for amounts returned to it in respect of certain claimed tax losses. On November 7, 2005, the Company requested a Review of the Supervision Action (Revisión de la Actuación Fiscalizadora, or “RAF”), which is an administrative review of the tax action brought by the Chilean IRS, and subsidiarily, a claim was filed against the abovementioned tax calculations No. 184 and 185 of 2005. The RAF was resolved on January 9, 2009 by the Chilean IRS, which resolution, however, only partially sustained the Company’s request. In response, the Company filed an additional complaint with regard to the portion of the RAF that was not granted by the administrative review. As of the date of this annual report, the investigation in respect of this complaint is pending.

The Company believes that its position in respect of this complaint is supported by solid legal arguments and that there is a reasonable likelihood that this matter will result in a favorable outcome for the Company. However, if this result does not occur, it is possible that an obligation will arise for the amount specified, which was $3,362,265,453 Chilean Pesos, plus any accrued interest as of the payment date.

DIVIDEND POLICY

Chilean law currently requires that, unless otherwise decided by the unanimous vote of our issued and subscribed shares eligible to vote, public corporations distribute a cash dividend in an amount equal to at least 30% of the corporation’s consolidated net income for each year on the basis of IFRS, unless and except to the extent the corporation has unabsorbed losses from prior years. In April 2002, our shareholders approved the current dividend policy, setting the cash dividend at 40% of our consolidated net income for each year which was determined on a Chilean GAAP basis through the year ended December 31, 2008, and as of January 1, 2009, is now determined on an IFRS basis. In accordance with IFRS, the determination of the dividend amount is based on the effective realized profit net of any relevant variations in the value of unrealized assets and liabilities. For information regarding the differences between Chilean GAAP and IFRS, see note 2 to our audited consolidated financial statements.

On November 27, 2007, our board of directors approved a provisory dividend for U.S.$0.95 per share, which was distributed on December 12, 2007 and charged to net income. On April 22, 2008, our shareholders approved a final dividend for 2007, which was distributed on May 7, 2008. On November 25, 2008, our board of directors approved a provisory dividend for U.D.$0.89 per share, which was distributed on December 10, 2008 and charged to net income. On April 23, 2009, our shareholders approved a final dividend for 2008, which was distributed on May 7, 2009. In the aggregate, dividends distributed equaled 40% of our consolidated net income for 2008, on a Chilean GAAP basis. On November 24, 2009, our board of directors approved an interim dividend of U.S.$0.2294 per share, which was distributed on December 11, 2009 and charged to net income. On April 27, 2010, our shareholders approved a final dividend of U.S.$0.5016 per share for 2009, which was distributed on May 11, 2010. In the aggregate, dividends distributed equaled 40% of our consolidated net income for 2009 as determined on an IFRS basis. On November 23, 2010, our board of directors approved an interim dividend of U.S.$0.7557 per share, which was distributed on December 15, 2010 and charged to net income. On April 26, 2011 our shareholders approved a final dividend of U.S.$1.6152 per share for 2010, which was distributed on May 11, 2011. Dividends distributed equaled 40% of our consolidated net income for 2010 as determined on an IFRS basis.

Although the board of directors has no current plans to recommend changes in our dividend policy, the policy has been changed in the past and no assurance can be given that the policy will not be changed in the future, due to changes in Chilean law, capital requirements, operating results or other factors.

 

Item 9. The Offer and Listing

Neither our stock nor our SEC-registered securities are listed on any stock exchange or other regulated market.

Trading in our securities takes place primarily in the over-the-counter market. Accordingly, we are unable to obtain reliable information on such trading.

 

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Item 10. Additional Information

ARTICLES OF INCORPORATION AND BY-LAWS

When we refer to the “Company,” “Arauco” or “we,” in this description of the articles of incorporation and by-laws, we mean Celulosa Arauco y Constitución S.A.

Organization and Registration

We are a corporation (sociedad anónima) organized in Chile under the laws of Chile, subject to certain rules applicable to Chilean public corporations (sociedades anónima abiertas) and registered on August 18, 1971, by resolution 300-S of the Chilean Securities Commission and recorded in the Santiago Commercial Register of 1971 on page 6433 under entry number 2994 and on page 6431 under entry number 2993. Notice was published in the Official Gazette on September 4, 1971.

Objects and Purposes

Our purpose, as stated in our by-laws (estatutos), includes the manufacture of forestry products, the management of forestry lands and other activities.

Capital

In 2002, our by-laws were amended such that our capital is denominated in U.S. dollars. In 2002, we and two of our subsidiaries, Aserraderos Arauco and Paneles Arauco, received authorization from the Chilean Internal Tax Service to prepare our audited consolidated financial statements in U.S. dollars, beginning January 1, 2002. In January 1, 2003, our subsidiaries Forestal Arauco, Bosques Arauco, Forestal Valdivia, Forestal Celco and Cholguán obtained the same permission from the Chilean Internal Tax Service.

Directors

Pursuant to our by-laws, our board of directors is composed of nine members elected by a general meeting of our shareholders. Our directors are not required to be shareholders. Our by-laws state that the amount of compensation to be received by the directors for their directorial services shall be fixed by the general shareholders’ meeting. Directors may be compensated for any non-directorial services rendered to us at levels of compensation comparable with compensation commonly paid for these services, compensation which is compatible with the directors’ compensation fixed by the general shareholders’ meeting. The by-laws also state that our board of directors has all of the authorities of administration and disposal that Chilean law or the by-laws do not confer upon the general shareholders’ meeting. The board of directors has the right to act on our behalf without the need for a special power of attorney, even in cases where a power of attorney is required by law. In particular, the by-laws provide that the board of directors is empowered to encumber our assets, real and personal property with mortgages, easements or pledges regardless of the value of such property or the amount of the respective encumbrances and to borrow money paying interest, with or without a guaranty for the loan.

Our by-laws provide that we may enter into acts or contracts in which one or more directors are interested only if the interested director’s interest is made known to the board, the acts or contracts are approved by the board and the terms of the act or contract conform to those prevailing in the market. In addition, board resolutions approving interested director transactions must be reported by the chair of the meeting at the first general shareholders’ meeting following the approval of the interested director transaction.

See “Item 6. Directors, Senior Management and Employees” for further information about our board of directors.

 

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Shareholders

Our share capital consists of ordinary shares of no par value issued in registered form. Record holders of shares are registered in our share register. Any transfer of shares must be noted in our share register.

Voting Rights

Each share of our stock entitles the holder to one vote at any meeting of shareholders. Resolutions may be taken upon a vote of an absolute majority of the voting shares present or represented. Any resolution relating to amendments to our by-laws must be approved by an absolute majority of the voting shares issued. Resolutions with regard to the following matters, among others, require the affirmative vote of two-thirds of the voting shares issued:

 

   

transformation, including division or merger with another company;

 

   

advanced dissolution;

 

   

change of corporate domicile;

 

   

reduction in our equity capital;

 

   

approval and appraisal of non-cash capital contributions;

 

   

reduction in the number of members of the board of directors;

 

   

the disposal of 50% or more of our assets, whether or not such disposal also includes any of our liabilities; the disposal of 50% or more of the assets of one our subsidiaries, provided that such subsidiary represents at least 20% of our assets; and any disposal of shares by the company that causes us to lose control of a subsidiary that represents at least 20% of our assets; and

 

   

changes to the way in which corporate benefits will be distributed.

According to our by-laws, holders of our shares also have the right to vote at the general shareholders’ meeting for the election of directors. Shareholders or their representatives may accumulate their votes in favor of one candidate or distribute them among various candidates. A vote on the election of directors may be omitted if an election is proposed by acclamation and none of the shareholders present or represented opposes the motion. The board of directors may also be dismissed by a regular or special general shareholders’ meeting, though the shareholders may only vote to dismiss the board as a whole.

Changes to Shareholders’ Rights

To change the rights of holders of our shares or create a new series of our shares, we must amend our by-laws. Any reduction in the number of our shares requires a two-thirds majority vote of all holders of our shares under Chilean law. Chilean law also requires that public corporations distribute a cash dividend in an amount equal to at least 30% of the corporation’s consolidated net income for each year (on an IFRS basis), unless otherwise decided by a unanimous vote of the corporation’s issued and subscribed shares eligible to vote. Any changes to the way in which corporate benefits are distributed must be approved by a two-thirds majority of all holders of the corporation’s shares.

Shareholders’ Meetings

Our by-laws provide that the board of directors shall call general shareholders’ meetings. Notice of general shareholders’ meetings must be made by a prominent notice published at least three times, on different days, in the newspaper of one of our corporate domiciles, as determined by a general shareholders’ meeting, or in the absence of a determination, in the Official Gazette.

 

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A shareholder must be registered in our share register as of the meeting date to be entitled to participate and vote at any shareholders’ meeting. In addition, other persons may represent shareholders at general meetings. Powers of attorney must be given in writing and must be granted with respect to all of the shares the shareholder is entitled to vote as of the date five days before the general shareholders’ meeting.

General shareholders’ meetings may be regular or special meetings. Regular shareholders’ meetings are held once a year within the first four months of the year. Among other things, the regular general shareholders’ meeting appoints independent external auditors to examine our accounts, inventory, balance sheet and other financial results. The by-laws provide that the following matters are to be considered at regular shareholders’ meetings:

 

   

the review of our results of operations and external auditors’ reports and the approval or rejection of our annual report, our balance sheet and financial statements;

 

   

the distribution of profits of each financial period and the distribution of our dividends;

 

   

the election or dismissal of the members of the board of directors; and

 

   

any matter of corporate interest that is not transacted at a special general shareholders’ meeting.

Special shareholders’ meetings may be held at any time required by corporate needs to consider any matter that the law or our by-laws require to be considered at a general shareholders’ meeting. Our by-laws require the meeting notice to disclose any matters to be discussed at a special shareholders’ meeting. According to the by-laws, the following matters must be considered at special shareholders’ meetings:

 

   

dissolution;

 

   

transformation, merger or division and the amendment of our by-laws;

 

   

the issue of bonds or debentures convertible into shares;

 

   

the disposal of 50% or more of our assets, whether or not such disposal also includes any of our liabilities; the disposal of 50% or more of the assets of one our subsidiaries, provided that such subsidiary represents at least 20% of our assets; and any disposal of shares by the company that causes us to lose control of a subsidiary that represents at least 20% of our assets; and

 

   

the grant of real or personal guarantees to secure obligations of third parties, unless they are subsidiaries, in which case the approval of the board of directors will be sufficient.

Any other matters within the competence of general shareholders’ meetings may be considered at special shareholders’ meetings.

Any act of a general shareholders’ meeting relating to our dissolution, transformation, merger or division, the amendment of our by-laws, any disposal of 50% or more of our assets or the issue of bonds convertible into shares or convertible debentures must be held before a notary public, who must certify that the minutes of such meeting are the true expression of what occurred and was resolved at such meeting.

Allocation of Net Income and Distribution of Dividends

Our by-laws provide that the shareholders at a general shareholders’ meeting shall determine the annual distribution of our net profits for each financial period, within the limitations prescribed by law. The shareholders shall also set the date on which any distribution shall be paid, within the time limits prescribed by law. Chilean law prescribes that distributions shall be paid within 30 days of the general shareholders’ meeting at which such distribution was determined.

 

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In accordance with Chilean law, in the event of liquidation, capital can be distributed to the shareholders only after the rights of the creditors have been secured or debts owed to creditors have been paid. Our by-laws provide that a general shareholders’ meeting will appoint one or more liquidators to carry out the liquidation and to call shareholders’ meetings, as required under Chilean law.

Regulation of and Restrictions on Foreign Investors

There are no limitations on the rights to hold securities, including rights of non-resident or foreign shareholders to hold or exercise voting rights on securities.

Disclosure of Shareholder Ownership

We register certain information about our shareholders in our shareholder registry. We are required to disclose this information to the Chilean Securities Commission on a quarterly basis.

Rights of Shareholders

Our by-laws provide that, in the case of a dispute between shareholders or between shareholders and management, the parties will submit their dispute to a mixed arbitrator, who may determine the procedural rules to be used in the arbitration but must issue a final judgment in accordance with Chilean law. Subject to limited exceptions, the arbitrator’s judgment shall not be subject to appeal. The parties shall appoint the arbitrator by mutual agreement and if no agreement is reached, an arbitrator will be appointed by the civil court system from among present and former associate justices of the Supreme Court of Justice of Chile.

EXCHANGE CONTROLS

The Central Bank is responsible for, among other things, monetary policies and exchange controls in Chile. Prior to 1989, Chilean law permitted the purchase and sale of foreign currency only in cases explicitly authorized by the Central Bank. Law No. 18,840, the Organic Law of the Central Bank of Chile (Ley Orgánica Constitucional del Banco Central de Chile), or the Central Bank Act, enacted in 1989, liberalized the rules that govern the ability to buy and sell foreign currency.

The Central Bank Act empowers the Central Bank to determine which types of foreign exchange operations must be carried out in the Formal Exchange Market rather than the Informal Exchange Market (Mercado Cambiario Informal). The Central Bank has ruled that certain foreign exchange transactions, including those attendant to foreign investments and bond issuances, may be effected only in the Formal Exchange Market. The Central Bank may also impose restrictions on foreign exchange operations that are conducted or are required to be conducted in the Formal Exchange Market. These restrictions may include the requirement of prior authorization from the Central Bank, the imposition of reserve requirements and the limitation of foreign exchange operations that may be conducted by the entities that participate in the Formal Exchange Market.

The Formal Exchange Market consists of banks and other entities authorized by the Central Bank to participate in such Formal Exchange Market. On April 16, 2001, the Central Bank agreed that, effective April 19, 2001, the prior foreign exchange restrictions would be eliminated and a new Compendium of Foreign Exchange Regulations (Compendio de Normas de Cambios Internacionales) would be applied.

The main objective of this change was to facilitate capital movements from and into Chile and to encourage foreign investment.

The following specific restrictions were eliminated:

 

   

a reserve requirement with the Central Bank for a period of one year;

 

   

the requirement for prior approval by the Central Bank for certain operations, such as repatriation of investments and payments to foreign creditors;

 

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the mandatory return of foreign currencies to Chile; and

 

   

the mandatory conversion of foreign currencies into Chilean pesos.

Under the amended regulations, only the following limitations are applicable to these operations:

 

   

the Central Bank must be provided with information related to certain operations, such as foreign investments and foreign credits; and

 

   

certain operations, such as money transfers to and from Chile related to foreign investments and foreign credits, must be conducted within the Formal Exchange Market.

International Issue of Bonds

Before April 19, 2001, any international issue of bonds was subject to approval by the Central Bank after submission of an application to the Central Bank through a bank or other participant in the Formal Exchange Market. Absent the Central Bank’s authorization, issuers were unable to offer bonds outside of Chile. On April 19, 2001, the Central Bank issued new foreign exchange regulations, effective as of March 1, 2002, that were included in the new Chapters XIV and VIII of the Compendium, applicable to bond issues made either from Chile or through an agency abroad. It must be noted however, that all debt issues made before the new regulations remain subject to the regulations existing at the time of their issue.

Debt securities issued directly by us

In accordance with the regulations issued by the Central Bank, which are included in the new Chapter XIV of the Compendium, any international issue of bonds in an aggregate amount exceeding U.S.$1,000,000 must be registered and dated by the Central Bank or by a bank or other entity authorized by the Central Bank to participate in the Formal Exchange Market before the proceeds from the issuance can be remitted to Chile and received by the issuer or simultaneously with the remittance into Chile of such proceeds. The issuer must submit forms regarding the offering to the registering entity or directly to the Central Bank, along with a letter of instructions indicating whether it prefers to receive the proceeds in Chilean pesos or in a foreign currency. If presented through a Formal Exchange Market entity, such entity must, in turn, verify that the forms submitted by the issuer are in accordance with the documentation relating to the issue and inform the Central Bank of the operation no later than 11:00 a.m. on the banking business day following the date on which the proceeds of the issue are transferred to the issuer.

If the issuer opts to receive the proceeds of the issue outside of Chile, it must report this to the Central Bank directly or through a Formal Exchange Market entity during the first ten calendar days of the month following the one in which the proceeds were received.

Chapter XIV of the Compendium also states that proceeds from the issue, as well as payment of capital and interest relating to the issue, must be received and sent from and through the Formal Exchange Market, but purchases of U.S. dollars in connection with payments on debt securities issued directly by us can be made either in the Formal or in the Informal Exchange Market. There can be no assurance, however, that we will be able to purchase U.S. dollars in the Informal Exchange Market or in the Formal Exchange Market at the time or in the amounts required to pay debt service related to any such debt securities. There can also be no assurance that further Central Bank regulations or legislative changes to the current foreign exchange control regime in Chile would not restrict or prevent our purchase of U.S. dollars to make payments under our securities.

In the case of debt securities issued directly by us before the effectiveness of the new regulations, the registration of the debt securities with the Central Bank grants us access to the Formal Exchange Market for the purchase of U.S. dollars necessary to make payments in respect of those securities but requires that payments on such debt securities shall be made only with U.S. dollars purchased in the Formal Exchange Market.

We will also be required to inform the Central Bank quarterly of the outstanding amounts due under our securities and from time to time of any information that has been previously filed.

 

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The regulations of Chapter XIV of the Compendium do not make any reference to the one-year mandatory deposit in the Central Bank that was previously required by Chapter XIV. However, the Central Bank is authorized, under the Central Bank Act, to impose such a requirement.

Debt securities issued through our Panamanian agency

In December 1996, we established a registered agency in Panama. We may from time to time issue debt securities directly or through our Panamanian agency depending on, among other factors, whether or not we expect to bring the proceeds thereof into Chile. In such cases, the proceeds of such issuance of the notes may be brought into Chile or held abroad. In either case, however, in accordance with Chapter VIII of the Compendium, we were required to inform the Central Bank of the issuance of international bonds through our Panamanian agency during the first ten calendar days of the month following the one in which the disbursement of funds to the agency was produced, and provide the schedule of payments of the notes. On December 27, 2007, the requirement to provide such information to the Central Bank was eliminated. We will no longer be required to inform the Central Bank of future issuances of bonds made through our Panamanian agency.

Purchases of U.S. dollars in connection with payments on debt securities issued through our Panamanian agency, whether before or after April 19, 2001, can be made either in the Formal Exchange Market or in the Informal Exchange Market. Although we were required to inform the Central Bank of the issuance of debt securities through our Panamanian agency, such communication to the Central Bank did not give us access to the Formal Exchange Market for the purchase of U.S. dollars necessary to make payments in respect of those debt securities.

There can be no assurance that we will be able to purchase U.S. dollars in the Informal Exchange Market or in the Formal Exchange Market at the time or in the amounts required to pay debt service related to any such debt securities. There can also be no assurance that further Central Bank regulations or legislative changes to the current foreign exchange control regime in Chile and will not restrict or prevent our purchase of U.S. dollars to make payments under our securities from Chile.

TAXATION

General

The following summary contains a description of the principal Chilean and United States federal income tax consequences of the purchase, ownership and disposition of our securities, but it does not purport to be a comprehensive description of all the tax considerations that may be relevant to a decision to purchase our securities. This summary does not describe any tax consequences arising under the laws of any state, locality or taxing jurisdiction other than the United States and Chile.

This summary is based on the tax laws of Chile and the United States as in effect on the date of this Form 20-F, as well as regulations, rulings and decisions of Chile and the United States available on or before such date and now in effect. All of the foregoing is subject to change, and any changes could apply retroactively and could affect the continued validity of this summary.

Prospective purchasers of our securities should consult their own tax advisors as to the Chilean, United States or other tax consequences of the purchase, ownership and disposition of our securities, including, in particular, the application to their particular situations of the tax considerations discussed below, as well as the application of state, local, foreign or other tax laws.

Chile and the United States have executed an income and capital tax treaty for the avoidance of double taxation and the prevention of fiscal evasion, but this treaty is not in effect, and its effectiveness is contingent upon ratification in the United States Senate and by the Chilean Congress. At this time it is not clear when the United States Senate and the Chilean Congress will consider ratification, and therefore the effective date of the treaty is uncertain.

 

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Chilean Taxation

The following is a general summary of the principal consequences under Chilean tax law, as currently in effect, of an investment in our securities made by a foreign holder. Foreign holder means either:

 

   

in the case of an individual, a person who neither is a resident nor is domiciled in Chile. For Chilean tax purposes, an individual is domiciled in Chile if such individual has his or her principal place of business in Chile. The individual will be considered as a resident if she or he stays in Chile for more than six months in one calendar year or a total of more than six months in two consecutive fiscal years; or

 

   

in the case of a legal entity, a legal entity that is not organized under the laws of Chile, unless our securities are assigned to a branch or a permanent establishment of such entity in Chile.

Under Chile’s income tax law, our payments of interest made from Chile in respect of our securities to a foreign holder will generally be subject to a Chilean withholding tax assessed at a rate of 4.0% (the “Chilean Interest Withholding Tax”).

We have agreed, subject to specific exceptions and limitations, to pay to the foreign holders of notes additional amounts in respect of the Chilean Interest Withholding Tax in order to ensure that the interest amount the foreign holder receives is net of Chilean Interest Withholding Tax. If we pay additional amounts in respect of the Chilean Interest Withholding Tax, any tax refunds in respect of these amounts will be for the benefit of the company. In the event that certain changes in Chilean tax laws require us to pay additional interest amounts in respect of the Chilean Interest Withholding Tax at a rate in excess of 4.0%, we have the right to redeem our securities.

Under existing Chilean law and regulations, a foreign holder will not be subject to any Chilean taxes in respect of payments of principal that we make with respect to our securities. Our payments with respect to our securities of amounts not considered principal or interest may be subject to a Chilean withholding tax of up to 35%.

The Chilean Income Tax Law provides that a foreign holder is subject to income tax on his Chilean source income. For this purpose, Chilean source income means earnings from activities developed in Chile or goods located in the country. According to the Chilean Income Tax Law, the source of interest income corresponds to the residence country of the debtor. Under these rules, the capital gain realized on the sale or other disposition by a foreign holder of our securities will be generally subject to taxes on capital gain.

A foreign holder will not be liable for gift, inheritance or similar taxes with respect to its holdings unless the securities held by a foreign holder:

 

   

are located in Chile at the time of such foreign holder’s death, or

 

   

are located outside of Chile, but were purchased or acquired with funds derived from Chilean source income.

A foreign holder should not be liable for Chilean stamp, registration or similar taxes.

The issue of our securities directly by us was subject to the Chilean stamp tax, which we paid. The issue of our securities through our Panamanian Branch was not subject to a stamp tax.

United States Taxation

This summary of certain United States federal income tax considerations deals principally with United States Holders that acquired our securities as part of the initial offering of our securities, hold our securities as capital assets and whose functional currency is the United States dollar. It does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular investor, and generally does not

 

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address the tax treatment of United States Holders that may be subject to special tax rules, such as banks, financial institutions, tax-exempt entities, regulated investment companies, real estate investment trusts, insurance companies, partnerships and partners therein, dealers in securities or currencies, traders in securities electing to mark to market, certain short-term holders of our securities, persons that will hold our securities as a position in a “straddle” or conversion transaction, or as part of a “synthetic security” or other integrated financial transaction, persons that own (or are deemed to own for United States tax purposes) 10% or more of our voting stock or persons that are not United States Holders. United States Holders should be aware that the U.S. federal income tax consequences of holding our securities may be materially different for investors described in the previous sentence, including as a result of certain laws applicable to investors with short holding periods or that engage in hedging transactions.

As used under this section “United States Taxation,” the term “United States Holder” means a beneficial owner of a Note that is a citizen or resident of the United States or a United States domestic corporation or that otherwise is subject to United States federal income taxation on a net income basis in respect of our securities.

Taxation of Interest and Additional Amounts

A United States Holder will treat the gross amount of interest and Additional Amounts (i.e., without reduction for Chilean Interest Withholding Tax, determined utilizing the 4.0% Chilean Interest Withholding Tax rate applicable to all United States Holders of our securities) as ordinary interest income in respect of our securities at the time that such payments are accrued or are received, in accordance with the United States Holder’s method of tax accounting. Any Chilean Interest Withholding Tax paid will be treated as foreign income taxes eligible for credit against such United States Holder’s United States federal income tax liability, subject to generally applicable limitations and conditions, or, at the election of such United States Holder, for deduction in computing such United States Holder’s taxable income. Interest and Additional Amounts will constitute income from sources outside the United States for foreign tax credit purposes. Such income generally will constitute “passive category income.” Foreign tax credits will not be allowed for withholding taxes imposed in respect of certain short-term or hedged positions in securities and may not be allowed for withholding taxes imposed in respect of arrangements in which a United States Holder’s expected economic profit is insubstantial. United States Holders should consult their own advisors concerning the implications of these rules in light of their particular circumstances.

The calculation of foreign tax credits and, in the case of a United States Holder that elects to deduct foreign taxes, the availability of deductions, involves the application of rules that depend on a United States Holder’s particular circumstances. United States Holders should consult their own tax advisors regarding the availability of foreign tax credits and the treatment of Additional Amounts.

A Holder of our securities that is, with respect to the United States, a foreign corporation or a nonresident alien individual (a “Non-U.S. Holder”) generally will not be subject to United States federal income or withholding tax on interest income or Additional Amounts earned in respect of our securities, unless such income is effectively connected with the conduct by the Non-U.S. Holder of a trade or business in the United States.

Taxation of Dispositions

Gain or loss realized by a United States Holder on the sale, redemption or other disposition of our securities generally will be treated as capital gain or loss and such gain or loss will be long-term capital gain or loss if at the time of the disposition, our securities have been held for more than one year. The net amount of long-term capital gain realized by a United States Holder that is an individual is generally taxed at a reduced rate. Gain, if any, realized by a United States Holder generally will be treated as U.S. source income for U.S. foreign tax credit purposes.

A Non-U.S. Holder of our securities will not be subject to United States federal income or withholding tax on gain realized on the sale or other disposition of our securities unless (i) such gain is effectively connected with the conduct by the Non-U.S. Holder of a trade or business in the United States or (ii) in the case of gain realized by an individual Non-U.S. Holder, the Non-U.S. Holder is present in the United States for 183 days or more in the taxable year of the sale and certain other conditions are met.

 

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Backup Withholding and Information Reporting

Payments of principal, premium, if any, and interest on our securities and payment of the proceeds of any disposition of our securities made to certain United States Holders may be subject to U.S. information reporting requirements. In addition, certain United States Holders may be subject to a U.S. backup withholding tax in respect of such payments if they do not provide their taxpayer identification numbers to the payor or otherwise establish an exemption. Non-U.S. Holders generally are exempt from these withholding and reporting requirements, but may be required to comply with applicable certification and identification procedures to establish their eligibility for such an exemption.

DOCUMENTS ON DISPLAY

We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended. In accordance with these requirements, we file reports and other information with the Securities and Exchange Commission. These materials, including this Annual Report and the exhibits thereto, may be inspected and copied at the Commission’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of the materials may be obtained from the Public Reference Room at the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. In addition, the Commission maintains an Internet website at http://www.sec.gov, from which these materials may be electronically accessed. The public may obtain information on the operation of the Commission’s Public Reference Room by calling the Commission in the United States at 1-800-SEC-0330.

 

Item 11. Quantitative and Qualitative Disclosures About Market Risk

The following discussion about our risk management activities includes forward-looking statements that involve risk and uncertainties. Actual results could differ materially from those projected in such forward-looking statements.

We are exposed to market risk from changes in interest rates and currency exchange rates. From time to time, we assess our exposure and monitor opportunities to manage these risks, including entering into derivative contracts. In the normal course of business, we also face risks that are either non-financial or non-quantifiable. Such risks principally include country risk, credit risk and legal risk and are not represented in the tables below.

Interest rate risk

Interest rate risk exists principally with respect to our indebtedness that bears interest at floating rates. At December 31, 2010, we had outstanding U.S.$3,388.7 million of long-term indebtedness, excluding accrued interest, of which 89.8% bore interest at fixed interest rates and 10.2% bore interest at floating rates of interest. These average rates do not reflect the effect of swap agreements. 79.6% of the indebtedness was denominated in U.S. dollars as of that date. The interest rate on our variable rate debt is determined principally by reference to LIBOR.

The following table summarizes our long-term debt obligations, including 2010 maturities, at December 31, 2010. These obligations are sensitive to changes in interest rates. The table presents the aggregate principal amount of each category of indebtedness maturing in each year, at the weighted average interest rate for each category of indebtedness. Average interest rates for liabilities are calculated based on the prevailing interest rate for each loan at December 31, 2010.

 

     Average
Interest
Rate
    2011      2012      2013      2014      2015      Thereafter      Total Long
Term Debt
     Fair
Value
 

Long-Term Interest Bearing Debt

                         

Fixed Rate

                         

(U.S.$-denominated)

     6.34     387.0            300.0            370.0         1,295.4         2,352.4         2,528.3   

(UF-denominated)

     3.60