20-F 1 d376712d20f.htm FORM 20-F Form 20-F
Table of Contents

As filed with the Securities and Exchange Commission on April 28, 2017

 

 

 

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, 2016

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.: 56-2-2461-7221

E-mail: gianfranco.truffello@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:

7.500% Notes due 2017

7.250% Notes due 2019

5.000% Notes due 2021

4.750% Notes due 2022

4.500% Notes due 2024

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: 113,159,655

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

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

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 ☒  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, a non-accelerated filer, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer      Accelerated Filer  
Non-Accelerated Filer      Emerging Growth Company  

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.  

 

The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

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  ☒

   Other  ☐

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:   Item 17 ☐  Item 18 ☐

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 ☒

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  
PART I       
    Item 1.   

Identity of Directors, Senior Management and Advisers

     1  
    Item 2.   

Offer Statistics and Expected Timetable

     1  
    Item 3.   

Key Information

     1  
    Item 4.   

Information on our 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

     72  
    Item 8.   

Financial Information

     74  
    Item 9.   

The Offer and Listing

     78  
    Item 10.   

Additional Information

     79  
    Item 11.   

Quantitative and Qualitative Disclosures About Market Risk

     88  
    Item 12.   

Description of Securities Other than Equity Securities

     90  
PART II       
    Item 13.   

Defaults, Dividend Arrearages and Delinquencies

     91  
    Item 14.   

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

     91  
    Item 15.   

Controls and Procedures

     91  
    Item 16A.   

Audit Committee Financial Expert

     92  
    Item 16B.   

Code of Ethics

     92  
    Item 16C.   

Principal Accountant Fees and Services

     92  
    Item 16D.   

Exemptions from the Listing Standards for Audit Committees

     93  
    Item 16E.   

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

     93  
    Item 16F.   

Change in Registrant’s Certifying Accountant

     93  
    Item 16G.   

Corporate Governance

     93  
    Item 16H.   

Mine Safety Disclosures

     93  
PART III       
    Item 17.   

Financial Statements

     93  
    Item 18.   

Financial Statements

     93  
    Item 19.   

Exhibits

     94  

 

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CERTAIN TERMS AND CONVENTIONS

Celulosa Arauco y Constitución S.A. is a sociedad anónima (corporation) organized under the laws of the Republic of Chile, and subject to certain rules applicable to sociedades anónimas abiertas (Chilean public corporations). 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; when we refer to “the U.S.,” “U.S.A.,” or “the United States,” we mean the United States of America; and when we refer to “Uruguay,” we mean the Oriental Republic of Uruguay. All references to “tonnes” 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 reais” “Brazilian reals” or “R$” are to Brazilian reais; references to “€” or “euro” are to the euro, the single European currency established pursuant to the European Economic and Monetary Union; references to “Rubles” are to Russian rubles; 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 Instituto Nacional de Estadísticas (Chilean National Institute of Statistics). As of December 31, 2016, one UF equaled U.S.$39.36 and Ch$26,347.96.

PRESENTATION OF FINANCIAL DATA

This report includes the audited consolidated statement of financial position of Arauco and our subsidiaries as of December 31, 2016, and 2015 and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the three years for the period ended December 31, 2016 (collectively, the “audited consolidated financial statements” or “financial statements”). In addition, this report includes selected financial information as of and for the periods ended December 31, 2012, 2013, 2014, 2015 and 2016.

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, 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, 2016, the observed exchange rate for Chilean pesos, as published in the Diario Oficial de la República de Chile (Official Gazette) on January 3, 2017, was Ch$669.47 to U.S.$1.00, and on April 25, 2017, the observed exchange rate was Ch$660.04 to U.S.$1.00. See “Exchange Rates.” 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. 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.

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

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial information as of December 31, 2012, 2013, 2014, 2015 and 2016 and for each of the five 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 the International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB).

 

    As of and for the year ended December 31,  
    2016     2015     2014     2013     2012  
    (in thousands of U.S. dollars, except ratios and share data)  

INCOME STATEMENT DATA

 

Revenue

    4,761,385       5,146,740       5,342,643       5,145,500       4,298,663  

Cost of sales

    (3,498,905     (3,511,425     (3,654,146     (3,557,210     (3,163,432

Gross profit

    1,262,480       1,635,315       1,688,497       1,588,290       1,135,231  

Other income

    257,863       273,026       368,924       385,055       408,251  

Distribution costs

    (496,473     (528,470     (556,837     (523,587     (452,760

Administrative expenses

    (474,469     (551,977     (550,809     (544,694     (479,625

Other expenses

    (77,415     (83,388     (138,769     (136,812     (105,325

Other gains (losses)

    —         —         —         —         16,133  

Finance income

    29,701       50,284       30,772       19,062       23,476  

Finance costs

    (258,467     (262,962     (246,473     (232,843     (236,741

Share of profit (loss) of associates and joint ventures accounted for using equity method

    23,939       6,748       7,481       6,260       18,933  

Exchange rate differences

    (3,935     (41,171     (9,961     (11,797     (17,245

Income before income tax

    263,224       497,405       592,825       548,934       310,328  

Income tax

    (45,647     (129,694     (448,652     (130,357     (166,787
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    217,577       367,711       144,173       418,577       143,541  

BALANCE SHEET DATA

         

Current assets

    2,722,360       2,686,412       3,140,715       2,808,321       2,785,517  

Property, plant and equipment

    6,919,495       6,896,396       7,119,583       7,137,467       6,816,742  

Biological assets (1)

    3,898,991       3,826,597       3,846,353       3,892,203       3,873,070  

Total assets

    14,006,181       13,670,391       14,593,214       14,335,106       14,116,747  

Total current liabilities

    1,346,064       1,034,251       1,547,086       1,682,016       1,546,728  

Total non-current liabilities

    5,660,834       5,989,695       6,231,392       5,608,550       5,604,260  

Issued capital

    353,618       353,618       353,618       353,618       353,176  

Total equity

    6,999,283       6,646,445       6,814,736       7,044,540       6,965,759  

CASH FLOW DATA

         

Net cash flow from operating activities

    773,584       853,650       985,175       897,720       442,394  

Net cash flow from investing activities

    (640,212     (477,780     (655,158     (687,620     (1,345,849

Net cash flow from financing activities

    (38,484     (812,176     (7,885     (7,776     1,055,482  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and equivalents before effect of exchange rate changes

    94,888       (436,306     322,132       202,324       152,027  

OTHER FINANCIAL DATA

         

Capital expenditures (2)

    556,633       564,795       604,155       942,638       1,186,374  

Depreciation and amortization

    409,387       400,145       353,434       298,647       252,381  

Fair value cost of timber harvested (3)

    340,199       306,673       353,273       320,894       311,821  

EBIT (3)

    491,990       710,083       808,526       762,715       523,593  

Adjusted EBITDA (3)

    1,052,142       1,282,443       1,272,209       1,143,382       861,745  

Adjusted EBITDA (3)/finance costs

    4.07       4.88       5.16       4.91       3.64  

Adjusted EBITDA (3)/revenue

    22.1     24.9     23.8     22.2     20.0

Average debt (4)/Adjusted EBITDA (3)

    4.18       3.66       3.97       4.37       4.80  

Total debt (5)

    4,481,003       4,305,435       5,078,430       5,026,494       4,962,116  

Total debt (5)/capitalization (6)

    39.0     39.3     42.7     41.6     41.6

Total debt (5)/equity attributable to parent company

    64.4     65.1     75.0     71.9     72.0

Working capital (7)

    1,376,296       1,652,161       1,593,629       1,126,305       1,238,789  

Number of shares

    113,159,655       113,159,655       113,159,655       113,159,655       113,152,446  

Net income per share (U.S.$ per share)

    1.9       3.2       1.2       3.4       1.2  

Dividends paid

    130,624       143,003       141,089       140,054       196,816  

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

    1.15       1.26       1.25       1.24       1.74  

 

(1) Biological assets refer to our forests and long-standing trees (current and non-current).
(2) Includes capital expenditures in respect of property, plant and equipment and biological assets accrued for the period. Excludes acquisitions of companies.
(3) We calculate EBIT as “net income” before “finance costs,” “finance income” and “income tax.” We calculate EBITDA as EBIT, plus “depreciation and amortization.”

Adjusted EBITDA is calculated by adding “fair value cost of timber harvested,” “exchange rate differences” and other expenses, and deducting “gain from changes in fair value of biological assets” to EBITDA. “Fair value cost of timber harvested” is a non-cash expense included in our cost of sales (as a component of raw materials) that represents the fair value of the wood

 

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harvested and sold from our own plantations, which is commonly excluded from the non-generally accepted accounting principles (non-GAAP) measures used by analysts to compare participants in our industry as it is a non-cash item (purchases of wood from third parties are cash expenses that are not included in “fair value cost of timber harvested”). “Gain from changes in fair value of biological assets” is a gain that does not represent cash flow. We believe that Adjusted EBITDA provides investors with a useful supplemental indicator of the performance of our core business because (i) it cancels out the effects of fair value that are independent of the cost efficiency of our operating facilities and (ii) it excludes the effect of exchange rate differences, which are mainly derived from our debt instruments.

In evaluating the performance of Arauco, we believe that each of these non-GAAP financial measures should be considered together with and should not be considered in isolation, or as a substitute for, the analysis of our results as reported under IFRS. Some of the limitations of our non-GAAP financial measures are that EBIT, EBITDA and Adjusted EBITDA do not reflect: (i) our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (ii) changes in, or cash requirements for, working capital needs; or (iii) the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our outstanding debt.

Because not all companies calculate EBIT, EBITDA or Adjusted EBITDA in the same manner, such measures as calculated by us may differ from such measures calculated by other companies. We compensate for these limitations by using EBIT, EBITDA and Adjusted EBITDA as supplemental measures to monitor our performance and by relying primarily on our financial statements that have been prepared in accordance with IFRS.

The following table presents, for the periods indicated, the reconciliation of EBIT, EBITDA and Adjusted EBITDA to net income.

 

     As of and for the year ended December 31,  
     2016     2015     2014     2013     2012  
     (in thousands of U.S. dollars)  

Net income

     217,577       367,711       144,173       418,577       143,541  

(+) Finance costs

     258,467       262,962       246,473       232,843       236,741  

(-)  Finance income

     (29,701     (50,284     (30,772     (19,062     (23,476

(+) Income Tax

     45,647       129,694       448,652       130,357       166,787  

Adjusted EBIT

     491,990       710,083       808,526       762,715       523,593  

(+) Depreciation and amortization(*)

     409,387       400,145       353,434       317,647       252,381  

EBITDA

     901,377       1,110,228       1,080,362       1,061,362       775,974  

(+) Fair value cost of timber harvested

     340,199       306,673       353,273       320,894       311,821  

(-)  Gain from changes in fair value of biological assets

     (208,562     (210,479     (284,497     (269,671     (243,295
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(+) Exchange rate differences

     3,935       41,171       9,961       11,797       17,245  

(+) Others(**)

     15,193       34,850       31,512       —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

     1,052,142       1,282,443       1,272,209       1,143,382       861,745  

 

(*) See Note 3 of our audited consolidated financial statements for more detail on amortization and depreciation.
(**) “Others” includes other non-cash expenses or gains. For 2016, 2015, and 2014 “Others” included provision for forestry losses.

 

(4) Average debt is calculated as the average of total debt between the beginning and the end of the applicable year.
(5) Total debt is calculated as the sum of other current financial liabilities and other non-current financial liabilities, less hedging instruments.
(6) Capitalization is calculated as total debt, including accrued interest, plus total equity.
(7) Working capital is calculated by subtracting current liabilities from current assets.

 

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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.$  

2012

     519.69        469.65        486.59        479.96  

2013

     533.95        466.50        495.18        524.61  

2014

     621.41        527.53        570.34        606.75  

2015

     715.66        597.10        654.66        710.16  

2016

     730.31        645.22        676.67        669.47  

Months (2016-2017)

                           

November

     679.24        650.72        666.46        673.54  

December

     677.11        649.40        666.97        669.47  

January

     673.36        646.19        660.09        646.19  

February

     648.88        638.35        643.34        648.88  

March

     669.52        650.98        661.86        663.97  

April (through April 25)

     663.97        647.47        654.61        660.04  

 

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 April 25, 2017, the observed exchange rate, as published in the Official Gazette on April 26, 2017, was Ch$660.04 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. Such statements constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the United States Private Securities Litigation Reform Act of 1995, as amended.

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 and timber products in the Chilean, Argentine, Brazilian, Uruguayan and North American export markets, international prices for forestry and sawn timber, the condition of our forests, possible shortages of energy, including electricity, 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, the effects of earthquakes, floods, tsunamis or other catastrophic events and changes in our regulatory environment, including our ability to comply with new or stricter environmental regulations and to resolve environmental liabilities. 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 and sawn timber products are highly correlated with international prices, while panelboards are more closely correlated with local prices. Consequently, the prices that we are able to charge for these products are highly dependent on prevailing international and local prices. Historically, such prices have been subject to substantial variation.

During the period from January 1, 2012 to December 31, 2016, the average price for Norscan bleached softwood kraft market pulp (pulp produced in North American, Nordic and Central European countries and 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.$762.18 per tonne in September 2012 to a high of U.S.$933.68 per tonne in November 2014. NBSK prices averaged U.S.$814.35 per tonne in 2012, and U.S.$856.91 per tonne in 2013. Throughout 2014, NBSK prices maintained a steady upward trend, reaching U.S.$932.15 per tonne in mid-January 2015, mainly driven by increased demand from China. Throughout 2015 and during the first half of 2016, NBSK prices followed a downward trend, decreasing to U.S.$789.2 per tonne at the end of April 2016, as China began to change its economic structure from export-driven growth to domestic-demand-driven growth. In addition, the price gap between both fibers increased, creating incentives for pulp customers to switch from softwood to hardwood, and adding downward pressure to prices. For the remainder of 2016, prices slightly recovered and finally stabilized, ending the year at U.S.$808.83 per tonne.

In the case of bleached hardwood kraft pulp (pulp made from eucalyptus or birch which is sold in Europe, which is the benchmark for Bleached Eucalyptus Kraft Pulp, or “BEKP”), prices ranged from a low of U.S.$648.85 per tonne in January 2012 to a high of U.S.$820.91 per tonne in June 2013. In 2014, two new short fiber pulp mills entered the market with a combined annual production capacity of 2.8 million tonnes. The additional supply caused BEKP prices to decline during the first nine months of 2014, reaching its lowest price at U.S.$724.27 per tonne in September 2015. Thereafter, BEKP began an upward trend, reaching U.S.$811.17 per tonne in November 2015, following increased demand, particularly from China, which was able to absorb the increased supply. However, the expectation of additional supply during 2016 and especially in 2017 continued to place downward pressure on prices, which reached their lowest level of 2016 in December 2016, at U.S.$652.58 per tonne. A new pulp mill located in Indonesia began its ramp-up in November 2016. With an annual capacity of 2.8 million tonnes, it is currently the largest pulp mill worldwide. As the ramp-up of new capacity has been delayed, pulp prices have started to increase during the first part of 2017, reaching U.S.$722.11 per tonne at the end of March 2017.

Although timber products markets improved until mid-year 2015, new competition from countries with depreciated currencies increased supply to our traditional markets, such as North America, which caused average prices to decrease. Markets recovered during 2016, although Latin American exports continued to affect prices in countries such as the United States. The North American market showed an improvement in the construction sector, which provided steady demand.

Global economic conditions may 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.

 

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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. 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. One or more of these factors could materially and adversely affect our business, financial condition, results of operations and cash flows.

Global economic developments, and particularly economic developments in the Asian, European 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 timber 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 timber products. 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 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 lower activity in the United States and Canadian construction markets. Our timber 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 due primarily to the credit crisis and downturn in the real estate market in the United States resulted in our decision to close five sawmills in 2008 and 2009.

A 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.

The financial and economic crisis that affected several European countries between 2009 and 2012 caused a general economic downturn in Europe, which negatively affected the banking and credit systems, employment and production. Thus, demand and prices for pulp and timber declined in the European market.

The devaluation of the Chinese Yuan during the third quarter of 2015 increased volatility in the markets and resulted in a decline in global demand for commodities. Also in 2015, the currencies of several countries depreciated, such as the Canadian dollar, the euro, the Chilean peso, the Brazilian real and the Argentine peso resulting in increased competition in exports, which in turn negatively impacted the average price of our timber products. A similar trend continued throughout 2016, although certain of these currencies recovered compared to the previous year.

Export sales of our timber products to Asia accounted for 8.3% of our revenue in 2016 compared to 9.1% in 2015 and 13.7% in 2014, and export sales of our timber products to North America accounted for 23.4% of our revenue in 2016 compared to 23.2% in 2015 and 21.7% in 2014.

Our business, financial condition, results of operations and cash flows could be materially and adversely affected if the economic conditions in Asia, Europe, the United States and elsewhere abroad deteriorate, and if we are unable to reallocate our sawn timber and other products in 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 2016, export sales, defined as sales out of the country where our goods were produced, accounted for 62.8% of our total revenues. During this period, 51.9% of our export sales were to customers in Asia and Oceania, 21.0% to customers in North America, 10.9% to customers in Europe, 10.0% to customers in Central and South America and 6.2% 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 tsunamis, and we experienced significant business disruption and losses as a result of the February 27, 2010 earthquake.

Our properties in Chile are located in a seismic area that exposes 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, or 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 implemented 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.

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 provided coverage up to an aggregate amount of U.S.$650 million for damages to our property, plant, equipment and inventories, with a deductible of U.S.$1 million for property damage, and for losses due to business interruption caused by such damage after the first 15 days for business interruption. On November 15, 2011, we and the insurers accepted the final report of the insurance adjusters. In accordance with such final report, we received a total recovery of U.S.$532.0 million.

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.

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 waste, the discharge of pollutants and the remediation of contamination. As a forest products manufacturer, we generate air and water emissions and solid and hazardous wastes. These emissions and our waste disposal 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, claims for environmental damages, remediation obligations, the revocation of environmental authorizations or the temporary or permanent closure of facilities. 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 and development 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/or 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, the Arauco Mill, the Nueva Aldea complex, the Licancel Mill and the Constitución Mill. As a result of these proceedings, we have been subject to monetary fines as well as sanctions, including orders to suspend or limit our operations. The operations of the Valdivia Mill recently became subject to the Secondary Water Quality Standard for the Valdivia River Basin (hereinafter, the “Norm” or “SWQSVR”). The Valdivia Mill discharges its treated effluents into the Cruces River, which is part of the Valdivia River Basin. We cannot exclude that the authority declare that the Basin is contaminated and thus initiate an administrative procedure to enact a decontamination plan, which may include limits on discharges of wastewater applicable to the Valdivia Mill.

Arauco expressed concerns, among others, regarding various aspects of the Norm’s General Environmental and Social Impact Assessment (AGIES, for its acronym in Spanish), prior to its enactment. These objections included the lack of identification and consideration for the effective economic and social costs resulting from the adoption of the Norm. Other objections include that the

 

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Norm’s parameters and limits exceed the reviewed water quality criteria enforced by reference countries in both quantity and stringency; and that many of the parameters and limits are not technically or environmentally reasonable. The Company challenged the validity of the Norm before the Third Environmental Court in January 2016. Several technical, economical and legal reports from third parties (scientists, economists and attorneys from different countries) were filed to support the challenge. Other local actors challenged the Norm as well, such as Corporación para el Desarrollo de la Región de Los Rios (Association for the Development of Los Rios Region) CODEPROVAL (for its acronym in Spanish) and the local company Forestal Calle Calle S.A. The Third Environmental Court ruled in our favor on September 29, 2016, declaring the invalidity of the Norm. This decision was challenged by the government before the Supreme Court and a final ruling is expected during 2017.

In the United States, our Moncure mill was subject to an administrative proceeding by the North Carolina Department of Environment and Natural Resources. We negotiated a settlement (Special Order by Consent) in 2015 with the Environmental Management Commission (an agency of the state of North Carolina), which included a monetary fine and an agreement to replace certain emissions control equipment. We expect that the administrative proceeding to be closed by October 1, 2018. In 2016, the Moncure mill was subject to an administrative proceeding for alleged infringements by the North Carolina Department of Environmental Quality (NCDEQ), which is currently ongoing. Corrective actions have been either proposed or executed, including ongoing training, the installation of alarms/interlocks and the installation of certain control devices. These actions are expected to begin and/or be completed by the end of 2017. Our Eugene, Oregon mill was subject to an administrative proceeding by the Lane Regional Air Protection Agency. We negotiated a settlement that included monetary fines and an agreement to implement improvements to certain emissions control equipment and processes. 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 “Item 3. Key Information—Risk Factors—Risks Relating to Us and the Forestry Industry—Environmental concerns led to the temporary suspension of our operations at the Valdivia Mill in 2005, 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 to the temporary suspension of our operations at the Valdivia Mill in 2005, which adversely affected, and in the future may continue to adversely affect, our business, financial condition, results of operations and cash flows.

Our operations at the Valdivia Mill, 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 have been raised regarding the mill’s potential environmental impacts in the area. Primarily, it has been alleged that the mill’s operations impacted the habitat of 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.

Until October 2007, our Valdivia Mill was under the jurisdiction of the COREMA of the Tenth Region of Chile, but due to a change in legislation creating two additional administrative regions in Chile, our Valdivia Mill 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 an environmental impact study for the construction of a pipeline to discharge the Valdivia Mill’s wastewater in the Pacific Ocean near Punta Maiquillahue, complying with the requirement that such wastewater be discharged in a body of water other than the Cruces River, the Carlos Anwandter Nature Sanctuary or their respective sources. In February 2010, through Exempt Resolution No. 27/2010, the COREMA approved this environmental impact study subject to additional conditions, certain of which we challenged before the Directive Council primarily because they would have prohibited the discharge of wastewater into the Cruces River under any circumstance, including emergencies. On October 23, 2012, the Committee of Ministers passed Exempt Resolution No. 1052, which upheld in part our appeal in permitting the discharge into the Cruces River upon the occurrence of certain contingencies that may affect the normal functioning of the conduction system and/or outfall, including bombings or sabotage, natural disasters, or accidents caused by third parties. On March 29, 2010, two Chilean individuals filed a recurso de participación ciudadana (reclamation action) before the COREMA of the Fourteenth Region of Chile, challenging Exempt Resolution No. 27/2010. On April 30, 2013, the Committee of Ministers passed Exempt Resolution No. 391, which upheld in part such reclamation action, modifying certain paragraphs of Exempt Resolution No. 27/2010 (establishing effluent discharge limits for 13 parameters). According to Chilean law, the environmental permit shall expire five years after its issuance, provided that the execution of the respective project had not begun. However, on May 16, 2014, the regional environmental authority issued letter No. 165 in which it recognized that although we have not yet carried out physical works with respect to the project, we have carried out systematic, uninterrupted and permanent activities towards its execution.

The construction and operation of the pipeline requested by the environmental authority in order to discharge the Valdivia Mill’s wastewater in a body of water other than the Cruces River, the Carlos Anwandter Nature Sanctuary or their respective sources, remains subject to many environmental, regulatory, engineering and political uncertainties. As of the date of this annual report, it has not been possible to obtain the relevant permits and authorizations for the project. As a result, we cannot provide any assurances that the project will be completed and that any deadline extensions would be granted, even if we comply with all the requirements that may

 

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be set forth by those authorities. 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. 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, or our other mills, will be able to operate without further interruption. See “Item 8. Financial Information—Legal Proceedings.”

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

In April 2005, the Consejo de Defensa del Estado (National Defense Council), 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 caused in the Carlos Anwandter Nature Sanctuary allegedly caused by effluent discharges from our Valdivia Mill. On July 27, 2013, a civil court of Valdivia ruled that the alleged environmental events were mainly caused by the Valdivia Mill. We decided not to appeal this ruling, in order to create the conditions to shortly begin an effective implementation of measures in favor of that Nature Sanctuary, without the delay of further legal action. In April 2014, we agreed with and paid the National Defense Council an indemnification amount of approximately U.S.$5,000,000. This indemnification is in addition to another U.S.$5,000,000, which will be designated for social programs for the benefit of the community of Valdivia. There were four additional measures ordered by the ruling (though not included in the agreement with the National Defense Council), which were discussed by the members of the Consejo Científico Social (Social Council), which includes representatives from Arauco, the National Defense Council, academic institutions, NGOs and public authorities. These measures are: (i) conducting a study, within one year, undertaken by an interdisciplinary committee of experts, about the current status of the wetland (which has already been completed); (ii) creating an artificial sentinel wetland for representative species, upriver from the discharge of effluents; (iii) implementation of a monitoring program of environmental impact, within a five-year period; and (iv) creating a new research center focused on wetlands (Centro de Investigación de Humedales). The National Defense Council and Arauco have agreed upon the manner in which these measures have been implemented.

Since the end of 2004, we have been subject to various criminal proceedings relating to alleged violations of several environmental laws in Chile, some of which have 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.

We are also subject to certain administrative proceedings as a result of a pipe leakage in the Nueva Aldea Mill in 2013, the death of fish in the Cruces River in January 2014, close to the Valdivia Mill effluent discharge, and a pipe leakage in the Arauco Mill in February 2016, all of which are currently under investigation by the competent authorities. In addition, in 2016 the Superintendence of the Environment initiated four administrative proceedings against the Valdivia, Nueva Aldea, Licancel and Constitución mills. The proceedings against the Valdivia Mill are ongoing, and may result in material administrative fines or sanctions, the revocation of environmental authorizations or the temporary or permanent closure of facilities. The Nueva Aldea and Constitución mills decided to submit compliance programs according to applicable regulations, both of which were approved by the Superintendence of the Environment. These programs require the mills to implement actions and/or make certain investments in connection with the charges made by the Superintendence. Once these activities have been completed, the proceedings will end. With regards to the Licancel Mill, the Company filed its defense in June 2016. In February 2017, the Superintendence of the Environment found the Licancel Mill liable for three out of four charges and imposed a fine of 239 UTA (approximately U.S.$205,000). This decision was appealed before the above Superintendence. A final decision by the Superintendence is expected in 2017.

As a result of such proceedings, we cannot assure you that, 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.

Our ability to access local and international credit or capital markets may be restricted at a time when we need financing, which could have a material adverse effect on our flexibility to react to changing economic and business conditions.

As of December 31, 2016, we had approximately U.S.$4.5 billion of outstanding indebtedness. See “Management’s discussion and analysis of financial condition and results of operations—Liquidity and capital resources—Contractual obligations.” The economic environment prevailing at any point in time may prevent us from accessing, or restrict our access to, credit and capital markets to satisfy our financing needs, or we may not be able to refinance our existing indebtedness on terms that are favorable to us or at all. If we are unable to refinance our indebtedness as it becomes due, or if we refinance such indebtedness on terms that are not favorable to us, our business, results of operations and financial condition could be materially and adversely affected.

 

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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, 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. 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;

 

   

prolonged power failures;

 

   

an equipment failure;

 

   

fires, floods, hurricanes or other adverse weather;

 

   

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 operation 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 or Uruguay, these pests or diseases may migrate and may significantly affect the forestry industries in Chile, Argentina, Brazil or Uruguay in the future. Similarly, forest fires are always a risk, particularly during low rainfall conditions. 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.

In January and February, 2017, wildfires, exacerbated by high temperatures, the action of the winds, low atmospheric humidity and the complexity of combatting multiple focal points that appeared simultaneously in different places, broke out in the central and southern regions of Chile, and in respect of the Company, in the Maule and Bío Bío regions. As a consequence of such fires, the Company has suffered the burning of approximately 80,000 hectares of forest plantations, which have a value in our accounting of approximately U.S.$240 million, according to IFRS accounting rules. The affected forest plantations represent approximately 6% of the IFRS value of the total of the forest plantations of the Company, and approximately to a 2% of the total assets of Arauco. The affected plantations will be managed by the Company in order to minimize the damage suffered as a consequence of the fires. It is estimated that this managing will permit a final recovery between 10% and 20% of the abovementioned accounting amount of U.S.$240 million. Additionally, the forest plantations affected by the fires have insurance coverage, with their corresponding deductibles and limitations. As a consequence, it is estimated that it will be possible to recover up to an amount of U.S.$35 million for this concept.

In turn, our El Cruce sawmill, which is owned by our subsidiary Maderas Arauco S.A., was also materially affected by the wildfires. El Cruce sawmill had a book value of approximately U.S.$4.5 million and an annual production capacity of 115,881 cubic meters, representing approximately 4.2% of our total sawmill production capacity at the time of the event. Although the El Cruce sawmill was insured, our insurance is subject to deductibles and caps.

 

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During the fourth quarter of 2014 and the first quarter of 2015, fires affected our forest plantations and destroyed 8,570 hectares. During the fourth quarter of 2015 and the first quarter of 2016, fires affected our forest plantations and destroyed 618 hectares. During the fourth quarter of 2016 and the first quarter of 2017, approximately 82,040 hectares of our forest plantations were affected.

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

A significant 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 carbon dioxide and other greenhouse gas emissions and combat 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, or if 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.

We may undertake mergers, acquisitions and investments to expand or complement our operations that could result in operating difficulties or otherwise adversely affect our business, financial conditions and results of operations.

From time to time, we carry out mergers, acquisitions and investments to expand or complement our operations. In connection with such transactions, we may be exposed to various risks, including those arising from: (i) not having accurately assessed the value, future growth potential, strengths, weaknesses and potential profitability of potential acquisition targets; (ii) difficulties in successfully integrating, operating, maintaining or managing newly-acquired operations, including personnel; (iii) unexpected costs of such transactions or (iv) unexpected contingent or other liabilities or claims that may arise from such transactions. If any of these risks were to materialize, it could adversely affect our business, financial condition and results of operations.

Our operations could be adversely affected by labor disputes.

Approximately 38% of our employees in Chile, 49% of our employees in Argentina, 25% of our employees in Uruguay, almost 100% of our employees in Brazil and none of our employees in the United States or Canada were unionized as of December 31, 2016. In the past, certain work slowdowns, stoppages and other labor-related disruptions have adversely affected our operations.

During 2016, in Chile we experienced seven stoppages caused by employees of our third-party contractors. We experienced stoppages in our Horcones complex caused by employees of our forestry contractors during February (lasting four days) and in April (lasting one day). Access to our El Colorado Saw Mill was blocked for three days in 2016. Our Viñales Saw Mill experienced three stoppages, each lasting one day, during the months of April, August and November 2016. During May 2016, our Constitución Mill had its access blocked for three days. In Uruguay, on June 4, 2016, our mill’s activity was suspended for five days when employees of our logistics contractors blocked the access to the mill.

During 2015, transportation contractors blocked the entrances of our Horcones complex (Chile) on four separate occasions, on January 13, February 17, March 23 and September 21, 2015.

During 2014, there were two events of transportation contractors blocking the entrance to our Valdivia mill. The first blockade was on June 12, 2014 and lasted one day. The second was between August 29 and September 5, 2014. There were also four separate occasions of transportation contractors blocking the entrances of our Horcones complex on February 24 and 25, September 3, October 22 and 23, and November 20, 2014.

In January 2013, we experienced a four-day stoppage in Chile at the Arauco plywood mill in January 2013, caused by employees of third-party contractors.

In Chile, we also experienced a four-day work stoppage in July 2012 at our Arauco plywood mill located in Arauco, during which production partially resumed after the second day, which was caused by the employees of our third-party forestry contractors.

In January 2015, we experienced a five-day stoppage at Arauco Argentina’s mills in Misiones as a result of a road blockage led by the truckers’ union, and we also experienced a four-day stoppage at Arauco Argentina’s pulp mill in December 2014 as a result of a strike by the pulp union.

 

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During 2015, production shifts were reduced at the unit in Piray MDF and in the particleboard plant in Zarate (Argentina), in order to improve operational efficiencies. Although the shift reductions and communications were performed in accordance with the provisions of the Labor Contract Law, workers of the plant in Zarate went on strike, causing a six-hour stoppage. Also during 2015, the pulp union carried out three work stoppages and blockades in Arauco Argentina’s pulp mill: the first event occurred on May 25 for 3 days; the second on August 3, also lasting 3 days; and the last one on September 1, which lasted 14 days.

During 2013, we experienced (i) a 27-day stoppage at Arauco Argentina’s Zarate mill in April 2013, as a result of a strike by the construction union; (ii) a two-day stoppage at Arauco Argentina’s chemical mill in May 2013, as a result of a strike by the Santa Fe Federation of Labor; and (iii) a one-day stoppage at Arauco Argentina’s pulp mill in June 2013 and a three-day stoppage at Arauco Argentina’s pulp mill in October 2013, both as a result of a strike by the pulp union. During 2011 we experienced a three-day stoppage at Arauco Argentina’s chemical mill in March 2011, as a result of a strike by the chemical union, but the strike were limited to two hours per shift and did not materially affect operations.

Our Brazilian operations have not experienced any work stoppages in the last six years.

During 2014, we experienced 7.5 days of work stoppages during the final phase of construction at Montes del Plata and the start of operations, caused by contractors and third parties. During 2015, there were 28 minor events amounting to 5.5 days of work stoppages, caused by transportation and timber logistics contractors.

In September 2011, we experienced a 21-day work stoppage of construction at the Montes del Plata joint operation in Uruguay. In 2012, we experienced approximately 17 days of work stoppages and in 2013, approximately 33 days of work stoppages during the construction at Montes del Plata. These stoppages were caused by national and local strikes related to various labor conflicts mostly of Montes del Plata subcontractors.

Our Canadian and U.S. operations did not experience any work stoppages in 2012, 2013, 2014, 2015 or 2016.

We renewed all collective-bargaining agreements that expired during 2016 in Chile. We cannot assure you that a work slowdown, or a work stoppage or strike, will not occur prior to or upon the expiration of our labor agreements, and we are unable to estimate the extent to which any such work slowdown, stoppage or strike may adversely affect our sales.

In addition, we depend to a significant extent on employees of contractors to which we outsource a wide range of services including management of certain of our plantations and transportation of raw materials and products. On July 1, 2012, we commenced the process of insourcing the operation of 13 sawn timber industrial facilities, which had previously been managed by third-party companies. In the process, we hired 2,900 employees of these third-party companies. As of December 31, 2016, we had contracts with approximately 854 contractors, who employed approximately 22,165 employees. Under Chilean and Brazilian labor legislation, we are secondarily liable for the payment of labor and the social security obligations owed to employees of our contractors. In Chile, 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 us, as the party hiring such contractor, although the contractor would remain primarily liable for such obligations. Generally, we are also responsible for the health and safety conditions of the contractors’ workers and are obligated to ensure that the contractors comply with all obligations related to such conditions while such workers are performing activities for us within our corporate purpose.

In Argentina, substantially similar joint liability rules apply to a principal and its contractors. In addition, national rural labor law, Law No. 26,727, promulgated on December 28, 2011 and fully in effect since March 2013, permits contractor employees under forestry contracts to bring actions directly against the principal to whom the employees’ services are being provided, instead of requiring them to bring actions against the contractor. For work or services related to the ordinary production process of a principal, the law provides that an employment relationship is deemed to exist between the principal and the employee of the contractor.

As a result of the foregoing, we may be affected by future strikes, work slowdowns, stoppages or other labor-related developments in the various countries in which we operate, including such developments attributable to employees of contractors performing outsourced services, and such strikes, slowdowns, stoppages or other developments could have a material adverse effect on our business, financial condition, results of operations or prospects.

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.

As of December 31, 2016, 63.3% of our property, plant and equipment and forest assets were directly owned by Celulosa Arauco y Constitución S.A., and our Chilean subsidiaries, and in 2016, 59.9% of our revenues were attributable to our Chilean

 

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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 – affecting interest rates, inflation, tax rates or charges on imports and/or exports, among others – 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’s actions have had and may continue to have a material effect on private sector entities. 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.

The Chilean government has exercised and continues to exercise substantial influence over many aspects of the economy. 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.

A tax reform bill with significant changes for companies was approved in September 2014 and the Chilean Superintendence of Securities and Insurance, or SVS, modified accounting reporting standards for companies under its supervision in October 2014.

On September 29, 2014, Law No. 20,780, as amended on February 8, 2016 by Law No. 20,899, collectively known as the “Tax Reform”, introduced significant changes to the Chilean taxation system and strengthened the powers of the Servicio de Impuestos Internos (Chilean IRS) to control, prevent, and counter tax evasion. The Tax Reform contemplates, among other matters, changes to the corporate tax regime, creating two general tax regimes. Since January 1, 2017, Chilean companies are subject to the sistema parcialmente integrado (the partially integrated regime) or the sistema de renta atribuida (the deemed taxation regime). The partially integrated regime is the default regime for companies owned by legal entities and only those companies owned by natural persons or non-resident taxpayers are eligible to opt for the deemed taxation regime. As a consequence, the default regime applies to Arauco and its Chilean subsidiaries, that is, the partially integrated system. Both regimes provide for the gradual increase of the corporate tax rate to 24% in 2016 (21% in 2014, 22.5% in 2015 and 24% in 2016). Depending on the tax regime applicable to a company, tax rates will gradually be increased to a maximum rate of 25% in 2017, in the case of the deemed taxation regime, or 27% in 2018, in the case of the partially integrated regime.

The Superintendence of Securities and Insurance issued Oficio Circular No. 856 on October 17, 2014, which instructs regulated entities to record as a charge to shareholders’ equity in their statutory financial statements the difference in deferred tax assets and liabilities that results from the increase in the tax rate set forth in Law No. 20,780. The impact of this circular has been incorporated in the statutory financial statements which are used to determine the distributable income. This circular differs from International Financial Reporting Standards (IFRS), which requires the impact to be recorded as part of the income statement. However, the financial statements that we prepared and filed with the SVS as of and for the periods ended September 30 and December 31, 2014, 2015 and 2016, account for deferred taxes in accordance with Oficio Circular No. 856.

In the attached financial statements prepared in accordance with IFRS, the effect of the change in the tax rate of first category in assets and liabilities relating to deferred taxes resulted in an expense of U.S.$292,717,000 (U.S.$292,155,000 attributable to owners of the parent) has been recorded in the income statement for the year ended December 31, 2014.

Further amendments could affect our income tax rates. We have no control and cannot predict how such amendments will affect, directly or indirectly, the Chilean economy or 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. Furthermore, the change imposed by SVS by Oficio Circular 856 dated October 17, 2014 obliging companies under its supervision not to follow IFRS could lead investors to improperly determine Arauco’s results with respect to the effect of the tax reform on Arauco’s deferred taxes.

Chile has different corporate disclosure 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 securities disclosure requirements applicable to certain 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, or the “SEC”.

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 investor protections available in the United States may not be available in the same form, or at all, in Chile.

 

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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 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 Euro, the Argentine peso, the Uruguayan peso, the Brazilian real, the Colombian peso, the Mexican peso and the Canadian dollar, among others. To the extent that the Chilean peso depreciates against the U.S. dollar, our domestic revenues may be adversely affected when expressed in U.S. dollars. The same effects may occur for our domestic sales in Argentina, Brazil and Canada, or other countries where we have operations for revenues related to 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.

As of December 31, 2016, 9.1% of our property, plant and equipment and forest assets were owned by our Argentine subsidiaries, and in 2016, 8.7% 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 Arauco Argentina to raise capital, depend, among other factors, upon economic conditions prevailing in Argentina. See “Item 4. Information on our Company—Description of Business—History.”

There are various aspects of the Argentine economy that could adversely affect our operations, including, among others, inflation, interest rates, foreign exchange controls and taxes. Between 2001 and 2016, there have been several monetary and currency exchange control measures implemented in Argentina, which have included the obligation to repatriate foreign currency earned abroad and tight restrictions on transferring funds abroad, with certain exceptions for authorized transactions. In 2016, certain of these measures have been eliminated or relaxed by the new Argentine administration that took office as of December 10, 2015. After moving quickly to eliminate foreign-exchange restrictions and shifting to a more flexible exchange rate, the government announced its intention to reduce inflation gradually.

We guarantee a portion of Arauco Argentina’s debt. We may be required to fulfill our obligation under our guarantees if Arauco Argentina’s ability to transfer funds abroad to service such debt is restricted. For a description of Arauco Argentina’s debt which we guarantee see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources.”

Although past restrictions did not materially affect Arauco Argentina’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 restrictions would be an obstacle to Arauco Argentina’s ability to transfer money abroad, which may negatively affect its financial condition, results of operations and cash flows.

We have no control over and cannot predict how any future changes in economic policy or other changes in the Argentine economy could affect our operations and revenues in Argentina.

Risks Relating to Brazil

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

As of December 31, 2016, 8.9% of our property, plant and equipment and forest assets were owned by our Brazilian subsidiaries, and in 2016, 7.4% of our revenues were attributable to our Brazilian operations. See “Item 4. Information on our Company—Description of Business.” 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.

 

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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 exercised and continues to exercise a substantial influence over many aspects of the Brazilian economy. 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;

 

   

inflation;

 

   

social instability;

 

   

price instability;

 

   

real estate ownership restrictions;

 

   

interest rates;

 

   

liquidity of domestic capital and lending markets,

 

   

tax policy;

 

   

political instability; 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.

Future economic, social and political developments in Brazil may adversely affect the business, financial condition, results of operations and cash flows of our Brazilian subsidiaries.

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 5.8% in 2012, 5.9% in 2013, 6.4% in 2014, 10.7% in 2015 and 6.3% in 2016, as measured by the Índice de Preços ao Consumidor-Amplo (Brazilian Consumer Price Index). In the past, inflation, governmental measures to combat inflation and public speculation about possible future actions have had significant effects on the Brazilian economy and on the financial condition and results of operation of business, such as ours, operating in Brazil.

Fluctuations in the value of Brazil’s currency against the value of the U.S. dollar may result in uncertainty in the Brazilian economy, 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. Depreciation over shorter periods has resulted in significant fluctuations in the exchange rate between the Brazilian real and the U.S. dollar and other currencies.

For example, the Brazilian real depreciated against the U.S. dollar by 47.7% in 2015 and appreciated by 16.4% in 2016. The exchange rate between the Brazilian real and the U.S. dollar may continue to fluctuate and may rise or decline substantially from current levels. From January 1 to March 31, 2017 the Brazilian real depreciated by 3.7% with respect to the U.S. dollar.

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.

 

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Risks Relating to Uruguay

Economic conditions in Uruguay, or the failure of Montes del Plata and its affiliates to service their debt, may have a direct impact on our financial condition, results of operations and cash flows.

As of December 31, 2016, 15.8% of our property, plant and equipment and forest assets were owned by Montes del Plata and its affiliates in Uruguay, and in 2016, 7.2% of our revenues were attributable to the Uruguayan operations of Montes del Plata. See “Item 4. Information on our Company—Description of Business.”

We have made significant investments in Uruguay and we may make additional investments in Uruguay in the future. See “Item 4. Information on our Company—Description of Business.” As a result, 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 the United States and Canada

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

As of December 31, 2016, 2.5% of our property, plant and equipment and forest assets were owned by our U.S. subsidiaries, and in 2016, 12.6% of our revenues were attributable to our U.S. subsidiaries. See “Item 4. Information on our Company—Description of Business.”

As of December 31, 2016, 0.4% of our property, plant and equipment and forest assets were owned by our Canadian subsidiaries, and in 2016, 4.2% of our revenues were attributable to our consolidated Canadian subsidiaries, which includes our Canadian subsidiaries’ operations in the United States. See “Item 4. Information on our Company—Description of Business.”

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 the United States and Canada.

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 on the level of economic activity, government and foreign exchange policies and political and economic developments in our principal export markets. In 2014, 2015 and 2016, 91.8%, 90.8% and 92.2%, respectively, of our total pulp sales, and 45.5%, 43.5%, and 44.5%, respectively, of our total sales of forestry, wood and panel products, were attributable to exports, principally to customers in Asia, the Americas and Western Europe, collectively. 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 countries, especially those in the United States, Europe, China and Latin America. 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 our ability to raise additional capital.

Risks Relating to Our Securities

The non-payment of funds by our subsidiaries could have a material 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.

 

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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 our 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.

Credit rating downgrades below investment grade could have a material and adverse effect on our business, financial condition, results of operations and ability to service our debt, including our securities.

Credit rating agencies could downgrade our ratings either due to factors specific to us, a prolonged cyclical downturn in the forestry industry or macroeconomic trends (such as global or regional recessions) and trends in credit and capital markets more generally. Any decline in our credit rating would increase our cost of borrowing and may significantly harm our financial condition, results of operations and profitability, including our ability to refinance our existing indebtedness.

In October 2012, citing soft pulp prices and our increased leverage due to the Flakeboard acquisition and the construction of the Montes del Plata pulp plant in Uruguay, Fitch Ratings, or Fitch, downgraded our foreign and local currency Issuer Default Ratings (IDR) to “BBB” from “BBB+,” in addition to downgrading our national scale rating from “AA (cl)” to “AA- (cl).” Fitch also downgraded the foreign currency IDR of Arauco Argentina, to “BBB” from “BBB+.” The unsecured debt issued by Arauco Argentina and Arauco in Chile was also downgraded to “BBB” and “AA- (cl),” respectively, from “BBB+” and “AA.” On February 6, 2013, Feller Rate, a Chilean subsidiary of Standard & Poor’s Ratings Services, or S&P, lowered our national scale rating to “AA-” from “AA”, citing the adoption of an aggressive financial policy combined with a cycle of low prices and increased costs of raw materials.

On March 7, 2013, Moody’s Investors Service, or Moody’s, downgraded our senior unsecured ratings to “Baa3” from “Baa2” with a negative outlook, citing deterioration in our performance coupled with a significant increase in debt that resulted in a significant increase in leverage. Additionally, Moody’s downgraded the rated notes of Arauco Argentina to “Baa3” from “Baa2”. On March 27, 2013, S&P lowered its rating on us from “BBB” to “BBB-”, citing high debt, our recent acquisitions, and soft pulp prices and rising operating costs. It considered our financial risk profile to be “intermediate” due to expectations of improved leverage.

On April 5, 2013, S&P lowered its corporate credit rating foreign currency on Arauco Argentina from “B+” to “B,” due to worsening business conditions in Argentina and our recent downgrade, as Arauco Argentina’s parent company, from “BBB” to “BBB-” on March 27, 2013. Then on September 13, 2013, the rating was downgraded again from “B” to “B-” following similar action on the Republic of Argentina which was lowered from “B-” to “CCC+.” On December 20, 2013, the foreign currency global scale rating on Arauco Argentina suffered its third downgrade from “B-” to “CCC+” to reflect the same transfer and convertibility risk assessment for Argentina, due to restrictions on access to foreign currency and/or restrictions on transferring money abroad.

On June 19, 2014, Moody’s changed our ratings outlook from negative to stable. Also, the Baa3 note rating of our Argentinean subsidiary Arauco Argentina, was affirmed, and its outlook changed to stable.

On October 5, 2016, Fitch Ratings changed our ratings outlook from stable to negative, citing a slower-than-expected decline of our net leverage due to weak operational cash flows, which in turn were affected by lower pulp prices throughout the year.

We cannot assure you that we will not be subject to further credit rating downgrades. Credit rating downgrades below investment grade could have a material and adverse effect on our ability to service our debt, including our securities, which, in turn, could have a material adverse effect on our business, financial condition and results of operations.

 

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Item 4. Information on our Company

DESCRIPTION OF BUSINESS

We believe that, as of December 31, 2016, we were one of Latin America’s largest forest plantation owners, and that we are Chile’s largest exporter of forestry and timber in terms of revenue. We have industrial operations in Chile, Argentina, Brazil, the United States, Canada and Uruguay (via our 50% share in Montes del Plata), Spain, Portugal, Germany and South Africa (via our 50% share in Sonae Arauco). As of December 31, 2016, we had more than 1.0 million hectares of plantations in Chile, Argentina, Brazil and Uruguay combined. During 2016, we harvested approximately 22.0 million cubic meters of sawlogs and pulplogs and sold approximately 7.9 million cubic meters of timber products, including sawn timber (green and kiln-dried lumber), remanufactured wood products, plywood and panels (medium density fiber board, or MDF, particleboard, or PBO, and high density fiber board, or HB). During 2016, we sold approximately 3.7 million tonnes of pulp in the form of hardwood bleached pulp, softwood bleached pulp, softwood unbleached pulp and fluff pulp.

Based on information published by Hawkins Wright Ltd., an independent research company for the pulp and paper industry, as of December 31, 2016, 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 6.5% share of the total world production capacity of bleached softwood kraft market pulp and a 24.1% share of the total world production capacity of unbleached softwood kraft market 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.

Based on information published by Hawkins Wright Ltd., 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 silvicultural techniques we apply in our forest management, our modern mill facilities and, in the case of Chile, the proximity of our operations to Pacific coast ports.

History

Celulosa Arauco y Constitución S.A. is a sociedad anónima (corporation) organized under the laws of Chile and subject to certain rules applicable to sociedades anónimas abiertas (Chilean public corporations). Our principal executive offices are located at Avenida El Golf 150, 14th Floor, Las Condes, Santiago, Chile, and our telephone number is +56-2-2461-7200.

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 (that, effective January 1, 2015, changed its name to Arauco Argentina S.A.), which, at the time of the acquisition, 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 2005, 2006 and 2007, 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 May 17, 2009, our subsidiary Inversiones Arauco Internacional Limitada (previously known as Arauco Internacional S.A.), or Arauco Internacional, and a subsidiary of Stora Enso agreed through a joint operation partnership to acquire the Uruguayan subsidiaries of ENCE, which acquisition was completed on October 16, 2009. The companies acquired by the joint operation 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 included 130,000 hectares of land, of which 73,000 had forestry plantations, 6,000 hectares under agreements with third parties, an industrial site, the necessary environmental permits for the 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 we paid 50% (or U.S.$167.5 million). See “Item 5. Operating and Financial Review and Prospects—Results of Operations.”

On August 26, 2009, our subsidiary Placas do Paraná S.A. (now, Arauco do Brasil 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 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

 

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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 Piên, Brazil, which is in the state of Paraná. The facility has an annual total installed capacity of 750,000 cubic meters, which includes three production lines: two lines producing MDF and one line producing PBO. The facility also has added-value lines to produce products for the construction and furniture industries.

On September 27, 2009, Arauco and its subsidiary Inversiones Arauco Internacional, executed a series of joint operation agreements with Stora Enso, pursuant to which Stora Enso Amsterdam B.V. agreed to transfer the 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.

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 became the owner of 100% of the shares of Dynea Brasil S.A., which was absorbed by Arauco do Brasil S.A. in May 2010.

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 capacity of 1.3 million tonnes, a port and a power producing unit based on renewable sources, all located in Punta Pereira in the department of Colonia, Uruguay. The total investment was approximately U.S.$2.5 billion. The pulp mill entered the production phase in June 2014, and reached full production capacity in October 2015.

In November 2011, Centaurus Holdings S.A., a Brazilian company that is 51% owned by Klabin S.A. and 49% owned by our subsidiary Arauco Forest Brasil S.A., acquired the shares of Florestal Vale do Corisco Ltda., which has 107,000 hectares of land in the Brazilian state of Paraná. The total purchase price for the transaction was U.S.$473.5 million, of which we paid 49%. On May 31, 2012, Centaurus Holdings S.A. was absorbed by Florestal Vale do Corisco Ltda.

In 2011, Arauco Argentina acquired 100% of the shares of Greenagro S.A. or Greenagro, a company duly incorporated under the laws of Argentina, for a total purchase price of U.S.$10.7 million. Greenagro is engaged in forestry activities in the area of Isla Victoria, province of Entre Ríos, Argentina.

In 2012, Arauco Panels USA, one of our U.S. subsidiaries, acquired an industrial facility in Moncure, North Carolina for U.S.$56 million plus approximately U.S.$6 million in respect of working capital, subject to adjustment based on actual working capital at closing. The facility includes MDF and high-density fiberboard, or HDF, production lines with annual production capacity of up to 330,000 cubic meters, a PBO production line with annual production capacity of up to 270,000 cubic meters and two melamine product production lines. This transaction closed in January 2012.

On June 7, 2012, we signed a share purchase agreement to acquire 100% of the shares of Flakeboard Company Limited or Flakeboard, a Canadian company, for a total purchase price of U.S.$242.5 million. Flakeboard is a key North American producer of wood paneling for furniture. It owns and operates seven panel mills in Canada and the U.S. with an aggregate annual production capacity of 1.2 million cubic meters of MDF panels, an annual production capacity of 1.2 million cubic meters of PB, and an annual production capacity of 634,000 cubic meters of melamine. This transaction closed in September 2012.

During the second quarter of 2013, our wholly-owned forestry subsidiaries—Bosques Arauco S.A., Forestal Valdivia S.A., Forestal Arauco S.A., and Forestal Celco S.A.—were merged with and into Forestal Celco S.A. This process started on July 1, 2013, when Bosques Arauco was merged with and into Forestal Valdivia. Subsequently, on September 1, 2013, Forestal Valdivia was merged with and into Forestal Arauco. On December 1, 2013, Forestal Arauco was merged with and into Forestal Celco. Finally, in May 2014, Forestal Celco changed its name to Forestal Arauco S.A.

On July 28, 2015, Mahal Empreendimentos e Participações S.A., a Brazilian company, of which our subsidiary Arauco Forest Brasil S.A. owned 84.53% (at the time of the purchase mentioned below) and Empreendimentos Florestais Santa Cruz Ltda. owned 15.47%, acquired 37,625 hectares of land in the Brazilian state of Mato Grosso do Sul. The total purchase price for the transaction was U.S.$53 million.

On October 27, 2015, our subsidiary Arauco Forest Brasil S.A acquired 51% of the shares of Novo Oeste Gestão de Ativos Florestais S.A. As a result of this acquisition, we became the owner of 100% of the shares of Novo Oeste Gestão de Ativos Florestais S.A., which has 26,229 hectares of forestry plantations in the Brazilian state of Mato Grosso do Sul.

On December 1, 2015, Arauco’s wholly-owned subsidiaries Paneles Arauco S.A., Aserraderos Arauco S.A. and Arauco Distribución S.A. were merged into Paneles Arauco S.A., company which will operate the timber segment, including panel and sawmill businesses.

On November 30, 2015, our subsidiary Inversiones Arauco Internacional Limitada, entered into a share purchase agreement with Sonae Industria (“Sonae”) under which the purchase of 50% of the shares of a Spanish subsidiary of Sonae, currently named

 

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Tableros de Fibras S.A., was agreed, along with the name change to “Sonae Arauco”. According with the executed agreements, both Sonae and Arauco agreed to jointly control Sonae Arauco. On May 31, 2016, we closed the Sonae Arauco transaction. The price paid was the amount of €137,500,000 (equivalent to U.S.$153.1 million at the time of the purchase). Sonae Arauco and its subsidiaries produce market wood panels, of the OSB, MDF and PB type, and sawn timber through the operation of: (i) two panel plants and one sawmill in Spain; (ii) two panel plants and one resin plant in Portugal; (iii) four panel plants in Germany, (iv) and two panel mills in South Africa. In the aggregate, the production capacity of Sonae Arauco is approximately 460,000 cubic meters of OSB, 1,450,000 cubic meters of MDF, 2,270,000 cubic meters of particleboards and 100,000 cubic meters of sawn timber.

On October 25, 2016, Arauco informed the approval by its board of directors of the commencement of the construction of the “MDP Grayling” project, which will be located in the State of Michigan, United States of America. Such project will be carried out by our U.S. subsidiary Flakeboard America Limited. The project comprises the construction and operation of a plant that will manufacture MDP. Arauco expects that the production capacity of the plant will be 800,000 cubic meters of finished product per year, of which approximately 300,000 cubic meters will be coated with melamine paper. Arauco expects that the Project will commence its operations by the end of 2018 and that its sales will exceed U.S.$200 million per year. The execution of this project requires an estimated investment of U.S.$400 million, which are expected to be financed with Arauco’s own resources.

 

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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.”

The following table sets forth our ownership interests in our subsidiaries as of December 31, 2016.

 

     Country of
incorporation
   Total stock held  

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

   Mexico      99.9990

Arauco Argentina S.A.

   Argentina      99.9801  

Arauco Australia Pty Ltd.

   Australia      99.9990  

Arauco Bioenergía S.A.

   Chile      99.9999  

Arauco Colombia S.A.

   Colombia      99.9982  

Arauco do Brasil S.A.

   Brazil      99.9990  

Arauco Florestal Arapoti S.A.

   Brazil      79.9992  

Arauco Forest Brasil S.A.

   Brazil      99.9991  

Arauco Europe Cooperatief U.A.

   The Netherlands      99.9990  

Arauco Middle East DMCC

   Dubai      99.9990  

Arauco Nutrientes Naturales SPA

   Chile      99.9484  

Arauco Panels USA LLC

   U.S.A.      99.9990  

Arauco Perú S.A.

   Peru      99.9990  

Arauco Wood Products, Inc.

   U.S.A.      99.9990  

Araucomex S.A. de C.V.

   Mexico      99.9990  

Consorcio Protección Fitosanitaria Forestal S.A.

   Chile      57.5404  

Empreendimentos Florestais Santa Cruz Ltda.

   Brazil      99.9789  

Flakeboard America Limited

   U.S.A.      99.9990  

Flakeboard Company Limited

   Canada      99.9990  

Forestal Arauco S.A.

   Chile      99.9484  

Forestal Cholguán S.A.

   Chile      98.4744  

Forestal Concepción S.A.

   Panama      99.9990  

Forestal Los Lagos S.A.

   Chile      79.9587  

Forestal Nuestra Señora del Carmen S.A.

   Argentina      99.9805  

Forestal Talavera S.A.

   Argentina      99.9942  

Greenagro S.A.

   Argentina      97.9805  

Inversiones Arauco Internacional Ltda.

   Chile      99.9990  

Investigaciones Forestales Bioforest S.A.

   Chile      99.9489  

Leasing Forestal S.A.

   Argentina      99.9801  

Mahal Empreendimentos e Participacoes S.A.

   Brazil      99.9934  

Novo Oeste Gestão de Ativos Florestais S.A.

   Brazil      99.9990  

Maderas Arauco S.A. (Ex Paneles Arauco S.A.)

   Chile      99.9995  

Savitar S.A.

   Argentina      99.9841  

Servicios Aéreos Forestales Ltda.

   Chile      99.9990  

Servicios Logísticos Arauco S.A.

   Chile      99.9997  

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;

 

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we continue to develop our facilities, transportation, shipping, storage and product distribution network that allow us to reach over 80 countries worldwide; and

 

   

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

Domestic and Export Sales

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

 

     Year ended December 31,  
     2016      2015      2014  
     (in millions of U.S. dollars)  

Export Sales

        

Bleached pulp

   $ 1,628      $ 1,762      $ 1,714  

Unbleached pulp

     253        275        302  

Sawn timber

     400        419        538  

Remanufactured wood products

     218        231        204  

Plywood

     185        203        175  

Panels

     305        300        372  

Other

     2        4        1  
  

 

 

    

 

 

    

 

 

 

Total export revenue

   $ 2,991      $ 3,195      $ 3,306  
  

 

 

    

 

 

    

 

 

 

Domestic Sales

        

Bleached pulp

   $ 152      $ 197      $ 171  

Unbleached pulp

     7        8        9  

Sawn timber

     80        79        100  

Remanufactured wood products

     28        57        32  

Plywood

     42        37        34  

Panels

     1,229        1,297        1,340  

Logs

     63        88        121  

Chips

     21        18        20  

Electric power

     103        121        160  

Other

     44        50        50  
  

 

 

    

 

 

    

 

 

 

Total domestic revenue

   $ 1,770      $ 1,952      $ 2,037  
  

 

 

    

 

 

    

 

 

 

Revenue

   $ 4,761      $ 5,147      $ 5,343  
  

 

 

    

 

 

    

 

 

 

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

 

     Year ended December 31  
     2016      2015      2014  
     (in millions of U.S. dollars)  

Asia and Oceania

   $ 1,553      $ 1,673      $ 1,720  

North America

     627        656        661  

Europe

     326        236        354  

Central and South America

     299        482        353  

Other

     186        148        218  
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,991      $ 3,195      $ 3,306  
  

 

 

    

 

 

    

 

 

 

 

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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 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. 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:

 

   

Forest Stewardship Council® Forest Management 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 (Forestal Arauco license code: FSC-C108276);

 

   

Sustainable Forest Management Certification (CERTFOR): 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;

 

   

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

 

   

FSC® Chain of Custody Certification: a certification from the FSC® that is designed to ensure traceability from certified forest and other controlled sources to the finished product (Forestal Arauco Zona Norte license code: FSC – C013026);

 

   

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; and

 

   

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

The information in this section refers to 100% of the plantations owned by Forestal Arauco S.A. (Chile), 80% of the plantations owned by Forestal Los Lagos S.A., 100% of the plantations owned by Arauco Argentina, 50% of the plantations we own in Uruguay through the Montes del Plata joint operation, 100% of the plantations owned by Arauco Forest Brasil, 80% of the plantations owned by Arauco Florestal Arapoti and 100% of the plantations owned by Mahal Empreendimentos e Participacoes S.A, unless otherwise mentioned.

As of December 31, 2016, our planted forests consisted of 67.9% radiata, taeda and elliottii pine and 29.9% eucalyptus. Radiata, taeda and elliottii pine have a rapid growth rate and a short harvest cycle compared to other commercial softwoods. These pine species are sufficiently versatile for both the production of forestry and timber and the production of long-fiber pulp for sale to manufacturers of paper and packaging. Eucalyptus is used to produce short-fiber pulp for sale to manufacturers of paper and tissue.

We seek to manage our forestry resources seeking to ensure that the annual growth of our forest is equal to or greater than the volume of resources harvested each year. In 2016, Arauco planted a total of 65,985 hectares and harvested a total of 63,078 hectares in Chile, Argentina, Brazil and Uruguay. We believe that our annual harvests and plantations, long-term sustainable equilibrium is approximately 72.8 thousand hectares.

 

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Our planted radiata pine forests are located in central and southern Chile, and most are located in close proximity to our major production facilities. As of December 31, 2016, our aggregate radiata pine holdings comprised 41% of all Chilean radiata pine plantations, making us the country’s largest radiata pine plantation owner according to the Chilean Forestry Institute. As of December 31, 2016, we owned approximately 1.1 million hectares of land in Chile, of which 718 thousand hectares are forest plantations.

As of December 31, 2016, we owned approximately 263,384 hectares of forest and other land in Argentina, approximately 181,298 hectares of forest and other land in Brazil and approximately 122,609 hectares of forest and other land that Montes del Plata owns in Uruguay. Of the total land we own in Uruguay through Montes del Plata, 100% is planted with eucalyptus: dunnii (80%), globulus (6%), grandis (6%) and other species (8%). Of the total land we own in these four countries, approximately 144,734 hectares of land is planted with taeda pine and elliottii pine, both 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 native forests.

The following table sets forth the number of hectares and types of uses of our land holdings and rights, as of December 31, 2016.

 

     As of December 31, 2016  
     Total      Distribution  
     (in hectares)      (percentage)  

Pine plantations (1)

     

0-5 years

     171,503        10.2

6-10 years

     160,528        9.6

11-15 years

     137,361        8.2

16-20 years

     136,014        8.1

21+ years

     90,839        5.4

Subtotal

     696,245        41.5

Eucalyptus plantations (2)

     306,593        18.3

Plantations of other species

     22,119        1.3

Subtotal of Plantations

     328,712        19.6

Land for plantations

     51,637        3.1

Land for other uses (3)

     599,308        35.8
  

 

 

    

 

 

 

Total (4)

     1,675,902        100.0
  

 

 

    

 

 

 

 

(1) All years are calculated from the date of planting.
(2) Approximately 76.7% of our eucalyptus plantations are less than 10 years old.
(3) Includes roads, firebreaks, native forests and yards.
(4) Includes 100% of the plantations owned by Forestal Arauco S.A. (Chile), 80% of the plantations owned by Forestal Los Lagos S.A., 100% of the plantations owned by Arauco Argentina, 50% of the plantations we own in Uruguay through the Montes del Plata joint operation, 100% of the plantations owned by Arauco Forest Brasil, 80% of the plantations owned by Arauco Florestal Arapoti and 100% of the plantations owned by Mahal Empreendimentos e Participacoes S.A. Also includes 22,843 hectares for which we have the right to harvest but do not own the land, of which 15,939 hectares are in Chile, 6,599 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 1,675,902 hectares as of December 31, 2016. In the five years ending December 31, 2016, we purchased 32,637 hectares of land, of which 13,441 hectares were purchased in Chile, 8,109 in Brazil and 11,087 in Uruguay. For more information regarding our material acquisitions, see “—History”.

We expect to acquire additional land if we are presented with the possibility to do so at a desired price or location. There can be no assurance that we would be able to acquire land at a desired price or in a desired 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.

 

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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, as of December 31, 2016, approximately 63% of our pine forests in Chile were conducive to 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, 2016, we had 18 nurseries in Chile, Argentina, Brazil and Uruguay, in which we grow seedlings using seeds and 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 when commercially necessary. Thinned trees are used in pulp production or, depending on the quality of the land, as sawlogs. Commercial thinning occurs when trees are eight to 14 years old and results in an average reduction of the number of trees per hectare from the original stocking of 1,250 and 1,600, depending on the productivity of the land, to 700 in the first thinning (8-9 years) and to approximately 450 in the second thinning (12-14 years).

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 clear wood saw log of 5.3 meters from each tree, and is conducted three times:

 

   

when trees are five to seven years old,

 

   

one year 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. 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, MDF and medium-density particleboard, or MDP, 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 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.

 

     2016      2015      2014  
     (in hectares)  

Thinning

     16,229        14,003        12,574  

Pruning

     33,547        31,292        28,195  

Harvesting

     31,863        33,266        35,653  

 

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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, 2016, we had arrangements with more than 261 independent contractors that employed over 11,894 workers in Chile. Many of these contractors have long-standing relationships with us, but we award the majority of 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 in Chile have been affected by two health problems: 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 a genetic program to make our trees more tolerant to this 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 minimize any fire damage to our forests. The operation consists primarily 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. The focus of this operation is to detect and control fires in less than 10 minutes in order to prevent fires from spreading. Since 2015, this system has limited fire damage to our forests to an average of 5,788 hectares of the plantations per year. Prior to 2015, we suffered wildfires on December 31, 2011, which destroyed our Nueva Aldea plywood mill and approximately 8,200 hectares of our forest plantations. Furthermore, during January and February 2017, large forest fires affected Arauco’s plantations in the Maule and Bio Bio Regions in southern Chile. About 80,000 hectares of our forest plantations were damaged to some extent and our El Cruce Sawmill was destroyed as a result of these fires.

During the end of 2015 and during the first quarter of 2016, fires that affected our forest plantations destroyed 618 hectares. During the end of 2016 and the first quarter of 2017, approximately 82,040 hectares of our forest plantations were affected. See “Item 3. Key Information—Risk Factors—Risks Relating to Us And the Forestry Industry—Disease or fire could affect our forests and manufacturing processes and, in turn, adversely affect our business financial conditions, results of operations and cash flows.”

Forest Production

We harvested 22 million cubic meters of logs during the year ended December 31, 2016, consisting of 9.3 million cubic meters of sawlogs, 7.3 million cubic meters of pine pulplogs and 5.4 million cubic meters of eucalyptus pulplogs and other logs. We did not export any pulplogs during 2016 because substantially all of the pulplogs from our forests were used in our pulp or panel mills. During 2016, our sawmills and panel mills used 7.7 million cubic meters of sawlogs. We also sold 1.3 million cubic meters of sawlogs to unaffiliated domestic sawmills during 2016.

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 1.8 million cubic meters of logs per year. The Nueva Aldea complex also includes a log merchandising facility, with an annual processing capacity of 1.6 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 2016. For the year ended December 31, 2016, pulp sales were U.S.$2.0 billion, representing 42.9% of our total revenue for the period.

Pulp obtained from wood fibers is mainly 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 strength to paper products. Hardwood 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, Argentina, and Uruguay. The raw wood is in the form of pulplogs and chips, which are used 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

 

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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 subject to a final stage where a sheet is formed and subsequently dried and baled for transport to customers. The lignin and bark produced during this process is used as fuel in the boilers to 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

As of December 31, 2016, we owned and operated five pulp mills in Chile, one in Argentina, and jointly owned and operated one in Uruguay with Stora Enso, with an aggregate installed annual production capacity of approximately 3.9 million tonnes. This figure includes 50% of our Montes del Plata joint operation. Our six pulp mills, together with the 50% volume we include from our interest in the Montes del Plata mill, produced 3.3 million tonnes of bleached pulp and 0.4 million tonnes of unbleached pulp in 2016.

All our pulp mills in Chile are certified under ISO 9001, ISO 14001 and under standard Chain of Custody FSC® and CERTFOR (PEFC Homologated). The Puerto Esperanza Pulp Mill in Argentina is certified under ISO 14001, OHSAS 18001 and Chain of Custody FSC®. The Montes del Plata Mill is certified under Chain of Custody FSC®. The following list sets forth the codes of license COC FSC® for each pulp mill:

 

   

Arauco Pulp Mill: FSC-C006552

 

   

Licancel Pulp Mill: FSC-C109896

 

   

Constitución Pulp Mill: FSC-C109895

 

   

Nueva Aldea Pulp Mill: FSC-C011929

 

   

Valdivia Pulp Mill: FSC-C005084

 

   

Puerto Esperanza Pulp Mill: FSC-C121377

 

   

Celulosa y Energía Punta Pereira (Montes del Plata) Pulp Mill: FSC-C116413

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

 

     Year ended December 31,  
     2016      2015      2014      2013      2012  
     (in thousands of tonnes)  

Chile

              

Arauco Mill (bleached)

              

Arauco I

     258        268        269        284        282  

Arauco II

     475        474        483        510        505  

Valdivia Mill (bleached)

     550        549        550        550        550  

Constitución Mill (unbleached)

     278        303        310        311        307  

Nueva Aldea Mill (bleached)

     999        934        985        944        882  

Nueva Aldea Mill (unbleached)

     —          —          —          3        —    

Licancel Mill (unbleached)

     152        152        150        147        137  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     2,712        2,681        2,747        2,749        2,663  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Argentina

              

Alto Paraná Mill (bleached)

     341        314        282        331        307  

Uruguay

              

Montes del Plata (bleached - 50%)

     643        608        240        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     3,695        3,603        3,269        3,080        2,970  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following is a description of each of our pulp mills in Chile, Argentina and Uruguay.

Chile

Arauco I. Arauco I, which began operations 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 most 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 tonnes of eucalyptus and pine bleached kraft pulp.

 

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Arauco II. Also located at the Arauco Mill, Arauco II was completed in 1991. Arauco II’s pulping process is generally 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 510,000 tonnes of pine bleached kraft pulp.

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, 2016, the Constitución Mill was the largest unbleached softwood market pulp mill in the world, with an installed annual production capacity of approximately 355,000 tonnes. The unbleached pulp produced in this mill does not use any chlorine in its production process.

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 155,000 tonnes of eucalyptus kraft pulp and pine bleached and unbleached kraft pulp. The Licancel Mill is equipped to produce elementary chlorine-free pulp.

Valdivia Mill. The Valdivia Mill commenced operations in February 2004. The Valdivia Mill is located in the 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 tonnes of bleached pulp, consisting of softwood pulp and eucalyptus pulp. The Valdivia Mill is equipped to produce elementary chlorine-free pulp.

In February 2015, the Environmental Assessment Service (SEA) unanimously approved the Environmental Impact Statement submitted by Arauco in order to move forward with the dissolving pulp project being developed at Valdivia Pulp Mill. This initiative, which requires a U.S.$185 million investment, will allow Arauco to be the first company in Chile to produce this type of pulp, in addition to creating a value-added product and diversifying its supply to the market. Dissolving pulp is mainly used in the manufacture of viscose, which is known for its softness, shine, purity and high water absorption, making it suitable for use in the production of fabric medical items and personal care items, specifically clothing. Unlike synthetic fibers that are mostly produced from oil based sources, dissolving pulp is natural and renewable. In addition, this project will increase the facility’s power generation by 15 megawatts (“MW”) in comparison with the power generation during bleached hardwood kraft pulp campaign. The construction and operation of this project is subject to many environmental, regulatory, engineering and political uncertainties. As a result, we cannot provide any assurances that the project will be completed.

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 tonnes 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.

Argentina

Arauco Argentina’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 tonnes of pulp, consisting of fluff pulp and bleached softwood pulp for paper use, currently representing almost all of the total bleached softwood pulp production capacity in Argentina.

 

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Uruguay

Montes del Plata. Located in Punta Pereira in the department of Colonia, Uruguay, the Montes del Plata Pulp Mill began operations in June 2014. The total investment was approximately U.S.$2.7 billion. The mill has an annual installed capacity of 1.3 million air dry tonnes (“AdT”) of bleached pulp. On June 4, 2014, the environmental authorities of Uruguay (MVOTMA) approved an annual production capacity of the Montes del Plata mill of 1.5 million AdT per year.

Production Costs

Based on information published by Hawkins Wright, our cash costs for softwood pulp production are lower than the average costs of market pulp producers in Canada, the United States and Scandinavia, particularly with respect to transportation, which enables our costs to be 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 cost of market pulp producers in selected regions in the Northern Hemisphere.

 

     Bleached Softwood Kraft Pulp Producers’ Cost  
     Arauco(1)(4)      British
Columbia
Coast
     West
Canada
Interior
     United
States(4)
     Sweden(4)      Finland(4)  
     (in U.S.$ per tonne)  

Wood

     181        212        188        157        244        283  

Chemicals

     53        59        56        68        46        45  

Labor and Others(2)

     133        194        178        193        93        90  

Total cash cost

     366        465        422        418        383        418  

Transportation(3)

     30        43        76        43        49        59  

Marketing and Sales

     3        6        12        14        6        8  

Total delivered cost

     399        514        509        475        438        485  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Source: Hawkins Wright. The Outlook for Paper Grade Pulp Demand, Supply, Costs and Prices, December 2016.

(1) For comparative purposes, includes only Arauco’s operations in Chile.
(2) Includes labor, energy, maintenance costs, and other mill costs.
(3) Delivered in China.
(4) Hawkins Wright and Arauco consider a byproduct credit, which is not included in the total delivered cost shown in the table above.

Sales

Total shipments of bleached kraft market pulp in the global market during the year ended December 31, 2016 equaled 57.3 million tonnes. Based on information published by Pulp and Paper Production Council, we believe that our production represented 5.3% of this market in 2016. During the year ended December 31, 2016, we exported 91.4% of our bleached pulp, principally to customers in Asia and Western Europe.

Integrated manufacturers dominate the world production of unbleached softwood pulp, as opposed to non-integrated companies that sell market pulp, like us. “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. With world shipments of unbleached softwood kraft pulp of 2.0 million tonnes for 2016, according to Pulp and Paper Production Council, we are the world’s largest single producer of unbleached softwood market pulp, based on sales, with 21.9% of the total market in 2016. During the year ended December 31, 2016, 97.4% of our total unbleached market pulp sales (in terms of tonnes sold) 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.

 

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

 

     For the Year Ended December 31,  
     2016      2015      2014  
     (in tonnes)  

Bleached Pulp

        

Asia and Oceania

     2,153,550        2,003,058        1,874,346  

Europe

     557,726        603,593        527,839  

North and South America

     399,195        435,287        416,539  

Other

     130,289        35,999        9,077  
  

 

 

    

 

 

    

 

 

 

Total

     3,240,760        3,077,937        2,827,801  
  

 

 

    

 

 

    

 

 

 

Unbleached Pulp

        

Asia and Oceania

     326,332        325,394        332,964  

North and South America

     94,288        116,613        100,352  

Europe

     4,618        6,795        11,270  

Other

     14,447        10,756        6,920  
  

 

 

    

 

 

    

 

 

 

Total

     439,684        459,558        451,505  
  

 

 

    

 

 

    

 

 

 

While there are many grades and varieties, pulp is a commodity that is marketed primarily based on 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 quality of our pulp derives from the high standards of production that we maintain at our 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 “Arauco Argentina” and our unbleached pulp is marketed under the brand name “Celco.” The 50% share of the pulp produced from Montes del Plata is marketed under the brand name “Arauco.”

Prices for bleached kraft market pulp produced from radiata pine and eucalyptus normally 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, the availability of substitutes and the relative strength of the U.S. dollar. 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 “—Pulp Prices” and “Item 3. Risk Factors-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.”

The following table sets forth our average bleached and unbleached pine pulp prices per tonne at the indicated dates for each quarter, of the years referenced.

 

     2016      2015      2014  
     (U.S.$ per tonne)  

Bleached Pulp

        

1Q

     570        644        690  

2Q

     590        643        670  

3Q

     564        652        668  

4Q

     558        610        644  

Unbleached Pulp

        

1Q

     594        619        704  

2Q

     608        600        705  

3Q

     573        628        678  

4Q

     574        621        664  

In accordance with customary pulp market practice, we do not have long-term sales contracts with our customers (except for 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, 2016, more than 230 customers. As of December 31, 2016, we employed 13 sales agents to represent us in more than 47 countries. We manage this worldwide sales network from our headquarters in Chile.

 

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Timber

We produce panels (fiberboard and particleboard), sawn timber (green, kiln-dried lumber and flitches), remanufactured wood products and plywood. For the year ended December 31, 2016, sales of timber totaled U.S.$2.5 billion, representing 52.2% of our total revenues.

Exports, which include sales to countries other than the countries in which the goods are produced, accounted for 43.5% of our total revenues of timber for the year ended December 31, 2016. We sell panels primarily to customers in North America, Brazil, Chile, Argentina and other countries in Latin America.

The following table sets forth our panel sales to unaffiliated third parties for each of the years indicated.

 

     Year ended December 31,  
     2016      2015      2014      2013      2012  
     (in thousands of cubic meters)  

Panels

     4,754        4,915        4,840        4,738        2,988  

Sawn timber

     1,944        2,079        2,361        2,284        2,009  

Remanufactured wood products

     442        422        429        411        413  

Plywood

     564        594        444        425        568  

Total

     7,704        8,010        8,074        7,858        5,978  

As of December 31, 2016, we owned and operated two panel mills, eight sawmills and two plywood mills in Chile; two panel mills and one sawmill in Argentina; two panel mills in Brazil; six panel mills in the United States; and two panel mills in Canada. Total aggregate installed annual production capacity as of December 31, 2016 was approximately 9.8 million cubic meters. 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 our sawmills are located near our pine plantations. As of December 31, 2016, we also owned 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 434,843 cubic meters of remanufactured wood products in 2016.

Two acquisitions expanded our North American manufacturing presence. In December 2011, Arauco Panels USA, one of our U.S. subsidiaries, entered into an asset purchase agreement to acquire an industrial facility in Moncure, North Carolina for U.S.$56 million plus approximately U.S.$6 million in working capital. In June 2012, we entered into a share purchase agreement to acquire five panel mills in the United States, one of which was located in Albany, Oregon; two in Bennettsville, South Carolina; one in Eugene, Oregon; and one in Malvern, Arkansas and two panel mills in Canada, located in St. Stephen, New Brunswick and Sault Ste. Marie, Ontario. On July 1, 2012, we commenced the process of insourcing the operation of 13 sawn timber industrial facilities in Chile, which had previously been managed by third-party companies. As a result, we incorporated 2,900 people into our workforce in that same year. In 2015, we agreed to purchase a 50% of Sonae Arauco for a total purchase price of €137.5 million (equivalent to U.S.$153.1 million), comprising the following operations: (i) two panel plants and one sawmill in Spain; (ii) two panel plants and one resin plant in Portugal; (iii) four panel plants in Germany, (iv) and two panel mills in South Africa. The transaction closed on May 31, 2016.

Our panel mills in Chile are certified under standard Chain of Custody FSC® (License Code FSC-C119538), which includes two panel mills. Also, our eight sawmills, two plywood mills and the remanufacturing facilities are certified under the Chain of Custody FSC® standard (License Code FSC-C119538). Additionally, all our timber mills in Chile are certified under CERTFOR (PEFC homologated).

In North America, all our panel mills are certified under the Chain of Custody FSC® standard (License Code FSC-C019364) and our composite panel mills are also certified under the ISO 14001/ OHSAS 18001 standard.

Our Zárate Mill in Argentina is certified under the Chain of Custody FSC® standard (License Code FSC-C119529). All our mills in Argentina are certified under the Environmental Management System ISO 14001 standard, as well as under the Occupational Health and Safety Assessment Series (OHSAS) 18001 standard.

Our panel mills in Brazil (Jaguariaiva and Piên) are certified under the Chain of Custody FSC® standard (License Code FSC-C010928 and FSC-C118530), the Environmental Management System ISO 14001 standard and the Occupational Health and Safety Assessment Series (OHSAS) 18001 standard.

 

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Chile

Teno Mill. This mill, which began production on July 4, 2012, has an installed annual production capacity of 300,000 cubic meters of PBO and 240,000 cubic meters of melamine laminate panels. The complex has a continuous PBO panel production line, two laminated panel production lines and one impregnation line.

Trupán-Cholguán Mill. This mill has an installed annual production capacity of approximately 575,000 cubic meters of panels and 35,000 cubic meters of melamine panels. It has three production lines, one of which produces HB with an annual capacity of 60,000 cubic meters and the other two of which produce MDF with an annual 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 was built on the same site as the original mill, which was destroyed as a result of the 2011 wildfires in the Bio-Bio Region of Chile. The new Nueva Aldea Mill started operating on December 18, 2013. It has an annual production capacity of 360,000 cubic meters of plywood panels.

Cholguán Sawmill and Remanufacturing Facilities. This sawmill has installed annual production capacity of approximately 317,000 cubic meters of lumber, as well as drying kiln facilities with installed annual production capacity of approximately 273,000 cubic meters and two remanufacturing facilities with installed annual production capacity of approximately 92,000 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 12,500 cubic meters.

Colorado Sawmill. This sawmill has an installed annual production capacity of approximately 273,000 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 175,000 cubic meters.

El Cruce Sawmill. This sawmill has an installed annual production capacity of approximately 116,000 cubic meters of lumber. Due to wildfires occurred during the months of January and February 2017 in Chile, the El Cruce Sawmill was destroyed.

Horcones I Sawmill and Remanufacturing Facility. This sawmill has an installed annual production capacity of approximately 484,000 cubic meters of lumber. It also has drying kilns with an installed annual capacity of approximately 362,000 cubic meters and a remanufacturing facility with an installed annual production capacity of approximately 130,000 cubic meters of remanufactured wood products.

Horcones II Sawmill. The annual production capacity of this mill is approximately 242,000 cubic meters of lumber. It also has drying facilities with an installed annual capacity of approximately 167,000 cubic meters.

Nueva Aldea Sawmill. This mill has installed annual production capacity of approximately 431,000 cubic meters of sawn timber and is equipped with drying kilns with installed annual capacity of approximately 351,000 cubic meters.

Valdivia Sawmill and Remanufacturing Facility. This sawmill has installed annual production capacity of approximately 464,000 cubic meters of lumber. It also has drying facilities with an installed annual capacity of approximately 336,000 cubic meters and a remanufacturing facility with installed annual capacity of approximately 85,000 cubic meters of remanufactured wood products.

Viñales Sawmill and Remanufacturing Facility. This sawmill has installed annual production capacity of approximately 377,000 cubic meters of lumber. It is also equipped with drying kilns with installed annual capacity of approximately 358,000 cubic meters and a remanufacturing facility with an installed annual capacity of approximately 101,000 cubic meters of remanufactured wood products.

Argentina

Piray Mill. This mill has an installed annual production capacity of approximately 300,000 cubic meters of MDF panels and 120,000 cubic meters of melamine lamination.

Zárate Mill. This mill has an installed annual production capacity of approximately 260,000 cubic meters of PBO panels and 220,000 cubic meters of melamine lamination, in addition to producing PBO.

Piray Sawmill and Remanufacturing Facility. This sawmill has installed annual production capacity of approximately 358,000 cubic meters of lumber. It is also equipped with drying kilns with installed annual production capacity of approximately 308,000 cubic meters and a remanufacturing facility with installed annual production capacity of approximately 67,000 cubic meters of remanufactured wood products.

 

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Brazil

Jaguariaiva Mill. This mill produces MDF and has an installed annual production capacity of approximately 815,000 cubic meters of MDF panels through the first production line and 500,000 cubic meters of MDF panels through the second production line. Its total melamine lamination capacity is 280,000 cubic meters.

Piên Mill. This mill has an installed annual production capacity of approximately 750,000 cubic meters of panels distributed among two production lines with a production capacity of 440,000 cubic meters of MDF boards, 310,000 cubic meters of PBO and 250,000 cubic meters of melamine lamination.

United States

Duraflake Mill. This mill located in Oregon, has an installed annual production capacity of approximately 442,000 cubic meters of PBO and 132,000 cubic meters of melamine lamination.

Bennettsville Mill. This mill located in South Carolina has an installed annual production capacity of approximately 251,000 cubic meters of MDF.

Eugene Mill. This mill located in Oregon has an installed annual production capacity of approximately 154,000 cubic meters of MDF.

Malvern Mill. This mill located in Arkansas has an installed annual production capacity of approximately 310,000 cubic meters of MDF.

Carolina Mill. This mill located in South Carolina has an installed annual production capacity of approximately 600,000 cubic meters of PBO and 285,000 cubic meters of melamine lamination. An expansion project was completed in the fourth quarter of 2016, increasing the mill’s PBO production capacity by 104,000 cubic meters and melamine capacity by 153,000 cubic meters.

Moncure Mill. This facility located in North Carolina includes an MDF production line with an annual production capacity of 285,000 cubic meters, a PBO production line with an annual production capacity of 262,000 cubic meters and two melamine lamination production lines with a combined annual production capacity of 150,000 cubic meters.

Canada

Sault Sainte Marie Mill. This mill located in Ontario has an installed annual production capacity of approximately 310,000 cubic meters of MDF and 115,000 cubic meters of melamine lamination.

St. Stephen Mill. This mill located in New Brunswick has an installed annual production capacity of approximately 376,000 cubic meters of panels distributed between two production lines with a production capacity of 216,000 cubic meters of PBO and 160,000 cubic meters of thin HDF, in addition to a melamine lamination capacity of 255,000 cubic meters, paint/print and décor paper lines and with an on-site resin facility.

Sonae Arauco

Sonae Arauco, of which we own 50%, and its subsidiaries produce market wood panels, of the OSB, MDF and PB type, and sawn timber through the operation of: (i) two panel plants and one sawmill in Spain; (ii) two panel plants and one resin plant in Portugal; (iii) four panel plants in Germany, (iv) and two panel mills in South Africa. In the aggregate, the production capacity of Sonae Arauco is approximately 460,000 cubic meters of OSB, 1,450,000 cubic meters of MDF, 2,270,000 cubic meters of particleboards and 100,000 cubic meters of sawn timber.

 

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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, 2016, sales of forestry products were U.S.$86.5 million, representing 1.8% of our 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,  
     2016      2015      2014      2013      2012  
     (in thousands of cubic meters)  

Sawlogs

     1,328        1,793        2,262        2,149        2,250  

Pulplogs

     459        591        499        546        274  

Posts

     0        0        2        13        22  

Chips

     366        278        303        305        365  

Energy and Sustainable Development

We utilize renewable fuels such as forest biomass sub-products in power plants that cogenerate the steam and electricity required for our manufacturing operations, thus contributing to reducing greenhouse emissions. Biomass co-generation allows for a high thermal efficiency, approaching 80% in some cases. In addition to meeting our own energy needs, in Chile we generate a significant amount of surplus power, which we deliver to the Sistema Interconectado Central (Chilean power grid, or SIC), which distributes electrical power throughout the Central and Southern Regions of Chile. In Uruguay, biomass sub-products from our Montes del Plata Mill also cogenerate the steam and electricity to meet our energy needs, and surplus power is delivered to the Uruguayan power grid.

The following table sets forth, by country and mill, our energy producing facilities and their annual installed capacities, maximum generation, average consumption and surplus power as of December 31, 2016:

 

Country/Mill

   Installed  Capacity
(MW)
     Maximum
Generation
(MW)
     Average
Consumption
(MW)
     Surplus power delivered
to Power Grid

(MW)
 

Chile

           

Arauco

     127        105        81        24  

Constitución

     40        30        22        8  

Cholguán

     29        28        15        13  

Licancel

     29        20        14        6  

Valdivia

     140        115        54        61  

Horcones (gas/diesel)

     24        24        0        24  

Nueva Aldea I

     30        28        14        14  

Nueva Aldea II (diesel) (1)

     10        N.A.        0        N.A.  

Nueva Aldea III

     136        100        63        37  

Bioenergía Viñales

     41        31        9        22  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Chile

     606        481        272        209  
  

 

 

    

 

 

    

 

 

    

 

 

 

Uruguay

           

Montes del Plata (2)

     82        74        38        36  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Uruguay

     82        74        38        36  
  

 

 

    

 

 

    

 

 

    

 

 

 

Argentina

           

Piray

     38        23        15        8  

Esperanza

     40        35        40        0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Argentina

     78        58        55        8  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     766        613        365        253  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Nueva Aldea II does not have energy available to sell to third parties
(2) Considers 50% of joint venture Montes del Plata

 

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As of December 31, 2016, we had registered five co-generation power plants in Chile as greenhouse emission reduction project activities under the Clean Development Mechanism (CDM) of the Kyoto Protocol. Three of them were registered during 2006, Trupán, Nueva Aldea (first phase) and Nueva Aldea (second phase); a fourth plant was registered in 2009, the Valdivia biomass power plant; and the fifth one was registered in January 2011, the Horcones power plant expansion project. Each of these power plants generates electricity through forestry biomass (forestry and wood industrial sub-products, including the wood pulp by-product called “black liquor”), which is a renewable carbon-neutral fuel that allows the facilities to decrease their reliance on fossil-fuel intensive grid electricity.

Arauco was the first Chilean forestry company to issue Certificates of Emission Reductions (CERs or carbon credits) through the CDM of the Kyoto Protocol in Chile. As of December 31, 2016, we had issued a total of 3.57 million CERs with our CDM projects. As of the date of this annual report, we have sold 1.6 million CERs, mainly to European companies subject to compliance obligations under the European Trading Scheme (ETS). The following table presents the total amount of CERs issued and sold by Arauco for each of the years indicated:

 

     Year ended December 31  
     2016      2015      2014      2013      2007-2012  

CERs issued (net of the commission paid to United Nations Framework Convention on Climate Change, or UNFCCC)

     109,844        827,971        403,317        488,475        1.67 million  

CERs sold or donated

     561,619        1,375        42,567        —          1.04 million  

In 2015, Arauco entered into a long-term sale agreement with Vattenfall Energy Trading Netherlands N.V., pursuant to which Arauco agreed to sell all its CERs generated between 2013 and 2020 to Vattenfall. This agreement provides for the sale of our carbon credits in the European compliance market, which is the largest carbon credit market currently in operation. In 2016, Arauco sold 560,267 CERs to Vattenfall Energy Trading Netherlands N.V. under the long-term agreement.

The Viñales biomass power plant, which began operations on May 17, 2012, reached its maximum production capacity on August 29, 2012. The power plant is located alongside the Viñales sawmill, in Chile’s Seventh Region. The plant includes a biomass-fueled power boiler with capacity to produce 210 tonnes of steam per hour and a 41 Megawatt extraction-condensing turbo generator. This power plant was also developed as an emission reduction project initiative by Arauco. On January 27, 2013, the Viñales emission reduction project activity was successfully registered as a greenhouse gas emission reduction project activity under the voluntary carbon standard: Verified Carbon Standard (VCS). This project issued its first verified emission reductions (VERs) in early 2017.

During January 2013, the biomass cogeneration power plant located in the Montes del Plata pulp mill facility in Uruguay was successfully registered as a CDM project activity. This was the eleventh CDM project registered in Uruguay. This project activity is expected to generate an average of 124,000 CERs per year, during its first 7-year crediting period. It is expected that this project will issue its first CERs in the first half of 2018.

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., or CMPC, and Fibria Cellulose S.A., or Fibria, 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 face competition from Brazilian, Scandinavian and U.S. producers. Our main competitors with respect to unbleached softwood pulp are from Canada and Russia.

Timber

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

For sales of PBO, in the Latin American market we compete mainly with Duratex S.A., Masisa S.A., Berneck S.A. and Fibraplac S.A. In North America, we mainly compete with Roseburg Forest Products Co., Temple-Inland Inc., Kaycan Ltd. and Sonae Indústria, SGPS, SA.

 

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Arauco’s principal competitors in the plywood markets are located in the United States, Finland, Chile and China. We compete mainly with CMPC, Eagon, Roseburg, Georgia-Pacific, and UPM, among others.

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. We believe that our operating efficiencies, competitive logistics costs, ability to serve customers with multiple specifications, geographical presence in 38 countries and the versatility of our radiata and taeda pine allow us to compete effectively in the world market for timber 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.

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

 

   

Coronel. A private port located between Concepción and the Arauco Mill, which we built as a member of a consortium with five other companies and in which we have an equity interest of 50%. We shipped 45% of our aggregate export volume through this port in 2016;

 

   

Lirquén. A private port in Concepción in which we have an equity interest of 20.3% and through which we shipped 28% of our aggregate export volume during 2016; and

 

   

San Vicente. A state-owned port near the city of Concepción through which we shipped 27% of our aggregate export volume during 2016.

The closest ports to our Chilean mills are located as follows: approximately 60 kilometers from the Arauco Mill, 310 kilometers from the Constitución Mill, 370 kilometers from the Licancel Mill, 70 kilometers from the Nueva Aldea Mill and 430 kilometers from the Valdivia Mill. We do not own pulp storage warehouses at 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 12 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 we do not exceed the free storage period for each shipment. As of December 31, 2016, we had approximately 86,620 AdT 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 more than 870 customers in over 350 cities, many of which are separated by long distances, is a key component to our competitiveness.

In Uruguay, our finished product of hardwood pulp is shipped mainly to Europe and Asia through our own Montes del Plata Mill port located next to the pulp mill in Punta Pereira, Colonia, Uruguay.

In North America, products sourced from our South American operations are shipped into 17 major ports of entry and are dispatched to more than 3,500 locations in the United States and Canada. Arauco’s eight composite panel plants in North America service over 580 customers throughout the region mainly through trucks, in addition to exporting products to the Caribbean, Central America and the Middle East.

 

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Description of Property

The following table presents our principal properties as of December 31, 2016.

 

Country

  

Forestry

  

Plants and Facilities

Chile   

1,108,611 total hectares

718,460 hectares of plantations

  

5 Pulp Mills

2 Panel Mills

2 Plywood Mills

8 Sawmills

4 Remanufacturing Facilities

Argentina   

263,384 total hectares

132,333 hectares of plantations

  

1 Pulp Mill

1 MDF Mill

1 PBO Mill

1 Sawmill

1 Remanufacturing Facility

1 Chemical Plant

Brazil   

181,298 total hectares

100,468 hectares of plantations

  

1 MDF Mill

1 MDF-PBO Mill

Uruguay (1)   

122,609 total hectares

73,696 hectares of plantations

   50% of 1 Pulp Mill
United States      

2 PBO Mills

3 MDF Mills

1 MDF-PBO Mill

Canada      

1 MDF Mill

1 MDF-PBO Mill

Portugal      

50% of 1 MDF Mill (2)

50% of 1 PBO Mill (2)

Spain      

50% of 1 MDF Mill (2)

50% of 1 PBO Mill (2)

50% of 1 Sawmill (2)

Germany      

50% of 2 MDF Mills (2)

50% of 1 MDF-PBO Mill (2)

50% of 1 PBO-OSB Mill (2)

South Africa      

50% of 1 PBO Mill (2)

50% of 1 PBO Mill (2)

 

(1) Corresponds to 50% of Montes del Plata.
(2) Corresponds to 50% of Sonae Arauco.

Future expansion plans will depend on global market conditions. For information regarding environmental risks associated with our use of our properties, see “Item 3. Key Information—Risk Factors—Risks Relating to Us and the Forestry Industry.”

Insurance

We carry a global insurance program, consistent with industry practice, covering our production plants, facilities and equipment. This insurance provides coverage, in the event of fire, explosion, machinery breakdowns or natural disasters, including earthquakes and tsunamis. Our insurance covers up to U.S.$750 million per loss in Chile, U.S.$300 million per loss in each country: Argentina, Brazil, United States and Canada (for Arauco North America), including physical damage and business interruption for up to 18 months. The deductible for Chile and Argentina for physical damage is U.S.$3 million per occurrence for damages caused by earthquakes and tsunamis, with a deductible of 2% of the insured amount for each location, subject to a cap of U.S.$25 million. Deductibles for business interruption are 30 days for all losses, 45 days for machinery breakdowns and 60 days for machinery breakdowns of turbines. We also have an annual self-insurance retention of U.S.$20 million, with a U.S.$10 million maximum per event. The deductible for Arauco North America, including physical damage and business interruption is U.S.$2.5 million, and the deductible for Brazil, including physical damage and business interruption is U.S.$1.5 million. All of our insurance policies covering our production plants, facilities and equipment in Chile, Argentina, Brazil, United States and Canada are carried by the Seguros Generales Suramericana S.A. (60.2%), Compañía de Seguros Generales Penta Mapfre S.A. (21.3%) and Ace Seguros S.A. (18.5%).

Also, we have contracted fire insurance policies for all of our Chilean forest holdings and nurseries but do not insure against pests or disease. In Argentina, we maintain fire insurance for 15,652 hectares of timber assets located in the Delta del Paraná, near Buenos Aires and Entre Ríos. For the rest of our Argentine operations, we do not maintain fire insurance for our timber assets because

 

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we believe that the risk of damage from fire is low as Argentina receives significant amounts of rainfall, particularly during the summer months. For our forests in Brazil we maintain fire insurance for 26,000 hectares of Novo Oeste’s timber assets located in Mato Grosso do Sul. For the rest of our forests in Brazil, we do not maintain fire insurance because we believe the risk of damage from fire does not justify the costs of carrying insurance. Terms, deductibles and limits of our insurance policies in all the countries where we operate are consistent with industry practice, which in conjunction with the Company’s own resources, allow it to minimize these risks.

The forestry insurance for plantations located in Chile is carried by Seguros Generales Suramericana S.A. (60%) and Compañía de Seguros Generales Penta S.A. (40%), with a U.S.$50 million maximum limit and a deductible of U.S.$15 million per event. The insurance policies for plantations located in the Delta del Paraná, Argentina, are carried by Sancor Seguros and have a maximum limit of U.S.$7 million with a deductible of U.S.$140 thousand. Our insurance policies for some of our plantations located in Mato Grosso do Sul, Brazil, are carried by Fairfax Insurance and have a maximum limit of R$30 million with a deductible per event of R$1.5 million.

For more information regarding the risks for which we insure our property, see “Item 3. Key Information—Risk Factors—Risks Relating to Us and the Forestry Industry.”

Our Nueva Aldea complex suffered significant fire related damage to our plywood mill and forests due to wildfires that affected the Eight Region of Chile on December 31, 2011. Our insurance covered the losses related to our forest plantations. We had a U.S.$1.0 million deductible for property damage and a U.S.$1.97 million deductible for business interruption at our Nueva Aldea plywood mill. On December 11, 2012, we and the insurers accepted the final report of the insurance adjusters. In accordance with such final report, as of December 31, 2013, we received a total recovery of U.S.$33 million, net of U.S.$110 million in advance payments that we had already received. With respect to our inventory, which was covered under a different policy, we received during 2013 a total recovery of U.S. $20.8 million.

 

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CAPITAL EXPENDITURES

To utilize our increasing volume of forest production, we have added to, expanded and modernized our processing facilities.

For the year ended December 31, 2014, our aggregate capital expenditures were U.S.$604.2 million, consisting primarily of U.S.$471.2 million for addition of property, plant and equipment and U.S.$133.0 million for the addition of biological assets.

For the year ended December 31, 2015, our aggregate capital expenditures were U.S.$564.8 million, consisting primarily of U.S.$438.7 million for addition of property, plant and equipment and U.S.$126.1 million for the addition of biological assets.

For the year ended December 31, 2016, our aggregate capital expenditures were U.S.$556.6 million, consisting primarily of U.S.$419.2 million for addition of property, plant and equipment and U.S.$137.4 million for the addition of biological assets.

For the year ending December 31, 2017, we have planned capital expenditures of U.S.$600 million, which principally include U.S.$240 million in maintenance of our existing mills, U.S.$230 million in expansion and other strategic initiatives, and U.S.$130 million in maintenance and acquisition of biological assets.

 

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GOVERNMENT REGULATION

Environmental Regulation

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 Ley Sobre Bases Generales del Medio Ambiente (Chilean Environmental Law) and related regulations. Current environmental institutions include the following public entities: the Ministry of the Environment (aimed at developing national environmental policy), the Service of Environmental Evaluation (in charge of administering the environmental assessment system), the Evaluation Commissions (in charge of evaluating projects and activities within the Environmental Impact Evaluation System), and the Superintendence of Environment (in charge of supervising and auditing environmental compliance).

Under the Chilean Environmental Law, we are required to conduct environmental impact studies or declarations on the 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.

Governmental agencies may 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 compliance with environmental regulations. Enforcement remedies include temporary or permanent closure of facilities and fines. The Superintendence of Environment has issued numerous resolutions, instructions and requirements to various companies, officials and supervised parties, including our Company.

The operations of the Valdivia Mill recently became subject to the Norm. The Valdivia Mill discharges its treated effluents into the Cruces River, which is part of the Valdivia River Basin. We cannot exclude that the authority declare that the Basin is contaminated and thus initiate an administrative procedure to enact a decontamination plan, which may include limits on discharges of wastewater applicable to the Valdivia Mill.

Arauco expressed concerns, among others, regarding various aspects of the Norm’s General Environmental and Social Impact Assessment (AGIES, for its acronym in Spanish), prior to its enactment. These objections included the lack of identification and consideration for the effective economic and social costs resulting from the adoption of the Norm. Other objections include that the Norm’s parameters and limits exceed the reviewed water quality criteria enforced by reference countries in both quantity and stringency; and that many of the parameters and limits are not technically or environmentally reasonable. The Company challenged the validity of the Norm before the Third Environmental Court in January 2016. Several technical, economical and legal reports from third parties (scientists, economists and attorneys from different countries) were filed to support the challenge. Other local actors challenged the Norm as well, such as Corporación para el Desarrollo de la Región de Los Rios (Association for the Development of Los Rios Region) CODEPROVAL (for its acronym in Spanish) and the local company Forestal Calle Calle S.A. The Third Environmental Court ruled in our favor on September 29, 2016, declaring the Norm invalid. This decision was appealed by the government before the Supreme Court. A final ruling is expected during 2017.

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. See “Item 3. Key Information—Risk Factors—Risks Relating to Us and the Forestry Industry—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.”

As of the date of this annual report, we have been subject to certain inspections, and the Superintendence has served us with several requests for information. As stated above, in 2016 the Superintendence of the Environment initiated four administrative proceedings against the Valdivia, Nueva Aldea, Licancel and Constitución mills. The proceedings against the Valdivia Mill are ongoing, and may result in material administrative fines or sanctions, the revocation of environmental authorizations or the temporary or permanent closure of facilities. The Nueva Aldea and Constitución mills decided to submit compliance programs according to applicable regulations, both of which were approved by the Superintendence of the Environment. These programs require the mills to implement actions and/or make certain investments in connection with the charges made by the Superintendence. Once these activities have been completed, the proceedings will end. With regards to the Licancel Mill, the Company filed its defense in June 2016. In

 

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February 2017, the Superintendence of the Environment found the Licancel Mill liable for three out of four charges and imposed a fine of 239 UTA (approximately U.S.$205,000). This decision was appealed before the above Superintendence. A final decision by the Superintendence is expected in 2017.

We have faced, and continue to face, certain other environmental proceedings in connection with certain of our mills. For a description of these proceedings, see “Item 8. Financial Information—Legal Proceedings.” and Note 18 of our audited consolidated financial statements.

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 must be chemically, biologically and thermally treated before being returned to public waters, such as the Paraná River. In addition, all gaseous emissions must be scrubbed to ensure satisfactory levels of waste particle recovery and odor removal. Regular testing of river water 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.

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 the 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 the 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 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.

Uruguay

Our activities at Montes del Plata are subject to Uruguayan national and municipal environmental regulations. The principal environmental authorization required to carry out such project’s construction activities was the environmental authorization, or AAP, regulated by the Environmental Impact Assessment Act, Law No. 16,466, and its regulatory Decree No. 349/005. AAPs are granted by the National Environmental Bureau, or DINAMA, which pertains to the Ministry of Housing, Land Use Management and Environment, or MVOTMA. In order to obtain this authorization, an applicant must submit a complete report regarding all aspects of any proposed works including a classification of the same by a competent professional in one of the three categories, A, B or C. If the proposed project is classified as B or C, a comprehensive environmental impact assessment (which includes all aspects of the project, including water and noise, among others) is required and in some cases a public hearing may be required. Once the AAP is granted, the interested party is required to perform the project in accordance with the terms and conditions of such authorization.

 

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For certain activities (including construction of an industrial plant) listed in Article 2 of Decree No. 349/005, a Viability Location Report, or VAL, is required. This report should be submitted before the National Environmental Bureau and must include a notification to the municipal government where the project is to be located (Intendencia) and the delivery of information similar to that required for the AAP. This process contemplates a period for public comment on summary information that is available. The Intendencia involved in any such project may submit its findings to the DINAMA for consideration. The VAL, if needed, must be obtained prior to the AAP. The relevant companies that comprise Montes del Plata have already obtained the AAP and the VAL.

Once construction is completed according to the approved project and the AAP conditions, and prior to starting operations, a company needs to obtain the environmental authorization for operation, or AAO, which is regulated by the same decree, and comes to regulate the environmental compliance of the relevant companies in the operational phase of the endeavor. Montes del Plata obtained this authorization from the National Environmental Bureau, DINAMA, in June 2014.

We believe that the Montes del Plata project is currently in material compliance with applicable local and national environmental regulations in Uruguay.

United States and Canada

Our North American operations are subject to U.S. and Canadian environmental legislation, including federal, provincial, state and local laws and regulations. Such laws and regulations govern the use, storage, handling, generation, treatment, emission, release, discharge and disposal of certain hazardous materials and wastes, the remediation of contaminated soil and groundwater, plant and wildlife protection, landfill sites and the health and safety of employees. For example, under the Clean Air Act, the United States Environmental Protection Agency, or the EPA, has established Maximum Achievable Control Technology, or MACT, environmental regulations that establish emission standards for point sources of pollution, such as press and dryer exhausts, process vents and equipment leaks. In addition, some of our operations require environmental permits and controls to prevent and reduce air and water pollution. Our failure to comply with applicable environmental, health and safety requirements, including permits related thereto, may result in:

 

   

civil penalties;

 

   

supplemental environmental projects;

 

   

enforcement actions or other sanctions, such as judicial orders enjoining or curtailing operations or requiring corrective measures;

 

   

loss of operating permits;

 

   

required installation of pollution control equipment; or

 

   

remedial actions.

In addition, we may become liable for third-party claims for personal injury and property damage due to contamination at our mills, even where the activity that caused such contamination occurred before we owned the mills.

We believe we are currently in material compliance with all applicable local and national environmental regulations and orders governing our operations in the United States and Canada.

Forestry, Land-Use and Land Ownership Regulations

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 native or planted forests, are subject to management plans that require the approval of the Corporación Nacional Forestal, or National Forest Service (“CONAF”). In addition, the Forests Law and Decree Law No. 701 impose 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 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 established a fund for the conservation and sustainable management of native forests. According to this law, owners of native forests are able to exploit them so long as they have a “management plan” approved by the CONAF. Depending on the owner’s approved plan, as well as other factors, the subsidy provided by the fund may

 

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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. 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. Our products come from established plantations only; we do not sell any wood 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. We believe that we are in material compliance with Law No. 20,283. See “Item 4. Description of Business—Forestry Activity.”

Argentina

The management and exploitation of forests in Argentina is regulated by National Law No. 13,273, National Law No. 25,080, and National Law No. 26,432, National Decree No. 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.

On December 28, 2011, National Law No. 26,737 was promulgated, which established limitations on the ability of foreigners to purchase rural land in Argentina. This law provides that foreigners cannot acquire more than 15% of all rural land in the country, and that no foreigner can individually hold more than 30% of said 15%. For the purposes of the National Law No. 26,737, rural land is all land located outside the urban area.

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 plants and wildlife govern our Brazilian forestry operations. Under this regulatory framework Brazilian authorities establish forest preservation areas and regulate replanting of forests after harvesting.

There are current discussions about certain Brazilian legal restrictions on the acquisition of rural properties by foreign companies and by Brazilian companies controlled by foreign persons. Those restrictions are contained in the Opinion issued by the Office of the General Counsel to the Federal Government in August 2010, which has been the subject to several judicial challenges. Currently, there is a pending litigation before the Supremo Tribunal Federal (Highest Court in Brazil) to determine if the Federal Law No. 5,709/1971 is applicable to Brazilian companies with foreign shareholders, as it could arguably be contrary to the Brazilian constitution. In addition, the Government is expected to submit a bill to Congress addressing this subject. Our local counsel has advised us that although in their opinion these restrictions are not applicable to the transactions consummated by our Brazilian subsidiaries, they could apply to future transactions. We believe that our Brazilian operations are in material compliance with the applicable regulatory framework.

Uruguay

The management and exploitation of forests in Uruguay is regulated primarily by Law No. 15,939 (as amended by Law No. 18,083 and by the regulatory decree No. 452/988), which has declared forestry activity as an area of national interest. This law classifies forests into three categories: protectors, yield and general, and provides certain tax and financial benefits related to forests classified as protectors and yield located in areas classified as forestry priority. If such forests were planted after January 1, 2007, they must also comply with the definition of quality wood. In order to obtain such classification, interested parties must submit a forestry management plan to the General Forestry Bureau. This law also establishes certain conservation requirements and controls for each category of forest.

Additionally, forest activity is subject to environmental and soil care regulations. According to Law No. 16,466 and Decree No. 349/005, plantations of more than 100 hectares need prior environmental authorization. Law No. 15,239 also provides certain measures that must be adopted to reduce erosion and degradation of the soil to promote its restoration when necessary.

We believe that the Montes del Plata forestry operations are in material compliance with the applicable regulatory framework.

 

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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 revenue from the sale of bleached and unbleached pulp, panels such as MDF, PBO, HB, and plywood, and sawn timber products such as sawn timber and remanufactured wood products, forestry products, such as sawlogs and pulplogs, and sales of electricity to the grid. Export sales constituted 62.1% of our total revenue for the year ended December 31, 2015 and 58.1% of our total sales revenue for the year ended December 31, 2016. Sales of pulp constitute the single largest component of our revenue. As with many commodities, pulp is subject to significant cyclical price fluctuations determined by global supply and demand. Accordingly, our revenue is subject to cyclical fluctuations. Prices for timber and forestry products, also fluctuate significantly among markets. 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 2014, we exported our products to Asia, North, Central and South America, Europe and, to a lesser extent, Africa and the Middle East. In 2014 and 2015, 91.8% and 90.8%, respectively, of total pulp revenues were export sales, and 26.6% and 25.9%, respectively, of total timber products and forestry product revenues were export sales. In 2016, 92.2% of our total pulp revenues were export sales, and 26.7% of total timber products and forestry product revenues were also export sales. Our business, earnings and prospects may be materially and adversely affected by developments in our 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.

As of December 31, 2016, 63.3% of our property, plant, equipment and forest assets were directly owned by Celulosa Arauco and Constitución S.A. and our Chilean subsidiaries, 9.1% by our Argentine subsidiaries, 8.9% by our Brazilian subsidiaries, 2.9% by our U.S. and Canadian subsidiaries and 15.8% by our joint operation in Uruguay. In 2016, 59.9% of our consolidated revenue was derived from our operations in Chile, 8.7% of our consolidated revenue was derived from our operations in Argentina, 7.4% of our consolidated revenue was derived from our operations in Brazil, 16.8% of our consolidated revenue was derived from our operations in the United States and Canada and 7.2% of our revenue was derived from our operations in Uruguay. Accordingly, our financial condition, results of operations and cash flows are affected by, to a significant degree, economic conditions in Chile, Argentina, Brazil, Uruguay, the United States and Canada.

Economic Indicators in Chile, Argentina, Brazil, Uruguay, the United States and Canada

Chile

According to the Central Bank of Chile, Chile’s GDP increased by 1.9% in real terms during 2014, and in 2015 and 2016 it grew at rates of 2.3% and 1.6%, respectively. See “Item 3. Key Information—Risk Factors—Risks Relating to Chile.”

 

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Argentina

According to the Instituto Nacional de Estadística y Censos (the Argentine National Statistics and Census Institute, or the “INDEC”), Argentina’s GDP increased by 0.5% in real terms during 2014, and in 2015, it grew at a rate of 2.6%. For 2016, the INDEC reported a negative growth of 2.3% in real GDP. In 2014 and 2015, the Argentine peso depreciated against the U.S. dollar by 30.7% and 51.7%, respectively. In 2016, the Argentine peso depreciated against the U.S. dollar by 20.9%.

From 2007 through 2015, the INDEC, underwent institutional and methodological reforms that gave rise to controversy regarding the reliability of the information that it produced, including inflation, GDP, unemployment and poverty data.    On January 8, 2016, based on its determination that the INDEC had failed to produce reliable statistical information, particularly with respect to its CPI, GDP and foreign trade data, the new Argentine administration declared a state of administrative emergency for the national statistical system and the INDEC that remained in effect through December 31, 2016. Following the emergency declaration, the INDEC ceased publishing statistical data until a rearrangement of its technical and administrative structure was finalized. As of the date of this annual report, the INDEC has published certain revised data, including the CPI monthly data since May 2016 and foreign trade and balance of payment statistics. On June 29, 2016, the INDEC published a report including revised GDP data for the years 2004 through 2015.

Although reports published by the International Monetary Fund (IMF) stated that their staff used alternative measures of inflation for macroeconomic surveillance, including data produced by private sources, which have shown inflation rates considerably higher than those published by the INDEC between 2007 and 2015, on November 9, 2016, the IMF Executive Board lifted its censure on Argentina, noting that Argentina had resumed the publication of data in a manner consistent with its obligations under the Articles of Agreement of the IMF. Future economic, social and political developments in Argentina, over which we have no control, could impair our and Arauco Argentina’s business, financial condition or results of operations. See “Item 3. Key Information—Risk Factors—Risks Relating to Argentina.”

Brazil

According to the Instituto Brasileiro de Geografia e Estatística (the Brazilian Institute of Geography and Statistics), Brazil’s GDP increased in real terms by 0.1% during 2014, and decreased by 3.8% in 2015. In 2016, Brazil’s GDP decreased in real terms by 3.6%. In 2014 and 2015, the Brazilian real depreciated against the U.S. dollar by 10.8% and 47.7%, respectively. In 2016, the Brazilian real depreciated against the U.S. dollar by 16.4%. See “Item 3. Key Information—Risk Factors—Risks Relating to Brazil.”

Uruguay

According to the Banco Central del Uruguay (the Central Bank of Uruguay), Uruguay’s GDP increased by 3.2% in real terms during 2014, and in 2015 and 2016 it grew in real terms at rates of 0.4% and 1.5%, respectively. In 2014, the Uruguayan peso appreciated against the U.S. dollar by 12.8% but in 2015 it depreciated against the U.S. dollar by 23.2%. In 2016, the Uruguayan peso again appreciated against the U.S. dollar by 3.2%. See “Item 3. Key Information—Risk Factors—Risks Relating to Uruguay.”

United States

According to the U.S. Bureau of Economic Analysis, the United States GDP increased by 2.4% in real terms during 2014, and in 2015 and 2016 it grew in real terms at rates of 2.6% and 1.6%, respectively. See “Item 3. Key Information—Risk Factors—Risks Relating to the United States and Canada.”

Canada

According to the Bank of Canada, Canada’s GDP increased by 2.5% in real terms during 2014, and in 2015 and 2016 it grew in real terms at rates of 1.2% and 1.4%, respectively. The Canadian dollar depreciated against the U.S. dollar by 9.0% in 2014, 19.6% in 2015 and 3.8% in 2016. See “Item 3. Key Information—Risk Factors—Risks Relating to the United States and Canada.”

Exchange Rate Fluctuations

We generally price our exports in U.S. dollars, whereas our domestic sales in Chile are priced in Chilean pesos except for pulp sales, which are priced in U.S. dollars; domestic sales in Brazil are priced in Brazilian 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 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 Chilean peso has been subject to devaluation in the past and could be subject to significant fluctuations in the future. During 2016, the value of the Chilean peso relative to the U.S. dollar increased 5.7% in nominal terms, based on the observed exchange rates

 

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on December 31, 2015 and December 31, 2016. The observed exchange rate on April 25, 2017, as published in the Official Gazette on April 26, 2017, was Ch$660.04 to U.S.$1.00. For information regarding historical rates of exchange in Chile from January 1, 2012, see “Item 3. Key Information—Exchange Rates.”

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, 2016, our U.S. dollar-denominated indebtedness was U.S. $4.5 billion. In addition, as the U.S. dollar appreciates against the legal currency in any of our export markets, we must from time to time price our sales in that local currency to compete effectively.

Future developments in the Chilean, Argentine, Brazilian, Uruguayan, Canadian and U.S. economies may impair our ability to proceed with our strategic plan, including with respect to pricing. For additional discussion regarding the risks we face in each of the aforementioned markets, see “Item 3. Key Information—Risk Factors—Risks Relating to Chile,” “—Risks Relating to Argentina,” “—Risks Relating to Brazil,” “—Risks Relating to Uruguay” and “—Risks Relating to the United States and Canada.”

In recent years, our 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.

 

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

 

     Year ended
December 31, (1)
 

Product (2)

   2016      2015      2014  
     (U.S.$ per tonne) (3)  

Pulp

        

Bleached pulp

     549.5        636.7        666.8  

Unbleached pulp

     592.4        616.6        687.0  
     (U.S.$ per cubic meter) (3)  

Timber

        

Sawn timber

     246.8        239.8        270.0  

Remanufactured wood products

     556.1        686.4        549.6  

Plywood

     402.4        403.8        472.1  

Panels

     322.6        325.0        353.6  

Forestry Products

        

Logs

     35.3        36.9        43.9  

 

(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, as applicable for domestic sales.

Pulp Prices

Overview

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. See “Item 3. Risk Factors—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 bleached grades of hardwood pulp, including eucalyptus, generally follow the same cyclical pattern as prices for NBSK, which is the benchmark for softwood 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 3.4% 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 BEKP.

In 2015, a new pulp mill entered the short fiber pulp market with an annual production capacity of 1.3 million tonnes. During the first half of 2015 the short fiber market remained stable, with a peak price of U.S.$ 811.2 per tonne in October 2015. Following the October peak BEKP prices began to decrease as a result of the global economic downturn and lower demand in the Chinese market as a result of the devaluation of the Yuan, ending the year at a price of U.S.$788.9 per tonne. Expectations of new supply during 2016 and especially in 2017, continued to pressure prices down, reaching their lowest level for 2016 in December 2016, at U.S.$652.58 per tonne. A new pulp mill located in Indonesia began its ramp-up in November 2016. With an annual capacity of 2.8 million tonnes, it is currently one of the largest pulp mills worldwide. Throughout 2015 and the first half of 2016, NBSK prices followed a downward trend, reaching U.S.$789.2 per tonne at the end of April 2016. For the remainder of the year, prices slightly recovered and stabilized, finishing the year at U.S.$808.83 per tonne.

 

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Prices of NBSK

The following table sets forth the prices for NBSK for the years indicated, as well as the variation with respect to the previous year, as listed on the NBSK index for the periods indicated:

 

List Price as of

December 31,

          Change YoY  

2013

   U.S.$ 906.48        12.0

2014

     932.06        2.8

2015

     808.36        (13.8 )% 

2016

     808.83        0.7

Prices of BEKP

The following table sets forth the prices for BEKP for the years indicated, as well as the variation with respect to the previous year, as listed on the BEKP index for the periods indicated:

 

List Price as of

December 31,

          Change YoY  

2013

   U.S.$ 769.73        (0.8 )% 

2014

     742.90        (3.5 )% 

2015

     788.91        6.2

2016

     652.58        (17.3 )% 

Prices of UKP

The following table sets forth the market price of UKP for the years indicated, as well as the variation with respect to the previous year:

 

Price as of December 31,

          Change YoY  

2013

     721.5        23.8

2014

     650.4        (9.9 )% 

2015

     601.7        (7.5 )% 

2016

     573.82        (4.6 )% 

Forestry and Timber Prices

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

During 2012, average sales prices in our timber products segment increased as compared to 2011, mainly due to a 6.7% increase in average sales prices of sawn timber. In 2012, sales in our panel segment increased by 3.7% as compared to 2011. This increase was mainly due to a 10.4% increase in sales volume, which was partially explained by the acquisition of the Moncure mill and Flakeboard in 2012.

During 2013, the average prices in our timber products segment increased 1.0%. The average price of panels increased 0.5%.

During 2014, all sawn timber improved, with increased demand that permitted the sales mix and prices to improve relative to 2013. Asian markets, in particular Japan, South Korea and China followed this positive trend. The North American market, despite an improvement in the Housing Starts index, did not show significant improvement, however prices rose in our solid wood moldings business. Also, our MDF and PBO sales in North America had positive and stable price levels. In Brazil, our panels business had relatively stable price levels in Brazilian reals.

During 2015, average prices for our timber products declined by 8.0% and 0.9% respectively, compared to 2014. Overall, countries with depreciated currencies increased their exports, resulting in greater supply in several markets, which in turn, lowered prices. In Brazil, for example, overall average prices dropped due to the country’s economic slowdown. In North America, increased competition mainly affected the MDF market, with increased exports from Brazilian and Canadian producers, among others. Prices for our moldings products remained stable. As a result of the decrease in Argentina’s competitiveness in the export market, we focused our sales efforts with respect to panels primarily on the domestic market. The higher production of our Nueva Aldea Mill increased our plywood sales volume throughout the year. Particleboards also showed increased sales benefitting from production at our Teno Mill, which reached full production capacity during the first quarter of 2015. We were also able to improve product mix sales, increasing sales of our greater value added products (such as melamine products). In addition, we experienced increased competition in the Middle East in the sawn timber market during the first six months of 2015 due to higher supply from European markets.

 

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During 2016, average prices for our panels and sawn timber declined by 0.7% and 2.7% respectively, in each case compared to 2015. Sales volumes decreased compared to 2015, with panels sales volume dropping by 3.3% and sawn timber sales volume dropping by 4.6%. Argentine markets continued to be pressured during 2016, and opportunities to export to other countries were limited. Brazilian markets followed a similar trend, although there were higher export opportunities, where the depreciation of their local currency against the U.S. dollar made costs more competitive. These export opportunities were mainly to North America, where higher supply volumes entered the market, partially offset by healthy demand throughout the year. Our new commercial sales office in the Middle East also enabled us to reach new customers and have a better presence in those markets.

Prices for our forestry and sawn timber may decline in the future. Our results of operations may be materially adversely affected if the prices of our products 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

 

   

energy and fuel costs.

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

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. For additional information relating to the accounting treatment of our biological assets, see “—Critical Accounting Policies—Biological Assets.”

Selling expenses consist primarily of per tonne fees we pay to our selling agents. Traffic, shipping and freight costs are the outbound logistics costs of carrying the product to the client’s destination.

Cost of sales increased 9.2% during 2012 as a result of increased sales volume in all our business segments and increases in the unit costs of our main products. Compared to 2011, our costs of sales per tonne increased 8.7% for bleached softwood pulp, increased 7.2% for bleached hardwood pulp, and increased 19.1% for unbleached softwood pulp. In 2012, our cost of sales measured as a percentage of total revenues was 73.6%, as compared to 65.9% in 2011.

Cost of sales increased 12.4% during 2013, when compared with 2012. This was mainly the result of an increase in the sales volumes of our panels, pulp and timber products business segments by 45.2%, 5.2% and 7.3%, respectively. In 2013, we were able to achieve lower unit costs of pulp. Our cost of sales per tonne of BSKP and BEKP decreased 4.7% and 6.0%, respectively. This was largely due to an improvement in production rates at our pulp mills as compared to 2012. In 2013, our cost of sales measured as a percentage of total revenues was 69.1%, as compared to 73.6% in 2012.

In 2014, our cost of sales increased 2.7% when compared with 2013. However, as a percentage of our revenues, in 2014 and 2013 cost of sales represented 68.6% and 69.1% of total revenues, respectively. The 2.7% increase in cost of sales reflects the volume increase in our sales of pulp, sawn timber and panels by 6.5%, 3.6% and 2.3%, respectively.

In 2015, our cost of sales decreased 3.9% when compared to 2014. Energy and fuel costs decreased 25.5% when compared to 2014, mainly due to the global decline in crude oil prices and its derivatives. In addition, cost of timber declined 20.7% mainly due to the decrease in the volume of sales of sawn timber, especially in Chile. The depreciation of each of the Chilean peso, the Argentine peso and the Brazilian real against the U.S. Dollar had a positive effect on costs denominated in those depreciated currencies.

 

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In 2016, our cost of sales decreased by 0.4% when compared to 2015. The cost of chemical products and energy and fuels for use during our production process decreased by 11.2% and 18.9% respectively, in each case compared to 2015. Energy prices followed a downward trend during the entire 2016, while fuel prices continued at levels much lower than their historical average (despite certain recovery in price levels during the second half of the year). Lower forestry labor costs also allowed for lower total cost of sales. A partially offsetting factor was the cost of timber which increased by 14.9% mostly as a result of our increase in sales volume in our pulp segment by 4.0% and an increase in the fair value cost of timber harvested by 10.9%.

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.

Biological Assets

IAS 41 requires that biological assets, such as standing trees, are shown on the statement of financial position 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 on 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.

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. The principal considerations used to calculate the valuation of forest plantations are presented in Note 20 to our audited consolidated financial statements.

Impairment of goodwill

Determining whether goodwill is impaired requires an estimate of the value in use of the cash-generating units to which goodwill has been allocated. Arauco estimates the value either based on appraisals and/or the future cash flows expected to arise from the cash-generating unit and a suitable discount rate to calculate present value. See Note 17 to our audited consolidated financial statements.

 

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Litigation and Contingencies

Arauco, its subsidiaries and our Uruguayan joint venture Montes del Plata are subject to certain ongoing lawsuits, the future effects of which need to be estimated by our management in collaboration with our legal advisors. See “Item 3. Key Information—Risk Factors—Risks Relating to Us and the Forestry Industry—We are subject to legal proceedings related to our mills which could adversely affect our business, financial condition, results of operations and cash flows” and “Item 8. Financial Information—Legal Proceedings.” See Note 18 to our audited consolidated financial statements.

Recently Issued Accounting Standards

Note 1 to our audited consolidated financial statements discusses new accounting pronouncements under IFRS that apply to annual periods beginning on or after January 1, 2016. There are no additional pronouncements, amendments or interpretations that could have a material impact on our financial statements.

Results of Operations

The following table provides a breakdown of our financial results of operations and sales volumes as of and for the years ended December 31, 2014, 2015 and 2016. The table and the discussion that follows are based on and should be read in conjunction with our audited consolidated financial statements, including the notes thereto, as of and for the years ended December 31, 2014, 2015 and 2016 included elsewhere herein. The audited consolidated financial statements included herein are prepared in U.S. dollars and in accordance with IFRS. The Timber segment was created following the merger of the companies Paneles Arauco S.A. (successor), Aserraderos Arauco S.A. and Arauco Distribución S.A, from the two business segments previously known as panels and sawn timber. This transaction had no effect on results and was performed to generate greater synergies, share best practices and achieve better results for our clients. See Note 14 and Note 24 to our audited consolidated financial statements.

 

     For the year ended December 31,  
     2016      2015      2014  
     Sales     %     Volume      Sales     %     Volume      Sales     %     Volume  
     (in millions of U.S. dollars, except where indicated)  

Revenue

                    

Pulp

                    

Bleached pulp(1)

     1,780.6       37.4     3,240.8        1,959.7       38.1     3,077.9        1,8885.5       35.3     2,827.8  

Unbleached pulp(1)

     260.5       5.5       439.7        283.4       5.5       459.6        310.2       5.8       451.5  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total

     2,041.1       42.9     3,680.4        2,243.1       43.6       3,537.5        2,195.7       41.1       3,279.3  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Timber

                    

Panels(2)

     1,533.6       32.2       4,753.9        1,597.2       31.0       4,914.8        1,711.7       32.0       4,840.1  

Sawn timber(2)

     479.8       10.1       1,943.8        498.4       9.7       2,078.9        637.6       11.9       2,361.5  

Remanufactured wood products(2)

     245.5       5.2       441.6        287.5       5.6       418.8        235.9       4.4       429.3  

Plywood

     226.9       4.8       563.9        239.9       4.7       594.1        209.6       3.9       443.9  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total

     2,485.8       52.2     7,703.2        2,623.0       51.0     8,006.6        2,794.7       52.3     8,078.3  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Forestry

                    

Logs, net(2)

     63.1       1.3       1,787.5        87.9       1.7       2,384.3        121.2       2.3       2,760.9  

Chips

     20.8       0.4       366.2        17.6       0.3       277.6        19.5       0.4       302.5  

Other

     6.1       0.1       7.8        3.8       0.1       15.7        2.1       0.0       44.0  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total

     90.0       1.9     2,161.4        109.2       2.1     2,677.6        142.8       2.7     3,107.4  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Energy

     103.4       2.2          121.1       2.4          159.9       3.0    

Other

     41.1       0.9          50.4       1.0          49.5       0.9    
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

   

Total revenue

     4,761.4       100        5,146.7       100        5,342.6       100  
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

   

Cost of sales

                    

Timber

     (736.4          (641.8          (809.0    

Forestry labor costs

     (600.3          (636.1          (655.3    

Maintenance costs

     (313.5          (305.7          (278.3    

Chemical costs

     (479.3          (539.9          (541.3    

Depreciation

     (378.0          (371.9          (323.3    

Other costs of sales

     (991.4          (1,016.1          (1,047.0    
  

 

 

        

 

 

        

 

 

     

Total cost of sales

     (3,498.9          (3,511.4          (3,654.1    
  

 

 

        

 

 

        

 

 

     

Gross profit

     1,262.5       26.5        1,635.3       31.8        1,688.5       31.6  

Other income

     257.9            273.0            368.9      

Distribution costs

     (496.5          (528.5          (556.8    

Administrative expenses

     (474.5          (552.0          (550.8    

Other expenses

     (77.4          (83.4          (138.8    

Other gains (losses)

     0.0            0.0            0.0      

Financial income

     29.7            50.3            30.8      

Financial costs

     (258.5          (263.0          (246.5    

Share of profit (loss) of associates and joint ventures accounted for using equity method

     23.9            6.7            7.5      

Exchange rate differences

     (3.9          (41.2          (10.0    

Income before income tax

     263.2            497.4            592.8      

Income tax

     (45.6          (129.7          (448.7    

Net income

     217.6            367.7            144.2      

 

(1) Volumes measured in thousands of tonnes. Does not include subproduct sales (i.e. energy, chemicals) which are presented in the pulp reportable segment in Note 24 in our audited consolidated financial statements.
(2) Volumes measured in thousands of cubic meters. Does not include subproduct sales (i.e. energy, chemicals) which are presented in the timber reportable segment in Note 24 in our audited consolidated financial statements.

 

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Year Ended December 31, 2015 Compared to Year Ended December 31, 2016

Revenue

Revenue decreased 7.5% from U.S.$5,146.7 million in 2015 to U.S.$4,761.4 million in 2016, primarily as a result of:

 

   

a 9.0%, or U.S.$202.0 million, decrease in revenue from pulp;

 

   

a 5.2%, or U.S.$137.2 million, decrease in revenue from timber;

 

   

a 17.6%, or U.S.$19.2 million, decrease in revenue from forestry products.

Pulp. Revenue from bleached and unbleached pulp decreased 9.0% from U.S.$2,243.1 million in 2015 to U.S.$2,041.1 million in 2016, reflecting a 9.0% decrease in sales volume and a 2.3% decrease in average prices. Sales of bleached pulp decreased 9.1% due to a 13.7% decrease in average prices, partially offset by a 5.3% increase in sales volume. During 2016, the gap between softwood and hardwood prices increased but prices remained stable during the last quarter. Hardwood prices followed a downward trend during the whole year due to an increase of supply to the market and lower expected demand. A pulp mill in Indonesia, with capacity of 2.8 million tonnes of hardwood pulp (currently the largest pulp mill worldwide) was set to start operations by the end of 2016. However, as we reached the second semester of 2016, it became clear to the market that the startup of the new mill would be delayed, thus taking pressure off prices. Demand also started picking up in China driven by the revitalization of its exports and price inflation. Softwood prices remained fairly stable after a drop during the first two quarters of 2016, along with stable demand. Revenue from unbleached pulp decreased 8.1% during 2016, mainly due to a 3.9% decrease in average prices and a 4.3% decrease in sales volume.

Timber. Revenue from timber decreased 5.2% from U.S.$2,623.0 million in 2015 to U.S.$2,485.8 million in 2016. This decrease in revenues was primarily due to a 3.8% decrease in sales volume and a 1.5% decrease in average prices. Panel prices, in particular for MDF moldings and other value added products, declined as a result of increased supply originating from Brazil and other countries with depreciated currencies, which in turn increased competition. Argentina showed a decline in prices and sales volume in PBO and MDF, mainly due to the economic downturn and difficulties exporting these items to other countries.

Revenue from sawn timber decreased 3.7%, from U.S.$498.4 million to U.S.$479.8 million due to a 6.5% decrease in sales volume, partially offset by a 2.9% increase in average prices. After a weak first quarter, sawn timber markets recovered over the rest of 2016, although not reaching the same revenue levels of 2015. Asia showed an overall healthy demand for our sawn timber products, although competition increased from countries with depreciated currencies. Remanufactured products revenue decreased 14.6% from U.S.$287.5 million in 2015 to U.S.$245.5 million due to a 19.0% decrease in average prices, partially offset by a 5.4% increase in sales volume. Plywood revenue decreased 5.4% from U.S.$239.9 million in 2015 to U.S.$226.9 million in 2016, with sales volumes decreasing 5.1% and prices decreasing 2.3%. The North American market maintained its dynamism, with the Housing Starts index maintaining its positive trend during 2016, which resulted in a sustained demand for sawn timber products.

Forestry products. Revenue from forestry products decreased 17.6% from U.S.$109.2 million in 2015 to U.S.$90.0 million in 2016. This decrease was primarily the result of a U.S.$24.8 million decrease in the revenue of log sales, driven in turn by a U.S.$8.8 million decrease in sales in sawlogs, and a U.S.$16.0 million decrease in sales in pulplogs.

 

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Other revenue. Revenue from other sources, consisting mainly of sales of energy and chemicals, decreased 15.7% from U.S.$171.4 million in 2015 to U.S.$144.4 million in 2016. This was primarily a result of a U.S.$17.7 million decrease in our energy sales, as a result of a decrease in average electricity prices in Chile.

Cost of sales

Cost of sales decreased 0.4% from U.S.$3,511.4 million in 2015 to U.S.$3,498.9 million in 2016, primarily as a result of a 3.8% decrease in sales volume of our timber products, which in turn decreased forestry labor costs by 5.6%. Costs of energy and fuel used in our operations decreased by 18.9% compared to 2015, as well as costs of energy we sold back to the power grid which decreased by 4.1%, mainly driven by a decline in average prices of crude oil and its derivatives compared to 2015 average prices.

Gross Profit

As a percentage of total revenue, our gross profit decreased from 31.8% in 2015 to 26.5% in 2016, primarily as a result of a 7.5% decrease in sales revenue, while cost of sales declined slightly by 0.4%.

Other income

Other income decreased 5.6% from U.S.$273.0 million in 2015 to U.S.$257.9 million in 2016. Profits from changes in the fair value of our biological assets remained more or less stable, decreasing slightly by 0.9% compared to 2015. In addition, we generated no gains on business combinations achieved in stages compared to a gain of U.S.$8.2 million in 2015, due to the purchase of the remaining 51.0% of Novo Oeste in Brazil during the last quarter of 2015.

Distribution costs

Distribution costs decreased 6.1% from U.S.$528.5 million in 2015 to U.S.$496.5 million in 2016, primarily due to a decrease by 7.7%, or U.S.$29.6 million, in total shipping and freight costs. This decrease was explained by a decline in shipping and freight tariffs. As a percentage of revenue, distribution costs remained fairly stable, at 10.4% in 2016, compared to 10.3% in 2015.

Administrative expenses

Administrative expenses decreased 14.0% from U.S.$552.0 million in 2015 to U.S.$474.5 million in 2016. As a percentage of revenue, administrative expenses also decreased from 10.7% in 2015 to 10.0% in 2016.

Finance costs

Finance costs decreased 1.7%, from U.S.$263.0 million in 2015 to U.S.$258.5 million in 2016. Despite an increase in total debt when compared to 2015, the decrease in finance costs was mainly due to the issuance of a local bond in December 2016, which served to refinance short and/or long-term liabilities. During the rest of 2016 we continued to focus on our de leveraging process.

Exchange rate differences

Losses from exchange rate differences totaled U.S.$3.9 million in 2016. In particular, the depreciation of the Argentine peso affected our cash and cash equivalents and account receivables of our Argentine subsidiary. Since the functional currency of our Brazilian subsidiaries, Arauco do Brasil S.A. and Arauco Forest Brasil S.A., is the Brazilian real, the depreciation of the Brazilian real also generated a loss given that their outstanding loans are denominated in U.S. dollars. See “—Economic Indicators in Chile, Argentina, Brazil, Uruguay, the United States and Canada—Argentina.”

Income tax

We recorded an income tax expense of U.S.$45.6 million in 2016 compared to U.S.$129.7 million in 2015. This decrease is mainly attributable to lower revenues which in turn decreased by 7.5% or U.S.$385.4 million compared to 2015. The decrease is also attributable to a direct credit in 2016 of approximately U.S.$16.7 million which positively impacted our income tax expense, as a result of a net increase in deferred tax assets attributable to the carry forward of unused tax losses after the restructuring of Novo Oeste, acquired at the end of 2015. See “Item 3. Risk Factors—Risks Relating to Chile—A tax reform bill with significant changes for companies was approved in September 2014 and the Chilean Superintendence of Securities and Insurance, or SVS, modified accounting reporting standards for companies under its supervision in October 2014.

 

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Net income

Net income in 2016 decreased 40.8% from U.S.$367.7 million in 2015 to U.S.$217.6 million in 2016. Lower sales in all of our business segments decreased our gross profit by 22.8% or U.S.$357.8 million. Lower distribution costs and administrative expenses partially offset this effect. See “Item 3—Risk Factors—Risks Relating to Chile—A tax reform bill with significant changes for companies was approved in September 2014 and the Chilean Superintendence of Securities and Insurance, or SVS, modified accounting reporting standards for companies under its supervision in October 2014.”

Year Ended December 31, 2014 Compared to Year Ended December 31, 2015

Revenue

Revenue decreased 3.7% from U.S.$5,342.6 million in 2014 to U.S.$5,146.7 million in 2015, primarily as a result of:

 

   

a 23.5%, or U.S.$33.6 million, decrease in revenue from forestry products;

 

   

a 6.1%, or U.S.$171.7 million, decrease in revenue from timber; which was partially offset by

 

   

a 2.2%, or U.S.$47.4 million, increase in revenue from pulp.

Pulp. Revenue from bleached and unbleached pulp increased 2.2% from U.S.$2,195.7 million in 2014 to U.S.$2,243.1 million in 2015, reflecting a 7.9% increase in sales volume, offset by a 5.3% decrease in average prices. Sales of bleached pulp increased 3.9% due to a 8.8% increase in sales volume, offset by a 4.5% decrease in average prices. Our increase in sales volume partially reflects new sales from the Montes del Plata mill. During 2015, the price difference between softwood pulp and hardwood pulp decreased, and in the third quarter, hardwood pulp traded above softwood pulp. This was mainly because softwood prices decreased driven by large discounts made by Russian producers, who benefited from the depreciation of the Ruble. Also, European producers have benefited from a weaker Euro and this has resulted in market pressure to lower softwood prices. In the fourth quarter of 2015, hardwood prices fell below softwood prices, mainly driven by uncertainty in the Chinese market as a result of the devaluation of the Chinese Yuan, which added pressure to pulp prices overall. Revenue from unbleached pulp decreased 8.6% due to a 10.2% decrease in average prices, which was partially offset by a 1.8% increase in sales volume.

Timber. Revenue from timber decreased 6.1%, from U.S.$2,794.7 million in 2014 to U.S.$2,623.0 million in 2015. This decrease in revenues was primarily due to a 5.3% decrease in average prices and 0.9% decrease in sales volume. Panel prices, in particular for MDF moldings and other value added products, declined as a result of increased supply originating from Argentina, Brazil and other countries with depreciated currencies, which in turn increased competition, especially in North America.

Revenue from sawn timber, remanufactured wood products and plywood decreased 5.3% from U.S.$1,083.1 million in 2014 to U.S.$1,025.9 million in 2015, primarily as a result of a 4.4% decrease in sales volume, partially offset by a 0.9% increase in average prices. Sawn timber revenue decreased 21.8% from U.S.$637.6 million to U.S.$498.4 million due to a 12.0% decrease in sales volume and a 11.2% decrease in average prices. Prices declined throughout 2015 due to increased exports from countries with depreciated currencies to countries with better market conditions. Remanufactured products revenue increased 21.9% from U.S.$235.9 million in 2014 to U.S.$287.5 million due to a 24.9% increase in average prices, offset by a 2.4% decrease in sales volume. The North American market maintained its dynamism, with the Housing Starts index maintaining its positive trend during 2015, resulting in a sustained demand for sawn timber products. Our product mix sales also improved, with products with higher margins accounting for a higher share of our sales.

Forestry products. Revenue from forestry products decreased 23.5% from U.S.$142.8 million in 2014 to U.S.$109.2 million in 2015. This decrease was primarily the result of a U.S.$33.4 million decrease in the revenue of logs, driven by a U.S.$47.0 million decrease in sales of sawlogs, which was partially offset by a U.S.$13.7 million increase in sales of pulplogs.

Other revenue. Revenue from other sources, consisting mainly of sales of energy and chemicals, decreased 17.7% from U.S.$208.3 million in 2014 to U.S.$171.4 million in 2015. This was primarily the result of a U.S.$38.8 million decrease in our energy sales, as a result of a decrease in average electricity prices in Chile.

Cost of sales

Cost of sales decreased 3.9% from U.S.$3,654.1 million in 2014 to U.S.$3,511.4 million in 2015, primarily as a result of a 10.5% decrease in our sales volume of timber, which in turn decreased timber costs by 20.7%. In Brazil, timber costs decreased in U.S. Dollar terms as a result of the depreciation of the Brazilian real. Costs of energy and fuel used in our operations decreased by 25.5% compared to 2014, as well as costs of energy we sold back to the power grid by 47.1%, mainly driven by a decline in prices of crude oil and its derivatives.

 

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Gross Profit

As a percentage of total revenue, our gross profit increased slightly from 31.6% in 2014 to 31.8% in 2015, primarily as a result of a 3.9% decrease in our cost of sales, which was offset by a 3.7% decrease in sales revenue.

Other income

Other income decreased 26.0% from U.S.$368.9 million in 2014 to U.S.$273.0 million in 2015. Profits from changes in fair value of our biological assets decreased by 26.0% when compared to 2014, which reflects the lower U.S. dollar valuation of our biological assets, primarily in Brazil. In addition, gains from asset sales decreased 79.4% when compared to 2014. In 2014, the sale of 11,000 hectares of non-strategic plantations in Chile generated a non-recurring gain of U.S.$91 million.

Distribution costs

Distribution costs decreased 5.1% from U.S.$556.8 million in 2014 to U.S.$528.5 million in 2015, primarily due to a 5.5%, or U.S.$27.9 million, decrease in total shipping and freight costs. This is explained by a decline in shipping and freight tariffs. As a percentage of revenue, distribution costs remained fairly stable, at 10.3% in 2015, compared to 10.4% in 2014.

Administrative expenses

Administrative expenses increased slightly from U.S.$550.8 million in 2014 to U.S.$552.0 million in 2015. As a percentage of revenue, administrative expenses also increased from 10.3% in 2014 to 10.7% in 2015.

Finance costs

Finance costs increased 6.7% from U.S.$246.5 million in 2014 to U.S.$263.0 million in 2015. This increase was mainly due to the impact of the full year accrual of interest on the debt related to Montes del Plata, compared to six-months in 2014.

Exchange rate differences

Losses from exchange rate differences totaled U.S.$41.2 million in 2015, as a consequence of the currency depreciation in most of the countries in which we have operations, especially in our Argentine and Brazilian subsidiaries. In particular, the depreciation of the Argentine peso affected our cash and cash equivalents and account receivables of our Argentine subsidiary. In our Brazilian subsidiaries, Arauco do Brasil S.A. and Arauco Forest Brasil S.A., the depreciation of the Brazilian real generated a loss given that the outstanding loans are denominated in U.S. dollars. See “—Economic Indicators in Chile, Argentina, Brazil, Uruguay, the United States and Canada—Argentina.”

Income tax

We recorded an income tax expense of U.S.$129.7 million in 2015 compared to U.S.$448.7 million in 2014. This decrease is mainly explained by a direct charge in 2014 of approximately U.S.$292 million explained by the impact of a net increase in deferred liabilities attributable to the increase of the tax rate in accordance with Law No. 20,780, in force since 2014. See “Item 3. Risk Factors—Risks Relating to Chile—A tax reform bill with significant changes for companies was approved in September 2014 and the Chilean Superintendency of Securities and Insurance, or SVS, modified accounting reporting standards for companies under its supervision in October 2014.

Net income

Net income in 2015 increased 155.0% from U.S.$144.2 million in 2014 to U.S.$367.7 million in 2015, due to the impact of the non-recurring charge on income taxes in 2014. See “Item 3—Risk Factors—Risks Relating to Chile—A tax reform bill with significant changes for companies was approved in September 2014 and the Chilean Superintendence of Securities and Insurance, or SVS, modified accounting reporting standards for companies under its supervision in October 2014.”

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.

Arauco has a liquidity policy, approved by the Board of Directors, which maintains conservative criteria regarding Arauco’s liquidity management.

 

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We also have access to two committed credit facility lines, which total U.S.$315 million. The first line has an available amount of UF2,885,000, or approximately U.S.$115.0 million, and matures on January 29, 2020. The second line has a maximum available amount of U.S.$200.0 million and matures on March 27, 2020. As of the date of this annual report, Arauco has not used any of these committed credit facility lines.

Cash Flow from Operating Activities

Our net cash flow provided by operating activities was U.S.$773.6 million in 2016 and U.S.$853.7 million in 2015. This decline was principally due to a 12.4% decrease in the collection of sales of goods and services. This was partially offset by U.S.$345.6 million decrease in payments to suppliers for goods and services.

Our net cash flow provided by operating activities was U.S.$853.7 million in 2015 and U.S.$985.2 million in 2014. This decline was principally due to a U.S.$70.3 million increase in payments to suppliers of goods and services, as well as a U.S.$50.5 million increase in income taxes paid, among others. This was partially offset by U.S.$104.5 million increase in the collection of sales of goods and services.

Cash Flow Used in Investing Activities

Our net cash used in investing activities was U.S.$640.2 million in 2016 and U.S.$477.8 million in 2015. This increase was principally due to higher capital expenditures, including U.S.$51.2 million for the water treatment plant in our Arauco Mill; U.S.$153.1 million for the acquisition of 50% of Sonae Arauco; and U.S.$ 16.0 million as the “MDP Grayling” project in Michigan began its construction phase.

Our net cash used in investing activities was U.S.$477.8 million in 2015 and U.S.$655.2 million in 2014. This decrease was principally due to a 30.1%, or U.S.$138.4 million, decrease in our purchases of property, plant and equipment, mainly explained by the completion of the Montes del Plata mill during the third quarter of 2014. Additionally, compared to 2014, there was a decrease of 85.1%, or U.S.$135.2 million, in loans to related parties.

Cash Flow Used in Financing Activities

Our net cash used in financing activities was U.S.$38.5 million in 2016, compared to U.S.$812.2 million used in 2015. During 2016, we received U.S.$737.7 million in loan proceeds, and we paid U.S.$645.2 million of principal and interest on our debt, including U.S.$72.0 million in payment of principal of loans made in connection with the construction of the Montes del Plata Mill. In addition, we paid U.S.$130.6 million in dividends.

Our net cash used in financing activities was U.S.$812.2 million in 2015, compared to the U.S.$7.9 million used in 2014. During 2015 we received U.S.$280.9 million in loan proceeds, and we paid U.S.$949.2 million of principal of and interest on our debt, including U.S.$370 million in a U.S. dollar-denominated bond, and U.S.$150 million in the prepayment of debt held by our subsidiary Flakeboard in North America. In addition, we paid U.S.$143.0 million in dividends.

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 our Company—Capital Expenditures.”

Contractual Obligations

As is customary practice in the pulp industry, we generally 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.

 

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The following table sets forth certain contractual obligations as of December 31, 2016, 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 thousands of U.S. dollars)  

Debt obligations (1)

     656,599        1,326,133        1,097,183        2,091,941        5,171,856  

Purchase obligations (2)

     57,043        5,722        —          —          62,765  

Capital (finance) lease obligations

     40,400        50,559        23,027        —          113,986  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     754,042        1,382,414        1,120,210        2,091,941        5,348,607  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes estimated interest payments related to debt obligations based on market values as of December 31, 2016. In the case of floating rate debt, interest rate is calculated using the current index setting in place as of December 31, 2016, and assume no changes in the year-end index for any of the future periods. The interest rate on our floating rate debt is determined principally by reference to the London inter-bank offered rate (LIBOR), and as of December 31, 2016, the average spread for our U.S. dollar floating rate debt over six-month LIBOR was 1.80%. Approximately 12.9% of our total debt is floating rate debt as December 31, 2016.
(2) 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.

Investing Activities

During 2016, our investment activities were mainly aimed at sustaining our existing property, plant and equipment, as well as our biological assets. Other investments included:

 

   

U.S.$153.1 million for the acquisition of Sonae Arauco;

 

   

U.S.$51.2 million for the new water treatment plant in the Arauco Mill;

 

   

U.S.$20.8 million for the “MDP Grayling” project.

Financing Activities

During 2016, our principal financing activities were as follows:

On December 1, 2016, Arauco issued local bonds in Chile for UF 5.0 million, equivalent to U.S.$201.4 million. These bonds are denominated in UF and have a 10-year tenor.

As of December 31, 2016, our current portion of our bank debt was U.S.$195.6 million of which 97.5% was U.S. dollar-denominated. As of December 31, 2016, our total non-current portion of our bank debt was U.S.$718.7 million of which 97.5% was U.S. dollar-denominated.

As of December 31, 2016, we also had total capital markets borrowings (including the current portion of such debt) of U.S.$4.5 billion, 68.3% of which were U.S. dollar-denominated.

As of December 31, 2016, the weighted average maturity of our non-current debt was 5.64 years. The interest rate on our floating rate debt is determined principally by reference to the London inter-bank offered rate (LIBOR), and as of December 31, 2016, the average spread for our U.S. dollar floating rate debt over six-month LIBOR was 1.80%. As of December 31, 2016, the average interest rate for our U.S. dollar fixed rate debt was 5.19%. These average rates do not reflect the effect of swap agreements.

As of December 31, 2016, we guaranteed obligations of U.S.$494.5 million related to Montes del Plata, U.S.$270.0 million related to Arauco Argentina and U.S.$19.0 million related to Arauco Forest Brasil and Mahal.

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 in effect on December 31, 2016 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.

 

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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 all bank loan and bond covenants as of December 31, 2016. Our U.S. dollar-denominated bonds do not contain financial covenants.

 

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OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance sheet arrangements.

 

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TREASURY MANAGEMENT

We manage the treasury activities of all 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;

 

   

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

 

   

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

Our Argentine, Brazilian, Uruguayan, Canadian and U.S. subsidiaries manage their treasury activities independently from us. Their activities are governed by corporate cash and deposit policies approved by our Chief Financial Officer. These policies are based on the same principles underlying our cash and deposits policy, and subject to compliance with local regulations, including foreign exchange controls.

 

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HEDGING

We periodically review our exposure to risks arising from fluctuations in foreign exchange rates and interest rates and decide, on a case-by-case basis, at our senior management level whether to hedge such risks. Our Derivatives Policy establishes the minimum requisites our counterparties must meet, as well as proper procedures. As a result, from time to time we enter currency and interest rate swaps with respect to a portion of our borrowings. See Note 23 to our audited consolidated financial statements. Arauco applies hedge accounting for financial instruments whose purpose is to hedge against foreign currency fluctuations.

Cross Currency Swap Agreements

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

 

Bank

   U.F.  Notional
Amount
     U.S.$ Notional
Amount
     Hedging Start
Date
     Maturity  

Deutsche—U.K.

     1,000,000        43,618,307        30-10-2011        30-10-2021  

JP Morgan—N.A.

     1,000,000        43,618,307        30-10-2011        30-10-2021  

Deutsche—U.K.

     1,000,000        37,977,065        30-04-2014        30-04-2019  

BBVA—Chile

     1,000,000        38,426,435        30-10-2014        30-04-2023  

BBVA—Chile

     1,000,000        38,378,440        30-10-2014        30-04-2023  

Santander—Chile

     1,000,000        37,977,065        30-10-2014        30-04-2023  

BCI—Chile

     1,000,000        37,621,562        30-10-2014        30-04-2023  

Corpbanca—Chile

     1,000,000        42,864,859        01-09-2010        01-09-2020  

BBVA—Chile

     1,000,000        42,864,859        01-09-2010        01-09-2020  

Deutsche—U.K.

     1,000,000        42,864,859        01-09-2010        01-09-2020  

Santander—Spain

     1,000,000        42,873,112        01-09-2010        01-09-2020  

BBVA—Chile

     1,000,000        42,864,257        01-09-2010        01-09-2020  

Corpbanca—Chile

     1,000,000        46,474,122        15-05-2012        15-11-2021  

JP Morgan—N.A.

     1,000,000        47,163,640        15-11-2012        15-11-2021  

BBVA—Chile

     1,000,000        42,412,852        15-11-2013        15-11-2023  

Santander—Chile

     1,000,000        41,752,718        15-11-2013        15-11-2023  

Deutsche—U.K.

     1,000,000        41,752,718        15-11-2013        15-11-2023  

Santander—Chile

     3,000,000        128,611,183        01-10-2014        01-04-2024  

JP Morgan – U.K.

     1,000,000        43,185,224        01-10-2014        01-04-2024  

Corpbanca—Chile

     1,000,000        43,277,070        01-10-2014        01-04-2024  

BCI—Chile

     1,000,000        43,185,224        01-10-2014        01-04-2021  

BCI—Chile

     1,000,000        43,196,695        01-10-2014        01-04-2021  

Santander—Chile

     5,000,000        201,340,031        15-11-2016        15-11-2026  

TOTAL

     29,000,000        1,214,300,605        

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 our outstanding bonds and pay fixed amounts in U.S. dollars, the currency in which a significant amount of our assets are denominated.

The aggregate fair value of our cross-currency swap agreements as of December 31, 2016, represented a liability of U.S.$80.3 million as compared to December 31, 2015, when they represented a liability of U.S.$205.6 million.

Interest Rate Swap Agreements

We have outstanding the following interest rate swap agreements to hedge fluctuations in floating rates for long-term debt in Uruguay:

 

Bank    Currency    U.S.$ Notional Amount

DNB Bank ASA

   USD    59,077,208(1)

 

  (1) U.S.$ notional amount includes multiple contract agreements.

The fair value of this agreement as of December 31, 2016, represented an asset of U.S.$650,657 for Arauco. The fair value shown in the table above is 50% of total fair value, since these agreements were entered into by Montes del Plata (of which Arauco owns 50% of its shares).

 

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Forward Agreements

As of December 31, 2016, we have outstanding forward agreements in Colombia and Uruguay to hedge fluctuations in their respective local currencies, as follows:

 

Bank    Exchange Rate      U.S.$ Notional Amount     Hedging Start Date    Maturity

BBVA Colombia

     USD-COP