20-F 1 d725706d20f.htm FORM 20-F Form 20-F
Table of Contents

As filed with the Securities and Exchange Commission on April 17, 2019

 

 

 

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, 2018

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.com

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:

7.250% Notes due 2019

5.000% Notes due 2021

4.750% Notes due 2022

4.500% Notes due 2024

3.875% Notes due 2027

5.500% Notes due 2047

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 every Interactive Data File required to be submitted 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 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      20  

    Item 5.

   Operating and Financial Review and Prospects      52  

    Item 6.

   Directors, Senior Management and Employees      73  

    Item 7.

   Major Shareholders and Related Party Transactions      80  

    Item 8.

   Financial Information      82  

    Item 9.

   The Offer and Listing      86  

    Item 10.

   Additional Information      87  

    Item 11.

   Quantitative and Qualitative Disclosures About Market Risk      95  

    Item 12.

   Description of Securities Other than Equity Securities      97  

PART II

     

    Item 13.

   Defaults, Dividend Arrearages and Delinquencies      98  

    Item 14.

   Material Modifications to the Rights of Security Holders and Use of Proceeds      98  

    Item 15.

   Controls and Procedures      98  

    Item 16A.

   Audit Committee Financial Expert      99  

    Item 16B.

   Code of Ethics      99  

    Item 16C.

   Principal Accountant Fees and Services      99  

    Item 16D.

   Exemptions from the Listing Standards for Audit Committees      101  

    Item 16E.

   Purchases of Equity Securities by the Issuer and Affiliated Purchasers      101  

    Item 16F.

   Change in Registrant’s Certifying Accountant      101  

    Item 16G.

   Corporate Governance      101  

    Item 16H.

   Mine Safety Disclosures      101  

PART III

     

    Item 17.

   Financial Statements      101  

    Item 18.

   Financial Statements      101  

    Item 19.

   Exhibits      102  

 

 

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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; when we refer to “Uruguay,” we mean the Oriental Republic of Uruguay; and when we refer to “Mexico,” we mean the United Mexican States. 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 may be 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; 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, 2018, one UF equaled U.S.$39.68 and Ch$27,565.79.

Regarding our pulp business, references to “hardwood” kraft pulp are to pulp made from eucalyptus or short fiber, and references to “softwood” kraft pulp are to pulp made from pine or long fiber.

PRESENTATION OF FINANCIAL AND OTHER DATA

This report includes the audited consolidated statement of financial position of Arauco and our subsidiaries as of December 31, 2018 and 2017 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, 2018 (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, 2014, 2015, 2016, 2017 and 2018.

We make statements in this report about the pulp market partly on the basis of information from third-party sources. This information is principally sourced from reports published by Hawkins Wrights Ltd. and Resource Information Systems Inc., which are specialized consultants in the pulp market.

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, 2018, the observed exchange rate for Chilean pesos, as published in the Diario Oficial de la República de Chile (Official Gazette) on January 2, 2019, was Ch$694.77 to U.S.$1.00, and on April 12, 2019, the observed exchange rate was Ch$660.67 to U.S.$1.00. See “Item 3. Key Information—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, 2014, 2015, 2016, 2017 and 2018 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,  
     2018     2017     2016     2015     2014  
     (in thousands of U.S. dollars, except ratios and share data)  

INCOME STATEMENT DATA

  

Revenue

     5,954,833       5,238,341       4,761,385       5,146,740       5,342,643  

Cost of sales

     (3,722,749     (3,574,532     (3,498,905     (3,511,425     (3,654,146

Gross profit

     2,232,084       1,663,809       1,262,480       1,635,315       1,688,497  

Other income

     124,304       111,513       257,863       273,026       368,924  

Distribution costs

     (556,805     (523,300     (496,473     (528,470     (556,837

Administrative expenses

     (561,284     (521,294     (474,469     (551,977     (550,809

Other expenses

     (95,880     (240,165     (77,415     (83,388     (138,769

Other income (loss)

     14,213       0       0       0       0  

Finance income

     20,895       19,640       29,701       50,284       30,772  

Finance costs

     (214,779     (287,958     (258,467     (262,962     (246,473

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

     17,246       17,017       23,939       6,748       7,481  

Exchange rate differences

     (26,470     98       (3,935     (41,171     (9,961

Income before income tax

     953,524       239,360       263,224       497,405       592,825  

Income tax

     (226,765     30,992       (45,647     (129,694     (448,652
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     726,759       270,352       217,577       367,711       144,173  

BALANCE SHEET DATA

          

Current assets

     3,441,160       2,770,363       2,722,360       2,686,412       3,140,715  

Property, plant and equipment

     7,174,693       7,034,299       6,919,495       6,896,396       7,119,583  

Biological assets(1)

     3,652,263       3,766,942       3,898,991       3,826,597       3,846,353  

Total assets

     14,593,748       13,994,600       14,006,181       13,670,391       14,593,214  

Total current liabilities

     1,579,764       1,399,394       1,346,064       1,034,251       1,547,086  

Total non-current liabilities

     5,675,013       5,478,313       5,660,834       5,989,695       6,231,392  

Issued capital

     353,618       353,618       353,618       353,618       353,618  

Total equity

     7,338,971       7,116,893       6,999,283       6,646,445       6,814,736  

CASH FLOW DATA

          

Net cash flow from operating activities

     1,280,921       1,072,425       773,584       853,650       985,175  

Net cash flow from investing activities

     (893,982     (633,348     (640,212     (477,780     (655,158

Net cash flow from financing activities

     129,871       (439,101     (38,484     (812,176     (7,885
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     516,810       (24     94,888       (436,306     322,132  

OTHER FINANCIAL DATA

          

Capital expenditures(2)

     937,934       844,082       556,633       564,795       604,155  

Depreciation and amortization

     407,422       421,551       409,387       400,145       353,434  

Fair value cost of timber harvested(3)

     319,448       334,100       340,199       306,673       353,273  

EBIT(3)

     1,147,408       507,678       491,990       710,083       808,526  

Adjusted EBITDA(3)

     1,850,537       1,353,159       1,067,121       1,290,486       1,280,481  

Adjusted EBITDA(3)/finance costs

     8.62       4.70       4.13       4.91       5.20  

Adjusted EBITDA(3)/revenue

     31.1     25.8     22.4     25.1     24.0

Average debt(4)/Adjusted EBITDA(3)

     2.37       3.23       4.12       3.64       3.95  

Total debt(5)

     4,510,276       4,273,518       4,481,003       4,305,435       5,078,430  

Total debt(5)/capitalization(6)

     38.1     37.5     39.0     39.3     42.7

Total debt(5)/equity attributable to parent company

     61.8     60.4     64.4     65.1     75.0

Working capital(7)

     1,861,396       1,370,969       1,376,296       1,652,161       1,593,629  

Number of shares

     113,159,655       113,159,655       113,159,655       113,159,655       113,159,655  

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

     6.4       2.4       1.9       3.2       1.2  

Dividends paid

     257,421       121,586       130,624       143,003       141,089  

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

     2.27       1.07       1.15       1.26       1.25  

 

(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.”

 

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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 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,  
     2018     2017     2016     2015     2014  
     (in thousands of U.S. dollars)  

Net income

     726,759       270,352       217,577       367,711       144,173  

(+) Finance costs

     214,779       287,958       258,467       262,962       246,473  

(-) Finance income

     (20,895     (19,640     (29,701     (50,284     (30,772

(+) Income Tax

     226,765       (30,992     45,647       129,694       448,652  

EBIT

     1,147,408       507,678       491,990       710,083       808,526  

(+) Depreciation and amortization(*)

     407,422       421,551       409,387       400,145       353,434  

EBITDA

     1,554,830       929,229       901,377       1,110,228       1,161,960  

(+) Fair value cost of timber harvested

     319,448       334,100       340,199       306,673       353,273  

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

     (84,476     (83,031     (208,562     (210,479     (284,497

(+) Exchange rate differences

     26,470       (98     3,935       41,171       9,961  

(+) Others(**)

     34,265       172,959       30,172       42,893       39,784  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

     1,850,537       1,353,159       1,067,121       1,290,486       1,280,481  

 

(*)

See Note 7 and Note 19 of our audited consolidated financial statements for more detail on depreciation and amortization.

(**)

“Others” includes other non-cash expenses or gains, mainly associated with charges for forestry losses due to fires and impairment for fixed assets and others. The increased in “Others” for 2017 is mainly due to provision for forestry losses that accounted U.S.$138 million due to wildfires that affected our forests at the beginning of 2017.

 

(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, minus 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.$  

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  

2017

     679.05        614.75        649.12        614.75  

2018

     698.56        588.28        640.62        694.77  

Months (2018-2019)

           

October

     698.56        656.25        678.57        698.56  

November

     688.76        667.46        676.24        671.09  

December

     695.69        666.49        683.23        694.77  

January

     697.64        666.76        675.38        657.81  

February

     665.90        649.22        656.00        651.79  

March

     683.73        656.57        668.95        678.53  

April (through April 12)

     672.56        660.67        665.46        660.67  

 

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 12, 2019, the observed exchange rate, as published in the Official Gazette on April 15, 2019, was Ch$660.67 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 wood 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 the Company

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 prices of our products are highly correlated with international prices. Consequently, prices of our products are highly dependent on prevailing international and regional prices. Historically, such prices have been subject to substantial variations.

During the period from January 1, 2014 to December 31, 2018, 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 bleached softwood pulp, ranged from a low of U.S.$789.20 per tonne in April 2016 to a high of U.S.$1,230 per tonne in October and November 2018. 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 softwood and hardwood 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. Throughout 2017, NBSK prices had a positive trend, ending the year at U.S.$999.63. Such upward trend continued through October and November 2018 when prices reached U.S.$1,230, followed by a slight decrease in December 2018, ending the year at U.S.$1,200.02. The 2017 and 2018 rise in prices was mainly driven by an increase of demand in China and stable capacity levels.

During the period from January 1, 2014 through December 31, 2018, prices of bleached hardwood kraft pulp (pulp made from eucalyptus or birch which is sold in Europe and is the benchmark for Bleached Eucalyptus Kraft Pulp, or “BEKP”) ranged from a low of U.S.$651.46 per tonne in January 2017 to a high of U.S.$1,050.01 per tonne in May 2018. 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 a price of U.S.$724.27 per tonne in September 2014. 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 in January 2017, at U.S.$651.46 per tonne. A new pulp mill located in Indonesia began its ramp-up in November 2016, initially with an annual capacity of estimated at 2.8 million tonnes. As the ramp-up of new capacity was delayed, pulp prices started to rise at the beginning of 2017, which was also supported by stronger than expected demand from China. Throughout 2017, prices continued to rise as the expected output of the mill located in Indonesia was revised to 1.7 million tonnes for the next three to four years and the lower capacity of other mills due to operational problems, leading to further increases in prices, reaching U.S.$979.31 per tonne at the end of 2017. The increase in prices continued through May 2018 when prices reached a peak at U.S.$1,050.01. During the rest of the year, prices stabilized with a slight decrease towards the end of 2018, ending the year at U.S.$1,025.73. The increase in prices through May 2018 was mainly due to sustained demand and stable capacity levels. The decrease in demand registered by the end of 2018 was mainly explained by the trade tensions between China and the United States.

Although wood 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. During 2017, the construction sector continued to improve, and average prices for wood products increased during certain months of the year. During the first half of 2018, Latin American countries (including Mexico) showed stable demand levels for wood products. Towards the end of 2018, the uncertainty surrounding the trade tensions between China and the United States affected demand. The construction sector in the United States experienced a slight increase compared to 2017, which was sustained throughout 2018. Average prices remained stable in 2018 compared to 2017, showing variations depending on the product.

 

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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.

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

We experience substantial worldwide competition in each of our geographical markets and in each of our product lines. Several of our competitors are larger than we are and have greater financial and other resources, which, among other things, may enhance their ability to support strategic expenditures directed to increase their market share. Our market share may be adversely affected if we are unable to successfully continue to expand our production capacity at the same pace as our competitors.

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 wood products. Our wood products segment, which is highly dependent on the strength of the home-building industry, has experienced decreases in its prices and demand for its products from time to time.

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 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 wood products. A similar trend continued throughout 2016, although certain of these currencies recovered compared to the previous year. During 2017, certain currencies continued to recover such as the Canadian dollar, the Brazilian real, the Euro and the Chilean peso. The Argentine peso depreciated throughout the year. Similar to what happened in 2015, throughout 2018 the currencies of several countries depreciated, including the Brazilian real, the Chilean peso, the Canadian dollar, and the Argentine peso (which depreciated the most).

Export sales to Asia accounted for 40.1% of our revenues in 2018 compared to 36.2% in 2017 and 32.6% in 2016, and export sales to North America accounted for 11.2% of our revenues in 2018 compared to 12.8% in 2017 and 13.2% in 2016.

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 deteriorate, and if we are unable to reallocate our wood products and other products to other markets on equally beneficial terms, which could require us to recognize additional impairment charges.

 

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

In 2018, export sales, defined as sales out of the country where our goods were produced, accounted for 67.8% of our total revenues. During this period, 59.1% of our export sales were to customers in Asia and Oceania, 16.4% to customers in North America, 11.9% to customers in Europe, 7.2% to customers in Central and South America and 5.4% 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 reallocate our products to other markets on equally favorable terms and our business, financial condition, results of operations and cash flows might be adversely affected.

We are located in a seismic area that exposes our properties 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 of 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 payment 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, or that our insurance coverage will be sufficient, any of which could have a material 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 and 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.

 

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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.

In November 2015, the Cruces river, where the Valdivia Mill disposes its effluents, 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.

The Company and other local entities challenged the validity of the Norm before the Third Environmental Court in January 2016, expressing concerns, among others, regarding various aspects of the Norm’s General Environmental and Social Impact Assessment (AGIES, for its acronym in Spanish). 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 included that the Norm’s parameters and limits exceeded the reviewed water quality criteria enforced by reference countries in both quantity and stringency; and that many of the parameters and limits were not technically or environmentally reasonable. The Third Environmental Court ruled in our favor on September 29, 2016, declaring the invalidity of the Norm, which decision was upheld by the Supreme Court in July 2017.

In December 2017, the government restarted the rulemaking process and published a new draft SWQSVR for public comments. The draft proposes to regulate using practically the same parameters and limits included in the previous Norm declared void by the Supreme Court. In our opinion, the draft presents flaws similar to those detected in the previous rulemaking process, among others, the lack of identification and consideration of its actual economic and social costs and that most of its parameters and limits are not technically or environmentally reasonable. The public comment process finished in March 2018 and several comments from the public and different stakeholders were submitted, including various technical, economical and legal reports from third parties. According to applicable regulations, the government shall analyze and weigh the comments to prepare a final draft, prior to submitting for consideration by the Sustainability Ministers’ Committee (Consejo de Ministros para la Sustentabilidad) and the President of the Republic. Once the new norm enters into force, we cannot exclude that the authority may declare that the Valdivia River Basin is contaminated and thus initiate an administrative proceeding to impose a decontamination plan, which may include new limits on discharges of wastewater applicable to the Valdivia Mill.

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. Arauco is pursuing an additional agreement with the state of North Carolina to obtain additional time for modifications and acclimation of abatement equipment installed under such 2015 Special Order by Consent.

In 2016, the Moncure mill was subject to an administrative proceeding for alleged infringements by the North Carolina Department of Environmental Quality (NCDEQ), which has terminated, as corrective actions have been executed, including ongoing training, the installation of alarms/interlocks and the installation of certain control devices.

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. The mill will be assessed a civil penalty and this should close the matter unless the mill fails to meet emission standards in future compliance testing. 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 the Company—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.

 

 

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In February 2009, as previously required by the environmental authorities, 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 and October 2012, the environmental authorities approved this environmental impact study subject to some conditions. On April 30, 2013, the Committee of Ministers passed Exempt Resolution No. 391, which modified certain paragraphs of the above mentioned approval (establishing effluent discharge limits for 13 parameters).

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 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.

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.

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 to 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 such Nature Sanctuary, without delay of further legal action. In April 2014, we agreed with and paid to the National Defense Council an indemnification amount of approximately U.S.$5,000,000. This indemnification was in addition to another payment of U.S.$5,000,000, used for social programs for the benefit of the community of Valdivia. There were four additional measures ordered by the ruling (although 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 of Arauco, the National Defense Council, academic institutions, NGOs and public authorities. These measures were: (i) conducting a study, within one year, undertaken by an interdisciplinary committee of experts, about the status of the wetland (which has been completed); (ii) creating an artificial sentinel wetland for representative species, upriver from the discharge of effluents (which has been constructed); (iii) implementing 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 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. However, in connection with the death of fish in the Cruces River in January 2014 close to the Valdivia Mill’s effluent discharge, in January 2019, the public prosecutor’s local office (in Mariquina) filed charges (“formalización de la investigación”) against five individuals, four of them currently working for the Company. This process will be under investigation for six months, which period could be extended for up to two years. Also in January 2019, the National Defense Council instituted a civil lawsuit seeking reparations from us for environmental harm allegedly caused by our Valdivia Mill in connection with the death of fish in the Cruces River in January 2014. The National Defense Council did not determine the damages in this lawsuit, which could be sought by the National Defense Council in a separate proceeding before a civil court. The Company filed its defense in February 2019. The lawsuit remains under review by the court as of the date of this annual report. We cannot predict the outcome or impact of this lawsuit or when it may be resolved. If the result of such lawsuit is unfavorable to us, we may be required to conduct studies on ecosystems and biodiversity as well as to implement programs to both repopulate and monitor species under conservation. We may be required to incur in significant costs to repair any environmental harm a court determines we have caused, which could materially and adversely affect our business, financial condition, results of operations and cash flows.

 

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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 the Cruces River event in 2014, and a pipe leakage in the Arauco Mill in February 2016, both of which are currently under investigation by the competent authorities. In addition, in 2016 the Superintendence of the Environment initiated administrative proceedings against the Valdivia, Nueva Aldea, Licancel and Constitución mills. In 2017, the Superintendence of the Environment initiated an administrative proceeding against the Arauco Mill. The first part of the proceeding against the Valdivia Mill concluded in 2017. On December 15, 2017, the Superintendence of the Environment decided that the Valdivia Mill was liable for ten out of eleven charges and imposed a fine of 7,777 UTA (approximately U.S.$6.5 million as of December 2018). We appealed this decision on April 5, 2018 before the Third Environmental Court. A final decision by the Third Environmental Court is expected to be rendered during 2019 and may be further appealed before the Supreme Court. In 2016, 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. In December 2018, the Nueva Aldea mill’s compliance program was officially terminated (“declaración de ejecución satisfactoria”) by the Superintendence of the Environment. With regard to the Constitución mill’s compliance program, once the activities are completed, the proceedings will end. We expect that such proceedings will end in 2019. With regard 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, which on August 7, 2017, materially reduced the fine. Arauco paid the fine and this case was closed. Finally, with regard to the proceeding against Arauco Mill, the Company filed its defense in September 2017 and, in May 2018 the Superintendence of the Environment found the Arauco mill liable for two charges and imposed a fine of 699,6 UTA (approximately U.S.$635,000). Arauco paid the fine with a 25% reduction (taking advantage of a benefit established by Chilean law) and this case has been closed.

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, 2018, we had approximately U.S.$4.5 billion of outstanding indebtedness. See “Item 5. Operating and Financial Review and Prospects—Management’s Discussion and Analysis of Financial Condition, Results of Operations and Cash Flows—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.

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 could 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, tunnels and ports;

 

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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.

In connection with losses to our production plants, facilities and equipment caused by material disruptions, our insurance coverage may be insufficient. The incurrence of losses or other liabilities that are not covered by insurance could result in significant and unexpected additional costs. Moreover, the terms and conditions for the renewal of our insurance policies may change in the future depending upon market circumstances and the type and amount of risks insured. See “Item 4. Information on our Company—Description of Business—Insurance”.

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 the forestry fires season that in Chile typically extends from the last quarter of each year through the southern hemisphere summer to the end of the first quarter of the following year.

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 suffered the burning of approximately 72,500 hectares of forest plantations, which had a fair value of approximately U.S.$210 million, according to IFRS accounting rules. The affected forest plantations represented approximately 5.6% of the IFRS value of the total of the forest plantations of the Company, and approximately 1.5% of the total assets of Arauco. The affected plantations have been managed by the Company in order to minimize the damage suffered as a consequence of the fires.

The forest plantations affected by the fires had insurance coverage, with their corresponding deductibles and limits. Based on the final report of the insurance appraisers, in October 2017 our subsidiary Forestal Arauco S.A. recovered a total of U.S.$35 million, after applying the U.S.$15 million deductible.

Also in 2017, our El Cruce sawmill, which is owned by our subsidiary Maderas Arauco S.A., was destroyed 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. With regard to the insurance claim, in October 2017 we recovered U.S.$50.9 thousand on account of affected inventory, and in 2018, we received approximately U.S.$1.04 million (net of the deductible) on account of property damage. In addition, during the fourth quarter of 2017, our Viñales sawmill and remanufacturing facility suffered a stoppage of seven days due to a wildfire.

During the 2017-2018 forestry fire season, wildfires were considerably less severe than in the 2016-2017 season. Nevertheless, 587 hectares of the Company’s forest plantations burned in the 2017-2018 season (which represented 0.8% of the plantations affected by fires in the 2016-2017 season). The affected forest plantations had an accounting value of approximately U.S.$2.6 million, according to IFRS accounting rules, representing approximately 0.07% of the IFRS value of the Company’s total forest plantations and approximately 0.02% of the total assets of Arauco.

During the 2018-2019 forestry fire season, approximately 1,579 hectares of our forest plantations were affected.

In connection with losses to our production plants, facilities and equipment caused by fires, our insurance coverage may be insufficient. We do not maintain insurance coverage against pests, diseases and, in certain areas, fires that could affect our planted forests. The incurrence of losses or other liabilities that are not covered by insurance could result in significant and unexpected additional costs. Moreover, the terms and conditions for the renewal of our insurance policies may change in the future depending upon market circumstances and the type and amount of risks insured. See “Item 4. Information on our Company—Description of Business—Insurance.”

 

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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 action and contractual disputes.

Approximately 53% of our employees in Chile, 49% of our employees in Argentina, 30% of our employees in Uruguay, 9% of our employees in Brazil (although 100% are represented by the unions) and none of our employees in the United States or Canada were unionized as of December 31, 2018. In the past, certain work slowdowns, stoppages and other labor-related disruptions have adversely affected our operations.

In Chile we experienced (i) one stoppage during April 2018 (lasting nine days), (ii) three stoppages caused by employees of our third party contractors in our Horcones complex during February (lasting two days), April (lasting two days) and November (lasting five days) of 2017; (iii) seven separate occasions of blockades during 2016, which included stoppages in the Horcones complex for four days and another for one day; a three-day stoppage at the entrance of our El Colorado sawmill; three one-day stoppages in our Viñales sawmill during the months of April, August and November 2016; and a three-stoppage in our Constitución Mill during May 2016; (iv) four separate occasions of transportation contractors blocking the entrance of our Horcones complex on January 13, February 17, March 24, and September 21, 2015; (v) a one-day stoppage at the Valdivia Pulp Mill on June 12, 2014 and an eight-day stoppage between August 29 and September 5, 2014, caused by employees of third party service providers; and (vi) 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. During 2015, the pulp union carried out three work stoppages and blockades; the first event occurred on May 25, lasting three days, the second on August 3, lasting three days and the last one on September 1, which lasted 14 days.

At the end of 2017, the Constitución pulp mill and the Viñales sawmill and remanufacturing facility experienced a 40-day stoppage caused by workers of certain transportation companies.

Our Argentine operations have experienced the following work stoppages in the last five years: (i) a four-day stoppage at Arauco Argentina’s pulp mill in December 2014, as a result of a strike by the pulp union; (ii) a five-day stoppage at Arauco Argentina’s mill in Misiones in January 2015, as a result of a road blockage lead by the truckers union; (iii) a 6-hour stoppage in Arauco Argentina’s mill in Zarate; and (iv) a stoppage of three days during May 2015 and August 2015, as well as a 14-day stoppage during September 2015 in Arauco Argentina’s pulp mill, Puerto Esperanza. During December 2018, we renewed the collective bargaining agreement with the chemical union that represents the employees of Petroquímica General San Martín.

 

 

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Our Brazilian operations have not experienced any work stoppages for the last eight years, other than a generalized truckers strike in 2018 that affected our operations. As a consequence of this event, the Company was prevented from receiving raw materials and dispatching products, and our employees could not easily access our Brazilian mills during such time, which resulted in a stoppage of ten days. As a result, transportation costs increased 25% in average, which directly affected the cost of our final product, rising them from 3% to 5% depending on the type of product.

During 2018, our Uruguayan operations did not experience any relevant work stoppages. Also, during 2018 and 2017, we entered into a labor agreement with unions representing the employees of our pulp mill and forestry nursery in Uruguay.

On June 4, 2016, the Montes del Plata mill’s activity was suspended for five days as a result of labor unrest involving employees of our logistics contractors, who blocked the access to the mill. Montes del Plata is the name of the 50/50 joint operation between Arauco and Stora Enso in Uruguay.

During 2014, we experienced 7.5 days of work stoppages during the final phase of construction at Montes del Plata in Uruguay 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.

During the last seven years, there have been no strikes or other material work stoppages at our U.S. and Canadian subsidiaries.

We renewed all collective-bargaining agreements that expired during 2018 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.

In Chile, as of December 31, 2018, we had contracts with approximately 377 contractors, who employed approximately 19,153 employees. During 2018, we incorporated approximately 481 employees in the wood products business, who were previously employed by certain suppliers. Such employees work in the Horcones Complex, the Valdivia Complex, the Nueva Aldea Complex and the Arauco plywood mill. In June 2018, we also commenced an insourcing process in three forest nurseries that were previously managed by contractor companies, which involved the hiring of 715 employees directly.

In Brazil, as of December 31, 2018, we had contracts with approximately 73 contractors, who in turn employed approximately 477 employees.

Under Chilean and Brazilian labor legislation, we are secondarily liable for the payment of labor and 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.

Our U.S. operations must comply with the regulations of the Occupational Safety & Health Administration (OSHA) and the Federal Labor Standards Act (FLSA), among others.

Our Canadian operations must comply with the regulations of the Occupational Safety & Health Administration (OSHA).

 

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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.

Cybersecurity events, such as a cyberattack could adversely affect our business, financial condition and results of operations

Our business depends on information technology systems to effectively manage our production processes. Therefore, interruptions in these systems caused by employee error or attacks, external cyber-attacks, obsolescence or technical failures can deeply harm our business operations. Cybersecurity risks have generally increased in recent years as a result of the proliferation of new technologies and the increased sophistication and activities of cyberattacks. Any failure of our systems related to sensitive information could disrupt our business and result in production errors, processing inefficiencies and the loss of sales and customers, which in turn could result in decreased revenue, increased costs and excess or out-of-stock inventory levels.

Additionally, cyberattacks or internal actions, including negligence or misconduct of our employees and suppliers, may have a negative impact on our reputation, our relationship with external entities (government, regulators, partners, among others) and our strategic positioning with relation to our competitors. Any significant security breaches or disruptions in the performance of our information technology systems could have a material adverse effect on our results of operations and financial condition.

Risks Relating to Chile

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

As of December 31, 2018, 60.8% of our property, plant and equipment and forest assets were directly owned by Arauco and our Chilean subsidiaries, and in 2018, 61.8% of our revenues were attributable to our Chilean operations. Accordingly, our business, financial condition, results of operations and cash flows depend, to a considerable extent, upon economic conditions in Chile. Future changes in the Chilean economy – 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.

As a way of example, on September 29, 2014, Law No. 20,780 (as amended) 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 increased the income tax rates applicable to us, currently corresponding to 27%. In addition, the former SVS, through the Oficio Circular 856 dated October 17, 2014, obliged companies under its supervision not to follow IFRS with respect to the effect of the tax reform on deferred taxes in the statutory financial statements filed with the SVS. Further amendments could affect our income tax rates. We cannot predict how tax reforms will affect, directly or indirectly, our operations and financial condition and the market price of our securities.

We have no control over and cannot predict how government intervention and policies will affect the Chilean economy or, directly and indirectly, our operations and revenues. Our operations and financial condition and the market price of our securities may be adversely affected by changes in policies involving exchange controls, taxation and other matters.

Chile has different corporate disclosure 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 “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, is 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 relative 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, 2018, 7.8% of our property, plant and equipment and forest assets were owned by our Argentine subsidiaries, and in 2018, 8.1% 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 S.A. (or “Arauco Argentina”, formerly known as Alto Paraná S.A.), 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 included the obligation to repatriate foreign currency earned abroad and tight restrictions on transferring funds abroad, with certain exceptions for authorized transactions. In 2016 and 2017, most of these measures were eliminated or relaxed by the 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. However, during 2018, the Argentine economy deteriorated due to certain factors such as (i) the increase in the U.S. interest rate, which partially caused capital outflows from Argentina leading to a depreciation of the Argentine peso and increased inflation; and (ii) a strong drought that affected soy crops, causing a sharp drop in U.S. dollar income derived from exports. In addition, during the second semester of 2018 the economy began to show signs of recession and the Argentine government adopted certain measures to contain fluctuations in exchange rates and aimed at reducing inflation. In this regard, an agreement for U.S.$57.1 billion was entered into with the International Monetary Fund (IMF), establishing a credit program requiring monetary restriction and certain fiscal reforms, including the adoption of an export tax. At the end of the year, the Argentina peso/U.S. dollar exchange rate had increased by 104.2% (year over year) and the inflation rate reached 47.6% (year over year).

In 2017, we signed an intercompany loan with Arauco Argentina for U.S.$250 million, which proceeds were used to repay in full certain Arauco Argentina debt that we guaranteed. During 2018, Arauco Argentina prepaid U.S.$90 million. Therefore, the balance due after such prepayment is U.S.$160 million.

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 or transfer funds abroad, if in the future such payments are restricted, our financial condition, results of operations and cash flows would be negatively affected.

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, 2018, 9.0% of our property, plant and equipment and forest assets were owned by our Brazilian subsidiaries, and in 2018, 8.4% 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 and expropriation;

 

   

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 6.4% in 2014, 10.7% in 2015, 6.3% in 2016, 3.0% in 2017 and 3.8%% in 2018, 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 1.8% in 2017 and by 14.6% in 2018. The Brazilian real/U.S. dollar exchange rate may continue to fluctuate and may rise or decline substantially compared to current levels. From January 1 to March 31, 2019 the Brazilian real appreciated by 0.90%. with respect to the U.S. dollar. The cost of many raw materials is closely correlated with the U.S dollar, so, if the Brazilian real appreciates against the U.S dollar, the cost of production will decrease and our EBTIDA margin would increase.

 

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

Risks Relating to Uruguay

Economic conditions in Uruguay, 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, 2018, 15.6% of our property, plant and equipment and forest assets were owned by Montes del Plata and its affiliates in Uruguay, and in 2018, 8.0% 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. 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, 2018, 6.4% of our property, plant and equipment and forest assets were owned by our U.S. subsidiaries, and in 2018, 10.1% of our revenues were attributable to our U.S. subsidiaries. See “Item 4. Information on our Company—Description of Business.”

As of December 31, 2018, 0.4% of our property, plant and equipment and forest assets were owned by our Canadian subsidiaries, and in 2018, 3.6% 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 2016, 2017 and 2018, 92.2%, 94.2% and 95.2% respectively, of our total pulp sales, and 43.1%, 42.6% and 42.7%, respectively, of our total sales of forestry and wood 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.

 

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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 ability to service debt is dependent, in part, on the cash flow and earnings of our subsidiaries and the payment of funds by those subsidiaries to us, in the form of loans, interest, dividends or otherwise. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due under the terms of our securities or to make any funds available for such purpose.

Furthermore, claims of creditors of our subsidiaries, including trade creditors, will have priority over our creditors, including holders of our securities, with respect to the assets and cash flow of 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 our subsidiaries’ 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 our 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.

On June 19, 2014, Moody’s changed our ratings outlook from negative to stable. Also, the Baa3 note rating of our Argentine 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.

On September 25, 2018, Fitch Ratings changed our ratings outlook from negative to stable, mentioning that the ratings were supported by the Company’s strong financial position and business position as a low-cost producer of market pulp.

On January 31, 2019, Feller Rate changed our local rating from AA- to AA, stating that this change was attributable to the strategic plan of the Company, focused on high internationalization through investments and acquisitions, which has led to an improvement in business profile and main credit indicators.

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 we are one of Latin America’s largest forest plantation owners and one of the world’s largest producers of bleached and unbleached softwood kraft pulp, bleached hardwood kraft pulp and wood products in terms of production capacity. We have industrial operations in Chile, Argentina, Brazil, Mexico, the United States and Canada. We also have industrial operations in Uruguay, via our 50% share in Montes del Plata, and in Spain, Portugal, Germany and South Africa, via our 50% share in Sonae Arauco. As of December 31, 2018, we had more than 1.0 million hectares of plantations in Chile, Argentina, Brazil and Uruguay combined.

Based on information published by Hawkins Wright Ltd., an independent research company for the pulp and paper industry, as of December 31, 2018, we were one of the world’s largest producers of bleached hardwood kraft market pulp and bleached and unbleached softwood kraft market pulp in terms of production capacity.

During 2018, we sold 3.7 million metric tons of pulp, in the form of hardwood bleached pulp, softwood bleached pulp, softwood unbleached pulp and fluff. During 2018, we harvested 22.3 million cubic meters of sawlogs and pulplogs and sold 8.2 million cubic meters of wood products, including sawn timber (green and kiln-dried lumber), remanufactured wood products, plywood and panels (medium-density fiberboard, or MDF, particleboard, or PBO, and high-density fiberboard, or HB). In 2018, export sales constituted approximately 67.8% of our total revenue. During 2018, sales in Asia, South and Central America and North America accounted for 40.1%, 23.4% and 24.8%, respectively, of our total revenue for such year.

As of December 31, 2018, our planted forests consisted of 64.7% radiata, taeda and elliottii pine and 33.0% eucalyptus. We seek to manage our forestry resources in a way that ensures that the annual growth of our forests is equal to or greater than the volume of resources harvested each year. In 2018, we planted a total of 85,243 hectares, and harvested a total of 65,441 hectares in Chile, Argentina, Brazil and Uruguay.

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). 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 Uruguayan companies 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).

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 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.

 

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On September 27, 2009, Arauco and its subsidiary 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. Such joint operation, named Montes del Plata, is formed by the companies Forestal Cono Sur S.A., Stora Enso Uruguay S.A., Eufores S.A., Celulosa y Energía Punta Pereira S.A., Zona Franca Punta Pereira S.A., Ongar S.A., Terminal Logística e Industrial M’Bopicuá S.A.and El Esparragal Asociación Agraria de R.L.

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, as per the Montes del Plata joint operation, 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 PBO, 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 owners 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 operates in the wood products segment (previously referred to as timber segment), including in the panel and sawmill businesses. In August 2016, Paneles Arauco S.A. changed its name to Maderas Arauco S.A.

 

 

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On November 30, 2015, our subsidiary Arauco Internacional, entered into a share purchase agreement with Sonae Industria, or Sonae, under which the purchase of 50% of the shares of a Spanish subsidiary of Sonae, currently named 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 PBO 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 and one impregnation papers plant 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, to 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 medium-density particle board, or 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. The project started its operations by the end of 2019’s first quarter. The execution of this project required an estimated investment of U.S.$450 million, which was financed using Arauco’s own resources and bank loans.

On September 13, 2017, Arauco announced the approval by its board of directors of the “Dissolving Pulp” project, relating to the Valdivia mill, which aims to diversify the type of pulp produced in the Valdivia mill, by enabling it to produce dissolving pulp. Arauco estimates that this project will require an investment of approximately U.S.$190 million (as revised in 2018). This project will be carried out in the current facilities of the Valdivia mill, implementing certain adjustments and incorporating new equipment. Among others, the project contemplates the installation of two new additional digesters to optimize the production level of dissolving pulp, a new discharging tank (storing process) of pulp and certain modifications to the treatment areas. In addition, the project is expected to increase the Valdivia’s mill capacity to inject energy to the Chilean power grid (Sistema Eléctrico Central, or SEN, formerly the Sistema Interconectado Central) from the current units of the mill. We expect that this project will start operations at the end of 2019.

On December 6, 2017, our Brazilian subsidiary Arauco do Brasil S.A. purchased from Masisa S.A., or Masisa, all of the equity rights in Masisa do Brasil Ltda., currently named Arauco Indústria de Painéis Ltda. The enterprise value of the transaction was U.S.$102.8 million, subject to certain deductions made under the contract. The main assets owned by Masisa do Brasil Ltda. consist of two industrial complexes located in Ponta Grossa (Paraná) and in Montenegro (Rio Grande do Sul). They have a line of MDF boards with an annual installed capacity of 300,000 m3, a line of MDP boards with a current annual installed capacity of 500,000 m3, and four lines of melamine coating, with a total annual installed capacity of 660,000 m3. The amount paid for the equity rights of Masisa do Brasil Ltda. was U.S.$ 32.9 million.

On December 19, 2017, Arauco’s subsidiaries Arauco Internacional and AraucoMex, S.A. de C.V., agreed with the Chilean company, Masisa, the purchase of all of the shares of Masisa’s Mexican subsidiaries, namely Maderas y Sintéticos de México, S.A. de C.V., Maderas y Sintéticos Servicios, S.A. de C.V., Masisa Manufactura, S.A. de C.V., Placacentro Masisa México, S.A. de C.V. and Masnova Química, S.A. de C.V., or Masisa’s Mexican Subsidiaries. The transaction closed on January 31, 2019 as detailed below.

On July 24, 2018, the project for the Modernization and Expansion of the Arauco Mill (Proyecto Modernización y Ampliación de la Planta Arauco, or MAPA project) was approved by the board of directors of the Company. The MAPA project contemplates an estimated investment of U.S.$2,350 million and is located at the commune and province of Arauco, in the Bio Bio Region, Chile. The project consists of the construction and start-up of a new production line of 1,560,000 annual tonnes of bleached hardwood kraft pulp (Line 3). Line 1 of the Arauco Mill will cease its operations once the Line 3 comes online. Therefore, this project is expected to increase the net production of the Arauco Mill by approximately 1,270,000 tonnes of pulp, reaching a total production capacity of approximately 2,100,000 annual tonnes. We expect that this project will start operations in the second quarter of 2021.

On January 31, 2019, Arauco’s subsidiaries Arauco Internacional and AraucoMex, S.A. de C.V., acquired the shares of the Masisa’s Mexican Subsidiaries. The price of the transaction was U.S.$160 million. The main assets acquired consist of two industrial complexes located in Durango and Zitácuaro, that jointly account for three particleboard (PBO) lines with an annual installed capacity of 339,000 m3; an MDF boards line of with an annual installed capacity of 220,000 m3; melamine coating (or TFL) lines with an annual installed capacity of 309,000 m3; a chemical plant with an installed capacity of 60,000 tonnes of resins and 60,600 tonnes of formaldehyde; and impregnation lines with an aggregate annual installed capacity of 28.9 million of m2. Further, one of Masisa’s Mexican Subsidiaries, i.e. Maderas y Sintéticos de México, S.A. de C.V., is the lessee of a chemical plant in Lerma, with an installed capacity of 43,200 tonnes of resins and 21,600 tonnes of formaldehyde.

 

 

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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. Our website is www.arauco.cl or www.arauco.com. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC (http://www.sec.gov).

 

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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 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, 2018.

 

     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 Europe Cooperatief U.A.    The Netherlands      99.9990  
Arauco Florestal Arapoti S.A.    Brazil      79.9992  
Arauco Forest Brasil S.A.    Brazil      99.9992  
Arauco Indústria de Painéis Ltda    Brazil      99.9990  
Arauco Middle East DMCC    Dubai      99.9990  
Arauco North America, Inc. (ex Flakeboard America Limited) (1)    U.S.A.      99.9990  
Arauco Nutrientes Naturales SpA    Chile      99.9484  
Arauco Perú S.A.    Peru      99.9990  
Arauco Wood (China) Company Limited    China      99.9990  
Araucomex S.A. de C.V.    Mexico      99.9990  
Consorcio Protección Fitosanitaria Forestal S.A.    Chile      57.0831  
Empreendimentos Florestais Santa Cruz Ltda.    Brazil      99.9985  
Flakeboard Company Limited    Canada      99.9990  
Forestal Arauco S.A.    Chile      99.9484  
Forestal Cholguán S.A.    Chile      98.5479  
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  
Maderas Arauco S.A. (Ex Paneles Arauco S.A.)    Chile      99.9995  
Maderas Arauco Costa Rica S.A.    Costa Rica      99.9990  
Mahal Empreendimentos e Participacoes S.A.    Brazil      99.9991  
Novo Oeste Gestão de Ativos Florestais S.A.    Brazil      99.9991  
Savitar S.A.    Argentina      99.9841  
Servicios Aéreos Forestales Ltda.    Chile      99.9990  
Servicios Logísticos Arauco S.A.    Chile      99.9997  

 

(1)

On December 31, 2018, both Arauco Wood Products Inc. and Arauco Panels USA, LLC merged into Flakeboard America Limited (currently, Arauco North America, Inc). This event did not have an impact on the consolidated financial statements.

Business Strategy

Our strategy consists of focusing on maximizing value from, and pursuing growth opportunities with respect to, our forestland, managing our operations sustainably and developing products that contribute to an economy based on renewable resources that we believe improves the quality of life of millions of people around the world. We seek to implement our strategy through the following principles and initiatives:

 

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Striving to combine science, technology and innovation in order to unlock the full potential of our plantations and develop renewable products in our forestry, pulp, timber, panels and clean energy business areas.

 

   

Seeking to manage our operations responsibly by adopting the best environmental practices and promoting the safety and development of our employees and contractors.

 

   

Creating high quality products and materials for the paper, packaging, furniture, construction and energy industries, and providing high quality service to our customers.

 

   

Consolidating and expanding our presence internationally, in regions we believe offer comparative advantages in the industry sectors in which we operate.

Domestic and Export Sales

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

 

     Year ended December 31,  
     2018      2017      2016  
     (in millions of U.S. dollars)  

Export Sales

        

Bleached pulp

   $ 2,402      $ 1,935      $ 1,628  

Unbleached pulp

     410        285        253  

Sawn timber

     421        400        400  

Remanufactured wood products

     230        231        218  

Plywood

     215        197        185  

Panels

     340        325        305  

Other

     22        10        2  
  

 

 

    

 

 

    

 

 

 

Total export revenue

   $ 4,040      $ 3,383      $ 2,991  
  

 

 

    

 

 

    

 

 

 

Domestic Sales

        

Bleached pulp

   $ 135      $ 127      $ 152  

Unbleached pulp

     8        9        7  

Sawn timber

     67        76        80  

Remanufactured wood products

     23        28        28  

Plywood

     40        41        42  

Panels

     1,385        1,318        1,229  

Logs

     72        73        63  

Chips

     31        25        21  

Electric power

     87        94        103  

Other

     67        64        45  
  

 

 

    

 

 

    

 

 

 

Total domestic revenue

   $ 1,915      $ 1,855      $ 1,770  
  

 

 

    

 

 

    

 

 

 

Revenue

   $ 5,955      $ 5,238      $ 4,761  
  

 

 

    

 

 

    

 

 

 

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

 

     Year ended December 31  
     2018      2017      2016  
     (in millions of U.S. dollars)  

Asia and Oceania

   $ 2,388      $ 1,898      $ 1,553  

North America

     664        671        627  

Europe

     479        361        326  

Central and South America

     289        256        299  

Other

     220        197        186  
  

 

 

    

 

 

    

 

 

 

Total

   $ 4,040      $ 3,383      $ 2,991  
  

 

 

    

 

 

    

 

 

 

 

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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 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. See “Item 4. Information on our Company—Certifications.”

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, 2018, our planted forests consisted of 64.7% radiata, taeda and elliottii pine and 33.0% 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 2018, Arauco planted a total of 85,243 hectares and harvested a total of 65,441 hectares in Chile, Argentina, Brazil and Uruguay.

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, 2018, our aggregate radiata pine holdings comprised 39.0% of all Chilean radiata pine plantations. As of December 31, 2018, we owned approximately 1.1 million hectares of land in Chile, of which 674 thousand hectares are forest plantations.

As of December 31, 2018, we owned approximately 263,213 hectares of forest and other land in Argentina, approximately 249,324 hectares of forest and other land in Brazil and approximately 125,843 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 (91.9%), globulus (1.1%), grandis (3.3%) and other species (3.7%).

Of the total land we own in these three countries, approximately 165,921 hectares of land are planted with taeda pine and elliottii pine, both species of softwood that have a growth rate similar to that of radiata pine, and 157,564 hectares with eucalyptus. The balance includes plantations of other species of trees, land to be planted, protected areas and native forests.

 

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The following table sets forth the number of hectares and types of uses of our land holdings and rights, as of December 31, 2018.

 

     As of December 31, 2018  
     Total      Distribution  
     (in hectares)      (percentage)  

Pine plantations (1)

     

0-5 years

     185,243        10.5

6-10 years

     142,526        8.1

11-15 years

     137,656        7.8

16-20 years

     97,424        5.5

21+ years

     95,739        5.4

Subtotal

     658,588        37.2

Eucalyptus plantations (2)

     336,164        19.0

Plantations of other species

     23,020        1.3

Subtotal of Plantations

     1,017,772        57.5

Land for plantations

     111,165        6.3

Land for other uses (3)

     640,062        36.2
  

 

 

    

 

 

 

Total (4)

     1,768,999        100.0
  

 

 

    

 

 

 

 

(1)

All years are calculated from the date of planting.

(2)

Approximately 83% 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 15,320 hectares for which we have the right to harvest but do not own the land, of which 15,015 hectares are in Chile, and 305 hectares are in Argentina; there are no hectares are in Uruguay.

Land Acquisition and Afforestation

Our total land assets have increased from fewer than 170,000 hectares in 1980 to 1,768,999 hectares as of December 31, 2018. In the five years ending December 31, 2018, we purchased 4,763 hectares of land, all of which were purchased in Chile. For more information regarding our material acquisitions, see “Item 4. Information on our Company—Description of the Business —History”.

We expect to acquire additional land if we have 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, the land that we own which we intend to afforest and the volume that we purchase from third-parties will be sufficient to satisfy our anticipated future demand for sawlogs and pulplogs.

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, 2018, 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.

 

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As of December 31, 2018, we had 7 nurseries in Chile, Argentina, Brazil and Uruguay (through Montes del Plata), 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 or mechanically. 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 cuting 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 8 to 14 years old and results in an average reduction of the number of trees per hectare from the original stocking of 1,000 and 1,333, depending on the productivity of the land, to 700 in the first thinning (8 to 9 years) and to approximately 450 in the second thinning (12 to 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 5.8 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 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.

 

     2018      2017      2016  
     (in hectares)  

Thinning

     10,358        5,553        16,229  

Pruning

     36,172        32,869        33,547  

Harvesting

     36,267        38,932        31,863  

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, 2018, we had arrangements with more than 338 independent contractors that employed over 12,822 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 seven 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—Risks Relating to the Company—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.”

 

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We operate an extensive fire control organization to minimize any fire damage to our forests. The operation consists primarily of a system of spotter towers and cameras, 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 the fires as soon as possible and to reach the location in less than 20 minutes in order to prevent fires from spreading. Also, when feasible, we work in firefighting activities with authorities, other fire control organizations and local communities. During the years 2015 and 2016, this system limited fire damage to our forests to an average of 3,907 hectares of the plantations per year. Notwithstanding such system, during January and February 2017, large forest fires affected Arauco’s plantations in the Maule and Bio Bio Regions in southern Chile. About 72,500 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 2015-2016 forestry fire season, fires that affected our forest plantations destroyed 618 hectares. During the 2016-2017 season, approximately 82,040 hectares of our forest plantations were affected. In the 2017-2018 season, approximately 587 hectares of our forest plantations were affected by forest fires.

Forest Production

We harvested 22.3 million cubic meters of logs during the year ended December 31, 2018, consisting of 9.2 million cubic meters of sawlogs, 8.0 million cubic meters of pine pulplogs and 5.1 million cubic meters of eucalyptus pulplogs and other logs. During 2018, our sawmills and panel mills used 7.3 million cubic meters of sawlogs. We also sold 1.8 million cubic meters of sawlogs to unaffiliated domestic sawmills during 2018.

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 2.0 million cubic meters of logs per year. The Nueva Aldea complex also includes a log merchandising facility, with an annual processing capacity of 2.6 million cubic meters of logs per year.

Pulp

We believe that we were Chile’s largest producer of bleached and unbleached softwood market pulp in terms of production in 2018. For the year ended December 31, 2018, our pulp sales were U.S.$ 3.0 billion, representing 49.6% of our total revenues 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 it is used to provide strength to paper products. Bleached hardwood 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 material is screened and washed, it is then passed to high-density tanks. For bleached pulp, the next step is a 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 to be transported to customers. The lignin and bark produced during this process are 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.

 

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Pulp Mills

As of December 31, 2018, 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 4.0 million tonnes. This figure includes 50% of our Uruguay (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 0.5 million tonnes of unbleached pulp in 2018.

All our pulp mills in Chile, the Puerto Esperanza pulp mill in Argentina and the Montes del Plata mill in Uruguay are certified under international standards. See “Item 4. Information on our Company—Certifications”.

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

 

     Year ended December 31,  
     2018      2017      2016      2015      2014  
     (in thousands of tonnes)  

Chile

              

Arauco Mill

              

Arauco I (bleached)

     271        264        258        268        269  

Arauco II (bleached)

     451        456        475        474        483  

Arauco II (unbleached)

     32        21        —          —          —    

Valdivia Mill (bleached)

     548        550        550        549        550  

Constitución Mill (unbleached)

     318        270        278        303        310  

Nueva Aldea Mill (bleached)

     1,033        992        999        935        985  

Licancel Mill (unbleached)

     158        144        152        152        150  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     2,811        2,697        2,712        2,681        2,747  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Argentina

              

Puerto Esperanza Mill (bleached)

     326        310        341        314        282  

Uruguay

              

Montes del Plata (bleached - 50%)

     654        688        643        608        240  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     3,791        3,695        3,696        3,603        3,269  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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

Chile

Arauco I. Arauco I or Line 1, 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 bleached hardwood kraft pulp.

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. Although the mill mainly produces bleached softwood kraft pulp, it could also produce unbleached softwood kraft pulp.

On July 24, 2018, the MAPA project was approved by the board of directors of the Company. The MAPA project contemplates an estimated investment of U.S.$2,350 million and is to be located at the commune and province of Arauco, in the Bio Bio Region, Chile. The project consists of the construction and start-up of a new production line of 1,560,000 annual tonnes of bleached hardwood kraft pulp (Line 3). Line 1 of the Arauco Mill will cease its operations once Line 3 comes online. Therefore, this project is expected to increase the net production of the Arauco Mill by approximately 1,270,000 tonnes of pulp, reaching a total production capacity of approximately 2,100,000 annual tonnes. We expect that this project will start operations in the second quarter of 2021.

Constitución Mill. The Constitución Mill is located in the heart of a group of our radiata pine forests in the Maule Region, Chile. As of December 31, 2018, 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.

 

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Licancel Mill. We acquired the Licancel Mill in September 1999. It is located in Licantén, which is 250 kilometers south of Santiago. Investments made during 2018 increased the mill’s installed annual production capacity from approximately 155,000 tonnes to 160,000 tonnes of unbleached softwood kraft 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 and hardwood 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.$190 million (as revised in 2018) 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, or MW, in comparison with the power generation during bleached hardwood kraft pulp campaign. In July 2017, the project was approved by the authorities and in September 2017, the board of directors of Arauco unanimously approved the project, which has started its construction phase in the fourth quarter of 2017. We expect that this project will start operations at the end of 2019.

Nueva Aldea Mill. Located in the Eighth Region of Chile, this mill was completed in 2006, and after certain investments made during 2018, it increased its production capacity from 1,027,000 tonnes per year to 1,040,000 tonnes per year, half of which is dedicated to the production of bleached softwood kraft pulp and the other half of which is dedicated to the production of bleached hardwood kraft pulp. The Nueva Aldea Mill is equipped to produce elementary chlorine-free pulp.

Argentina

Puerto Esperanza Mill. 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 Puerto Esperanza Mill (formerly known as 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.

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 1.4 million air dry tonnes 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 tonnes per year.

Regarding our Montes del Plata mill in Uruguay, during 2017 we made some operational improvements that led to an increase in the annual capacity of the mill, reaching approximately 1.4 million tonnes from 1.3 million tonnes. Of the total annual capacity of the mill we own the 50% due to the joint operation we had with Stora Enso, which correspond approximately to 700 thousand tonnes of annual capacity.

Production Costs

Based on information published by Hawkins Wright Ltd., 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 sets forth our costs for the production of bleached softwood kraft pulp.

 

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     Arauco(1)  Bleached
Softwood Kraft Pulp Cash Costs
 
     (in U.S.$ per tonne)  

Wood

     182  

Chemicals

     62  

Labor and Others(2)

     145  

Total cash cost

     389  

Transportation(3)

     35  

Marketing and Sales

     3  

Total delivered cash cost

     427  
  

 

 

 

 

Source: Arauco

(1)

Only includes Arauco’s operations in Chile.

(2)

Includes labor, energy, maintenance costs, and other mill costs.

(3)

Delivered in China.

Sales

Estimated installed bleached kraft pulp capacity worldwide for the year ended December 31, 2018 equaled 65.9 million tonnes. Based on information published by Hawkins Wright Ltd., we believe that our production capacity represented 5.1% of this market in 2018. During the same year, we exported 98.3% of our bleached pulp (in terms of tonnes sold), 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 a worldwide installed capacity of unbleached softwood kraft pulp of 2.4 million tonnes for 2018, according to Hawkins Wright Ltd., we are the world’s largest single producer of unbleached softwood market pulp, based on production capacity, with 20.0% of the total market in 2018. During the same year, 98.2% of our total unbleached market pulp sales (in terms of tonnes sold) consisted of export sales. While for the last six 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. 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,  
     2018      2017      2016  
     (in tonnes)  

Bleached Pulp

        

Asia and Oceania

     2,289,694        2,311,090        2,153,550  

Europe

     597,116        547,012        557,726  

North and South America

     301,226        335,251        399,195  

Other

     532        134,422        130,289  
  

 

 

    

 

 

    

 

 

 

Total

     3,188,568        3,327,775        3,240,760  
  

 

 

    

 

 

    

 

 

 

Unbleached Pulp

        

Asia and Oceania

     407,659        338,648        326,332  

North and South America

     81,600        88,425        94,288  

Europe

     1,186        2,073        4,618  

Other

     3,729        15,948        14,446  
  

 

 

    

 

 

    

 

 

 

Total

     494,174        445,094        439,684  
  

 

 

    

 

 

    

 

 

 

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.”

 

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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. Key Information—Risk Factors—Risks Relating to the Company—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 for each quarter, of the years referenced.

 

     2018      2017      2016  
     (U.S.$ per tonne)  

Bleached Pulp

        

1Q

     784        565        570  

2Q

     804        620        590  

3Q

     808        633        564  

4Q

     773        730        558  

Unbleached Pulp

        

1Q

     847        596        594  

2Q

     873        664        608  

3Q

     876        660        573  

4Q

     864        768        574  

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, 2018, more than 250 customers. As of December 31, 2018, we employed 12 sales agents to represent us in more than 33 countries. We manage this worldwide sales network from our headquarters in Chile.

 

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Wood Products

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, 2018, sales of wood products totaled U.S.$2.7 billion, representing 45.7% of our total revenues.

Exports, which include sales to countries other than the countries in which the goods are produced, accounted for 44.3% of our total revenues of wood products for the year ended December 31, 2018. We sell panels primarily to customers in North America, Brazil, Chile, Argentina and other countries in Latin America.

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

 

     Year ended December 31,  
     2018      2017      2016      2015      2014  
     (in thousands of cubic meters)  

Panels

     5,410        4,866        4,754        4,915        4,840  

Sawn timber

     1,825        1,893        2,022        2,079        2,361  

Remanufactured wood products

     438        445        442        422        429  

Plywood

     532        567        564        594        444  

Total

     8,205        7,771        7,782        8,010        8,074  

As of December 31, 2018, we owned and operated two panel mills, seven sawmills and two plywood mills in Chile; two panel mills and one sawmill in Argentina; four 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, 2018 was approximately 7.4 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, 2018, 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 387,442 cubic meters of remanufactured wood products in 2018.

In December 2011, we 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 as a result of which we acquired 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 at the time of the purchase), 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 and one impregnation of melamine papers plant in Germany, (iv) and two panel mills in South Africa. The transaction closed on May 31, 2016.

On December 6, 2017, our Brazilian subsidiary Arauco do Brasil S.A. purchased all of the equity rights in Masisa do Brasil Ltda. See “Item 4. Information on our Company—Description of Business—History.”

On January 31, 2019, Arauco’s subsidiaries Arauco Internacional and AraucoMex, S.A. de C.V., acquired the shares of Masisa’s Mexican Subsidiaries. See “Item 4. Information on our Company—Description of Business—History.”

Our wood products mills in Chile, North America, Argentina and Brazil are certified under international standards. See “Item 4. Information on our Company—Certifications.”

 

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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. In 2018, Teno mill started its production capacity increase project through the Teno 340 project, to increase the PBO annual installed capacity up to 340,000 cubic meters.

Trupán-Cholguán Mill. This mill has an installed annual production capacity of approximately 575,000 cubic meters of panels and 40,000 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. The HB line has been recently shut down.

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 Plywood 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.

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 166,000 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 MDF 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.

 

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Piray Sawmill and Remanufacturing Facility. This sawmill has installed annual production capacity of approximately 318,000 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.

Brazil

Jaguariaiva Mill. This mill produces MDF and has an installed annual production capacity of approximately 780,000 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 480,000 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 264,000 cubic meters of melamine lamination. In December 2018, the powder silo of one of the lines in this mill suffered damage that paralyzed the operations of the PBO panels for approximately ten days. This event did not cause a material impact on the financial statements.

Montenegro Mill. This mill has an installed annual production capacity of approximately 410,000 cubic meters of PBO panels and 200,000 cubic meters of melamine lamination.

Ponta Grossa Mill. This mill produces MDF and has an installed annual production capacity of approximately 310,000 cubic meters of MDF panels. Its melamine lamination capacity is 360,000 cubic meters.

México

Durango Mill. This mill includes two PBO production lines with an annual installed capacity of 155,000 cubic meters; one MDF production line with an annual installed capacity of 220,000 cubic meters and four melamine lines with an annual installed capacity of 210,000 cubic meters. The Durango mill was acquired in January 2019.

Zitácuaro Mill. This mill includes one PBO production line with an annual installed capacity of 184,000 cubic meters and three melamine production lines with an annual installed capacity of 107,120 cubic meters. Zitácuaro mill was acquired on January 2019.

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.

Grayling Mill. This facility is located in Michigan and includes one production line with an annual installed production capacity of 800,000 cubic meters of PBO. This facility had been under construction since 2017 and started its operations during the first quarter of 2019.

 

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Panolam Mill. This facility is located in Oregon and includes two thermally fused lamination lines with an annual installed production capacity of 75,000 cubic meters of melamine. It was acquired in July 2018.

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 PBO 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 and one impregnation of melamine papers plant in Germany, (iv) and two panel mills in South Africa (one of them is currently shut down). In the aggregate, the production capacity of Sonae Arauco is approximately 516,000 cubic meters of OSB, 1,482,000 cubic meters of MDF, 2,330,000 cubic meters of particleboards and 50,000 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, 2018, sales of forestry products were U.S.$105 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,  
     2018      2017      2016      2015      2014  
     (in thousands of cubic meters)  

Sawlogs

     1,794        1,608        1,328        1,793        2,262  

Pulplogs

     746        616        459        591        499  

Posts

     —          —          —          —          2  

Chips

     546        443        366        278        303  

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 SEN, 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, 2018:

 

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       —         24  

Nueva Aldea I

    30       28       14       14  

Nueva Aldea II (diesel)

    10       N.A.       —         10  

Nueva Aldea III

    136       100       63       37  

Bioenergía Viñales

    41       31       9       22  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Chile

    606       481       272       219  
 

 

 

   

 

 

   

 

 

   

 

 

 

Uruguay

       

Montes del Plata (1)

    91       90       39       50  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Uruguay

    91       90       39       50  
 

 

 

   

 

 

   

 

 

   

 

 

 

Argentina

       

Piray

    38       30       16       15  

Puerto Esperanza

    44       44       39       —    
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Argentina

    82       74       55       15  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

    779       645       366       284  
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Considers 50% of joint operation Montes del Plata

 

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As of December 31, 2018, 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. From 2007 to December 31, 2018, Arauco had contributed 7.8% of total carbon credits in the energy generation from residual biomass projects portfolio registered worldwide in accordance with the CDM standard. This represents a net issuance of 4.2 million CERs with our CDM projects.

As of the date of this annual report, accumulated in the period from 2007 to 2018, we have sold 2.98 million CERs, mainly to European companies subject to compliance obligations under the European Trading Scheme (ETS) and to global companies who aim to compensate their emissions in the voluntary market. The following table presents the total amount of CERs issued and sold by Arauco for each of the years indicated:

 

     Year ended December 31  
     2018      2017      2016      2015      2014      2013      2012-2007  

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

     247,588        457,309        109,844        827,971        403,317        488,475        1.67 million  

CERs sold or donated

     658,512        1,095,780        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 2018, Arauco sold 626,650 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 96,110 Verified Carbon Units (VCUs) as its first verified emission reductions (VERs) on January 3, 2017. In addition, during the second quarter of 2018, the project issued 506,776 VCUs as its second VERs.

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. On April 26, 2018, the first issuance of CERs was accomplished by generating 66,006 CERs with the Punta Pereira biomass power plant project.

Competition

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

Pulp

In general, our main competitors in the pulp market have activities in many regions, considering pulp variety and commercial presence. Fibria Cellulose S.A., or Fibria, and CMPC Celulosa S.A., or CMPC, are our main competitors because they have a wide geographical presence, the former in hardwood and the latter in hardwood and softwood pulp. Furthermore, there are competitors such as Suzano Papel e Cellulose S.A., or Suzano, and El Dorado Brasil Celulose S.A., or El Dorado, with a relevant presence in the Asian markets, specifically in China and Korea where the main both hardwood and softwood customers are located. Competitors from all regions participate in the diversified European market, where we mainly face competition from Brazilian, Scandinavian and U.S. producers. Our main competitors in Asia in unbleached softwood pulp come from New Zeland, Canada and Russia.

 

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On January 14, 2019, a merger between Fibria and Suzano was consummated, as publicly reported by the companies.

Wood Products

Arauco’s main competitors in the MDF market are: in Latin America, Duratex S.A., Masisa, Berneck, Proteak, Guararapes and other large South American producers; in North America, local producers such as Roseburg Forest Products Co., West Fraser and Plum Creek; 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, Novopan, Berneck S.A., Egger and Fibraplac S.A. In North America, we mainly compete with Panolam, Roseburg Forest Products Co., Funder America, Uniboard, Temple-Inland Inc., Kaycan Ltd. and Sonae Indústria, SGPS, SA.

Arauco’s principal competitors in the plywood markets are located in the United States, Finland, Chile, Brazil 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, China, 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 40 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 47.3% of our aggregate export volume through this port in 2018;

 

   

Lirquén. A private port in Concepción in which as of December 31, 2018, we had an equity interest of 20.3% and through which we shipped 26.2% of our aggregate export volume during 2018. On April 5, 2019, we sold such equity interest to DP World Holding UK Ltd., or DP; and

 

   

San Vicente. A state-owned port near the city of Concepción through which we shipped 26.4% of our aggregate export volume during 2018.

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, 2018, we had approximately 140,561 tonnes 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 general greater distance from main markets, 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 mainly shipped to Europe and Asia through our own Montes del Plata Mill port located next to the pulp mill in Punta Pereira, Colonia, Uruguay.

 

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In North America, products sourced from our South American operations are shipped into 20 major ports of entry and storaged in 14 warehouses. These are dispatched to more than 3,500 locations in the United States and Canada. Arauco’s eight composite panel plants (one in construction and two impregnation plants) in North America service over 580 customers throughout the region mainly through trucks, in addition to exporting products to Central America.

Description of Property

The following table presents our principal properties as of December 31, 2018. (1)

 

Country

 

Forestry

  

Plants and Facilities

Chile  

1,130,618 total hectares

674,020 hectares of plantations

  

5 Pulp Mills

1 PBO Mill

1 MDF-HB Mill(2)

2 Plywood Mills

7 Sawmills

4 Remanufacturing Facilities

Argentina  

263,213 total hectares

132,617 hectares of plantations

  

1 Pulp Mill

1 MDF Mill

1 PBO Mill

1 Sawmill

1 Remanufacturing Facility

1 Resin Plant

Brazil  

249,324 total hectares

134,331 hectares of plantations

  

2 MDF Mill

1 PBO Mill

1 MDF-PBO Mill

1 Resin Plant

Uruguay (3)  

125,842 total hectares

76,804 hectares of plantations

   50% of 1 Pulp Mill
United States     

3 PBO Mills

3 MDF Mills

1 MDF-PBO Mill

1 Impregnation of melamine papers Plant

Canada     

1 MDF Mill

1 HDF-PBO Mill

1 Resin Plant

Portugal     

50% of 1 MDF Mill (4)

50% of 1 PBO Mill (4)

50% of 1 Resin Plant (4)

Spain     

50% of 1 MDF Mill (4)

50% of 1 PBO Mill (4)

50% of 1 Sawmill (4)

Germany     

50% of 2 MDF Mills (4)

50% of 1 MDF-PBO Mill (4)

50% of 1 PBO-OSB Mill (4)

50% of 1 Impregnation of melamine

papers Plant (4)

South Africa     

50% of 1 PBO Mill (4)(5)

50% of 1 MDF-PBO Mill (4)

 

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(1)

Does not include Mexican mills acquired in January 2019.

(2)

The HB line has been recently shut down

(3)

Corresponds to 50% of Montes del Plata.

(4)

Corresponds to 50% of Sonae Arauco.

(5)

This mill is currently shut down.

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 the Company.”

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 Argentina, United States and Canada (for Arauco North America) and R$839 million per loss in Brazil, including physical damage and business interruption for up to 18 months for Chile, Argentina and Brazil, and up to 12 months for United States and Canada. The deductibles for Chile and Argentina for physical damage are U.S.$3 million per occurrence for damages caused. In case of damages caused by earthquakes and tsunamis in Chile, the deductible is 2% of the total insured amount for each location, subject to a cap of U.S.$25 million. Deductibles for Chile and Argentina for business interruption are 30 days for all losses, 45 days for machinery breakdowns and 45 days for machinery breakdowns of turbines. For Chile and Argentina, we also have an annual self-insurance retention of U.S.$15 million, with a U.S.$7.5 million maximum per event. The deductible for Arauco North America, including physical damage and business interruption is U.S.$2.5 million. The deductible for Brazil, including physical damage and business interruption is R$5 million. Our insurance policy covering our production plants, facilities and equipment in Chile are carried by Seguros Generales Suramericana S.A. (50.0%), Mapfre S.A. (25.0%) and Chubb Seguros Chile S.A. (25.0%); in Argentina and Brazil are carried by Seguros Generales Suramericana S.A. (100%); in the United States is carried by SOMPO Japan Insurance Company of America (100%), and in Canada by Royal & Sun Alliance Insurance Company of Canada, Inc. (100%).

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.$100 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 (approximately U.S.$9.2 million as of December 31, 2018) with a deductible per event of R$1.5 million (approximately U.S.$0.5 million as of December 31, 2018).

In addition, we have contracted fire insurance coverage for all of our Chilean forest holdings and nurseries but do not insure against pests or disease. In Argentina, we maintain fire insurance for 16,324 hectares of timber assets located in the Delta del Paraná, close to Buenos Aires and Entre Ríos. For the rest of our Argentine operations, we do not maintain fire insurance for our timber assets because we believe that the risk of damage from fire is low 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 the 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

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 Bio Bio regions. As a consequence of such fires, the Company suffered the burning of approximately 72,500 hectares of forest plantations, which had a fair value of approximately U.S.$210 million, according to IFRS. The forest plantations affected by the fires had insurance coverage, with their corresponding deductibles and limits. In accordance with the final report of the insurance adjusters, in October 2017 our subsidiary Forestal Arauco S.A. recovered U.S.$35 million, after applying the U.S.$15 million deductible.

Also, in 2017, our El Cruce sawmill, which is owned by our subsidiary Maderas Arauco S.A., was destroyed by 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. With regard to the insurance claim, in October 2017 we recovered U.S.$50.9 thousand on account of affected inventory, and during the first quarter of 2018 we received approximately U.S.$1.04 million (net of the deductible) on account of property damage.

 

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After the 2017 wildfires in Chile, we increased the limits of our forestry insurance coverage in Chile to U.S.$85 million with a deductible of U.S.$25 million for the whole season (regardless of the number of the events). This policy is carried by Mapfre Compañía de Seguros Generales S.A. (100%) and the insurance period is from October 3, 2018 to October 3, 2019. We also established satellite-assessment for damaged areas, which enables us to face potencial claims in a faster way.

During the 2017-2018 forestry fire season, wildfires were considerably less severe than in the 2016-2017 season. Nevertheless, 587 hectares of the Company’s forest plantations burned in the 2017-2018 season (which represented 0.8% of the plantations affected by fires in the 2016-2017 season). The affected forest plantations had a fair value of approximately U.S.$2.6 million, according to IFRS accounting rules, representing approximately 0.07% of the IFRS value of the Company’s total forest plantations and approximately 0.02% of the total assets of Arauco.

In connection with losses to our production plants, facilities, forests and equipment caused by fires or otherwise, our insurance coverage may be insufficient. The incurrence of losses or other liabilities that are not covered by insurance could result in significant and unexpected additional costs. Moreover, the terms and conditions for the renewal of our insurance policies may change in the future depending upon market circumstances and the type and amount of risks insured. For more information regarding the risks for which we insure our property, see “Item 3. Key Information—Risk Factors—Risks Relating to the Company.”

Cybersecurity

We have developed a cybersecurity policy based on the guidelines and criteria contemplated by the international standards ISO 27001 and ISO 27002, as well as control mechanisms, technologies, processes and procedures developed on the basis of guidelines and criteria addressed by the international standard ISO 27032 / NIST. Additionally, we periodically make security assessments, which allow us to complement and improve ongoing initiatives. For more information regarding cybersecurity risk, see “Item 3. Key Information—Risk Factors—Risk Relating to Our Company—Cybersecurity events, such as a cyber-attack could adversely affect our business, financial condition and results of operations.”

 

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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, 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 ended December 31, 2017, our aggregate capital expenditures were U.S.$844.1 million, consisting primarily of U.S.$533.8 million for addition of property, plant and equipment and U.S.$310.3 million for the addition of biological assets. The increase with respect to 2016 was mainly attributable to higher capital expenditures in respect of biological assets to replace those lost because of the wildfires in 2017.    

For the year ended December 31, 2018, our aggregate capital expenditures were U. S.$938.0 million, consisting primarily of U.S.$730.5 million for addition of property, plant and equipment and U.S.$207.5 million for the addition of biological assets. The increase with respect to 2017 was mainly attributable to higher capital expenditures in ongoing projects.

For the year ending December 31, 2019, we have planned capital expenditures of U.S.$1,892 million, which principally include U.S.$469 million for maintenance of our existing mills, U.S.$1,073 million for expansion and other strategic initiatives, and U.S.$350 million for 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.

In November 2015, the Cruces river, where the Valdivia Mill disposes its effluents, became subject to the Norm (as defined above). The Valdivia Mill discharges its treated effluents into the Cruces River, which is part of the Valdivia River Basin.

The Company and other local entities challenged the validity of the Norm before the Third Environmental Court in January 2016, expressing concerns, among others, regarding various aspects of the Norm’s General Environmental and Social Impact Assessment (AGIES, for its acronym in Spanish). 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 included that the Norm’s parameters and limits exceeded the reviewed water quality criteria enforced by reference countries in both quantity and stringency; and that many of the parameters and limits were not technically or environmentally reasonable. The Third Environmental Court ruled in our favor on September 29, 2016, declaring the invalidity of the Norm, which decision was upheld by the Supreme Court in July 2017.

In December 2017, the government restarted the rulemaking process and published a new draft SWQSVR for public comments. The draft proposes to regulate using practically the same parameters and limits included in the previous Norm declared void by the Supreme Court. In our opinion, the draft presents flaws similar to those detected in the previous rulemaking process, among others, the lack of identification and consideration of its actual economic and social costs and that most of its parameters and limits are not technically or environmentally reasonable. The public comment process finished in March 2018 and several comments from the public and different stakeholders were submitted, including several technical, economical and legal reports from third parties, were submitted. According to applicable regulations, the government shall analyse and weigh the comments to prepare a final draft, prior to submitting for the consideration by the Sustentability Ministers’ Committee (Consejo de Ministros para la Sustentabilidad) and the President of the Republic. Once the new norm enters into force, we cannot exclude that the authority may declare that the Valdivia River Basin is contaminated and thus initiate an administrative proceeding to impose a decontamination plan, which may include new limits on discharges of wastewater applicable to the Valdivia Mill.

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 the Company—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.”

 

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As of the date of this annual report, we have been 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 administrative proceedings against the Valdivia, Nueva Aldea, Licancel and Constitución mills. In 2017, the Superintendence of the Environment initiated an administrative proceeding against the Arauco Mill. The first part of the proceeding against the Valdivia Mill concluded in 2017. On December 15, 2017, the Superintendence of the Environment decided that the Valdivia Mill was liable for ten out of eleven charges and imposed a fine of 7,777 UTA (approximately U.S.$6.5 million as of December 31, 2018). We appealed this decision on April 5, 2018 before the Third Environmental Court. A final decision by the Third Environmental Court is expected to be rendered during 2019 and may be further appealed before the Supreme Court. In 2016, 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. In December 2018, the Nueva Aldea mill compliance program was officially terminated (declaración de ejecución satisfactoria) by the Superintendence of the Environment. With regard to the Constitución mill’s compliance program, once the activities are completed, the proceedings will end. We expect that such proceedings will end in 2019. With regard 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, which on August 7, 2017, materially reduced the fine. Arauco paid the fine and this case has been closed. Finally, with regard to the proceeding against Arauco the Company filed its defense in September 2017 and, in May 2018, the Superintendence of the Environment found the Arauco mill liable for two charges and imposed a fine of 699,6 UTA (approximately U.S.$635,000). Arauco paid the fine with a 25% reduction (taking advantage of a benefit established by Chilean law) and this case has been closed.

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, soil 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.

 

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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.

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, comes to regulate the environmental compliance of the relevant companies in the operational phase of the endeavor and needs to be renewed every 3 years. Montes del Plata obtained this authorization from the National Environmental Bureau, DINAMA, in June 2014, and has been renewed until December 2020.

We believe that the Montes del Plata operation 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

 

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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, or 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 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. Information on our Company—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 (as amended and extended), 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.

 

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There are 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 subject to several judicial challenges. Currently, there is a pending litigation before the Supremo Tribunal Federal (Highest Court in Brazil) to determine if Federal Law No. 5,709/1971 is applicable to Brazilian companies with foreign shareholders, as it could arguably be contrary to the Brazilian constitution. 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 from August 2010 and to future transactions which have as object, the acquisition of land by persons that have foreign majority capital. 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. Forestry regulations from local municipalities may also require additional permits depending on the forest location.

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

 

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Certifications

Forestry

Certain of our subsidiaries have received various international and local 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, Forestal Los Lagos license code: FSC-C008129, Eufores S.A. (Montes del Plata) license code: FSC-C016979, Arauco Argentina S.A- license code: FSC-C128100, Arauco Argentina S.A. license code: FSC-C128100, Arauco Florestal Arapoti license code: FSC-C010673, Arauco Forest Brasil-Tunas do PR license code: FSC-C116843, Arauco Forest Brasil- C.Tenente e Sengés license code: FSC-C010303 and Mahal Empreendimentos e Participações S/A license code: FSC-C131921);

 

   

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, Forestal Arauco Zona Centro license code: FSC – C008122, Forestal Arauco Zona Sur license code: FSC – C017136, Forestal Los Lagos license code: FSC – C018322 and Eufores S.A. (Montes del Plata) code: FSC-C023409);

 

   

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.

Pulp

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 in Uruguay 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

Wood Products

Our panel mills in Chile are certified under standard Chain of Custody FSC (License Code FSC-C119538), which includes two panel mills. Also, our seven 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), ISO 14001 and Occupational Health and Safety Assessment Series (OHSAS) 18001.

 

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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 and Piray sawmill in Argentina are certified under the Chain of Custody FSC standard (License Code FSC-C119529 and License Code FSC-C130094). 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. The sawmill Piray, remanufacture Piray, Zarate Mill and Chemical Arauco Argentina are certified under ISO 9001.

All our panel mills in Brazil are certified under the Environmental Management System ISO 14001. Occupational health and safety management OHSAS 18001 and Quality Management ISO 9001. The Jaguariaíva Pien Mills, Ponta Grossa e Motenegro Mills are certified under the Chain of Custody FSC Multi-site standard (License Code FSC-C010928).

 

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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 revenues from the sale of bleached and unbleached pulp, wood products such as MDF, PBO, HB, plywood, sawn timber and remanufactured wood products, forestry products, such as sawlogs and pulplogs, and sales of electricity. Export sales constituted 64.6% of our total revenues for the year ended December 31, 2017 and 67.8% of our total sales revenues for the year ended December 31, 2018. Sales of pulp constitute the single largest component of our revenues. As occurs with other commodities, pulp is subject to significant cyclical price fluctuations determined by global supply and demand. Accordingly, our revenues are subject to cyclical fluctuations. Prices for wood and forestry products, also fluctuate significantly among domestic 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 43.9% and 42.3%, respectively, of total wood and forestry products revenues were export sales. In 2016, 92.2% of our total pulp revenues were export sales, and 43.1% of total wood and forestry products revenues were also export sales. In 2017, 94.2% of our total pulp revenues were exports sales, and 42.6% of total wood and forestry products revenues were also export sales. In 2018, 95.2% of our total pulp revenues and 42.7% of total wood and forestry products revenues were 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, 2018, 60.8% of our property, plant, equipment and forest assets were directly owned by us and our Chilean subsidiaries, 7.8% by our Argentine subsidiaries, 9.0% by our Brazilian subsidiaries, 6.8% by our U.S. and Canadian subsidiaries and 15.6% by our joint operation in Uruguay. In 2018, 61.8% of our consolidated revenues were derived from our operations in Chile, 8.1% of our consolidated revenues were derived from our operations in Argentina, 8.4% of our consolidated revenues were derived from our operations in Brazil, 13.7% of our consolidated revenues were derived from our operations in the United States and Canada and 8.0% of our revenues were 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 1.6% in real terms during 2016, and in 2017 and 2018 it grew at rates of 1.1% and 4.2%, 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 declined by 2.0% in real terms during 2016, and in 2017, it increased by 2.7%. For 2018, the INDEC reported a decline of 2.5% in real GDP. In 2016 and 2017, the Argentine peso depreciated against the U.S. dollar by 20.9% and 16.4%, respectively. In 2018, the Argentine peso depreciated against the U.S. dollar by 105.3%. The INDEC’s national CPI (as defined below) has registered an increase of 24.7% on a year-over-year comparison for 2017, and an increase of 47.6% for 2018.

On January 8, 2016, 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 Indice de Precios al Consumidor (Consumer Prices Index, or 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. On July 11, 2017, the INDEC started to publish the national CPI. The INDEC has since then published the national CPI for each month through March 2019.

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 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 decreased in real terms by 3.6% during 2016, and increased in real terms by 1.0% in 2017. In 2018, Brazil’s GDP increased in real terms by 1.1%. In 2016, the Brazilian real appreciated against the U.S. dollar by 19.8% and in 2017 the Brazilian real depreciated against the U.S. dollar by 1.8%. In 2018, the Brazilian real depreciated against the U.S. dollar by 14.6%. 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 1.5% in real terms during 2016, and in 2017 and 2018 it grew in real terms at rates of 2.9% and 1.6%, respectively. In 2016, the Uruguayan peso appreciated against the U.S. dollar by 3.2% but in 2017 it depreciated against the U.S. dollar by 1.0%. In 2018, the Uruguayan peso depreciated against the U.S. dollar by 12.9%. 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 1.6% in real terms during 2016, and in 2017 and 2018 it grew in real terms at rates of 2.3% and 2.9%, 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 1.4% in real terms during 2016, and in 2017 and 2018 it grew in real terms at rates of 3.0% and 1.8%, respectively. The Canadian dollar depreciated against the U.S. dollar by 3.8% in 2016, 6.8% in 2017 and 6.9% in 2018. See “Item 3. Key Information—Risk Factors—Risks Relating to the United States and Canada.”

Exchange Rate Fluctuations

We generally express our export prices 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.

 

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The Chilean peso has been subject to devaluation in the past and could be subject to significant fluctuations in the future. During 2018, the value of the Chilean peso relative to the U.S. dollar decreased by 14.0% in nominal terms, based on the observed exchange rates on December 31, 2017 and December 31, 2018. The observed exchange rate on April 12, 2019, as published in the Official Gazette on April 15, 2019, was Ch$660.67 to U.S.$1.00. For information regarding historical rates of exchange in Chile from January 1, 2014, 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, 2018, our U.S. dollar-denominated indebtedness was U.S.$4.5 billion. In addition, if the U.S. dollar appreciates against the legal currency in any of our export markets, we must, from time to time, express 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 revenues have been affected by price level volatility in the export market. The prices for each of our pulp, 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, domestic market conditions affect prices in markets such as Asia, Europe and the United States.

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

 

     Year ended
December 31,(1)
 

Product(2)

   2018      2017      2016  
     (U.S.$ per tonne)(3)  

Pulp

        

Bleached pulp

     795.6        619.7        549.5  

Unbleached pulp

     846.7        659.0        592.4  
     (U.S.$ per cubic meter)(3)  

Wood Products

        

Sawn timber

     272.7        258.5        246.8  

Remanufactured wood products

     577.1        582.8        556.1  

Plywood

     480.7        420.5        402.4  

Panels

     318.9        337.7        322.6  

Forestry Products

        

Logs

     27.8        32.7        35.3  

 

(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. Key Information—Risk Factors—Risks Relating to the Company— 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 bleached softwood kraft 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.

 

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Prices for unbleached softwood market pulp also follow cyclical patterns related to worldwide demand, stock levels and supply. Based on information published by Hawkins Wright Ltd., unbleached softwood market pulp represents about 3.3% 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.

During 2017, average prices of BEKP and NBSK followed an upward trend, with NBSK reaching U.S.$999.63 per tonne at the end of the year, the highest level since 2011. BEKP prices increased significantly during 2017 reaching U.S.$979.31 at the end of the year (the rise in this type of fiber has reduced the gap between both fibers). Prices increased mainly because the expected capacity of the mill located in Indonesia was revised to 1.7 million tonnes for the next three to four years and the lower capacity of other existing mills due to operational problems. Demand had a steady rise during 2017, which also drove prices to reach higher levels.

During 2018, average prices of BEKP and NBSK followed an upward trend, slightly decreasing in the last part of the year, with NBSK reaching U.S.$1,200.02 per tonne and BEKP U.S.$1,025.73 per tonne. The positive trend during most of the year was mainly due to strong demand and stable capacity levels, while the slight decrease at the end of 2018 was mainly driven by the trade tensions between China and the United States.

Prices of NBSK(1)

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*  

2015

     808.36        (13.8 )% 

2016

     808.83        0.7

2017

     999.63        23.6

2018

     1,200.02        20.0

 

  *

YoY means year over year

Prices of BEKP(1)

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  

2015

     788.91        6.2

2016

     652.58        (17.3 )% 

2017

     979.31        50.1

2018

     1,025.73        4.7

 

  (1)

Source: RISI.

 

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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  

2015

     601.70        (7.5 )% 

2016

     573.82        (4.6 )% 

2017

     768.03        33.8

2018

     853.77        11.2

Source: Arauco.

Forestry and Wood Products 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 2014, the sawn timber market improved, with increased demand that permitted the sales mix and prices to improve compared 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, even though 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 and sales volume for our wood products declined by 5.3% 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 profits 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.

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 margins 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.

During 2017, average prices for our wood products division increased by 5.1% compared to 2016. The panels market increased in average prices and sales volume by 4.7% and 2.4% respectively compared to 2016. Our sawn timber average prices increased by 4.7% compared to 2016, offset by a decrease of 5.3% in sales volume. North American market demand improved in 2017 fueled by the construction and retail sectors. The Brazilian market has been recovering slowly after the economic and political crisis. The Argentine market has improved in sales volume. Despite the new MDF mills in Brazil and Mexico that increased competition, we were able to maintain and increase prices in some markets. With the acquisition of the assets of Masisa in Brazil, we expect to consolidate our position in the market.

During 2018, average prices of our wood products decreased by 1.7% compared to 2017. The panels market showed a decrease in average prices by 5.6% while sales volumes showed an increase of 11.2%. The downward trend in prices was explained by an oversupply mainly from Brazil, Chile, the United States and Asia, and seasonality in the northern hemisphere. Sawn timber had a 5.5% increase in average prices throughout 2018, partially offset by a slight decrease in sales volume of 2.9%, which was mainly explained by lower demand from China, which in turn is related to the uncertainty surrounding the trade tensions between this country and the United States.

 

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

Costs

Our major costs of sales are the following:

 

   

timber,

 

   

harvesting (forestry works),

 

   

maintenance,

 

   

chemicals,

 

   

depreciation and amortization, and

 

   

energy and fuel.

Our major administrative and selling expenses are wages and salaries, traffic, shipping and freight costs, information technology (IT) expenses, 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, panels 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.

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.

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 14.7% 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%.

In 2017, our cost of sales increased by 2.2% compared to 2016. The cost of energy and fuels for our production processes increased by 33.3% and the cost for our chemical products increased by 8.0% in 2017 compared to 2016. Fuel prices rose during 2017, following an upward trend of various commodities. Higher indirect cost and forestry labor cost also had an impact on the higher cost of sales. These cost increases were partially offset by lower maintenance cost and other raw materials cost that decreased 16.2% and 14.9%, respectively, compared to 2016.

In 2018, our costs of sales increased by 4.1% compared to 2017. The main reason was the 8.3% increase in the cost of chemical products used in our production processes. Additionally, the cost of forestry labor increased by 6.5% compared to 2017, and other raw materials costs were 21.1% higher. These higher costs were partially offset by a 4.7% decrease in the cost of wood and a 18.3% decrease in costs of electricity.

 

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Critical Accounting Policies

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

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 minus 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 and sensibility analysis over significant inputs 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 operation 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 the Company—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” 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 standards, interpretations and amendments that are mandatory for the first time for the annual period beginning on January 1, 2018 and also the new standards, interpretations and amendments, the application of which is not yet mandatory, which have not been adopted in advance.

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, 2016, 2017 and 2018. 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, 2016, 2017 and 2018 included elsewhere herein. The audited consolidated financial statements included herein are prepared in U.S. dollars and in accordance with IFRS.

 

     For the year ended December 31,  
     2018      2017      2016  
     Sales     %     Volume      Sales     %     Volume      Sales     %     Volume  
     (in millions of U.S. dollars, except where indicated)  

Revenue

                    

Pulp

                    

Bleached pulp(1)

     2,536.9       42.6       3,188.6        2,062.4       39.4       3,327.8        1,780.6       37.4       3,240.8  

Unbleached pulp(1)

     418.4       7.0       494.2        293.3       5.6       445.1        260.5       5.5       439.7  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total

     2,955.3       49.6       3,682.7        2,355.7       45.0       3,772.9        2,041.1       42.9       3,680.5  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Wood Products

                    

Panels(2)

     1,725.1       29.0       5,410.0        1,643.3       31.4       4,866.2        1,533.6       32.2       4,753.9  

Sawn timber(2)

     487.7       8.2       1,788.4        476.1       9.1       1,841.6        479.8       10.1       1,943.8  

Remanufactured wood products(2)

     252.6       4.2       437.7        259.3       5.0       445.0        245.5       5.2       441.6  

Plywood

     255.5       4.3       531.6        238.2       4.5       566.5        226.9       4.8       563.9  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total

     2,721.0       45.7       8,167.8        2,616.9       50.0       7,719.3        2,485.8       52.2       7,703.2  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Forestry

                    

Logs, net(2)

     71.9       1.2       2,539.9        72.6       1.4       2,223.7        63.1       1.3       1,787.5  

Chips

     31.4       0.5       546.0        25.2       0.5       443.4        20.8       0.4       366.2  

Other

     4.1       0.1       0.1        8.2       0.1       5.2        6.1       0.1       7.8  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total

     107.4       1.8       3,086.0        106.0       2.0       2,672.3        90.0       1.9       2,161.5  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Energy

     86.7       1.5          93.8       1.8          103.4       2.2    

Other

     84.4       1.4          65.9       1.2          41.1       0.9    
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

   

Total revenue

     5,954.8       100          5,238.3       100          4,761.4       100    
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

   

Cost of sales

                    

Timber

     (691.1          (725.1          (736.4    

Forestry labor costs

     (672.2          (631.3          (600.3    

Maintenance costs

     (280.7          (262.8          (313.5    

Chemical costs

     (560.2          (517.5          (479.3    

Depreciation

     (377.6          (389.8          (378.0    

Other costs of sales

     (1,140.9          (1,048.0          (991.4    
  

 

 

        

 

 

        

 

 

     

Total cost of sales

     (3,722.7          (3,574.5          (3,498.9    
  

 

 

        

 

 

        

 

 

     

Gross profit

     2,232.1       37.5        1,663.8       31.8        1,262.5       26.5  

Other income

     124.3            111.5            257.9      

Distribution costs

     (556.8          (523.3          (496.5    

Administrative expenses

     (561.3          (521.3          (474.5    

Other expenses

     (95.9          (240.1          (77.4    

Other income (loss)

     14.2            —              —        

Financial income

     20.9            19.6            29.7      

Financial costs

     (214.8          (287.9          (258.5    

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

     17.2            17.0            23.9      

Exchange rate differences

     (26.5          0.1            (3.9    

Income before income tax

     953.5            239.4            263.2      

Income tax

     (226.8          31.0            (45.6    

Net income

     726.8            270.4            217.6      

 

(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 wood products reportable segment in Note 24 in our audited consolidated financial statements.

 

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Year Ended December 31, 2017 Compared to Year Ended December 31, 2018

Revenue

Revenues increased by 13.7% from U.S.$5,238.3 million in 2017 to U.S.$5,954.8 million in 2018, primarily as a result of:

 

   

a 25.5%, or U.S.$599.6 million, increase in revenues from pulp;

 

   

a 4.0%, or U.S.$104.1 million, increase in revenues from wood products;

 

   

a 1.3%, or U.S.$1.4 million, increase in revenues from forestry products

Pulp. Revenues from bleached and unbleached pulp increased by 25.5% from U.S.$ 2,355.7 million in 2017 to U.S.$2,955.3 million in 2018, reflecting a 28.5% increase in average prices, partially offset by a 2.4% decrease in sales volume. Sales of bleached pulp increased by 23.0% due to a 28.4% increase in average prices, partially offset by a 4.2% decrease in sales volume. Revenues from unbleached pulp increased by 42.6% during 2018, mainly due to a 28.5% increase in average prices and a 11.0% increase in sales volume. Prices for both types of fiber (softwood and hardwood) showed a similar upward trend throughout most of 2018, and demand remained stable until the last quarter. By the end of the year, both prices and demand were impacted by the effects of the trade tensions between China and the United States.

Wood products. Revenues from wood products increased by 4.0% from U.S.$2,616.9 million in 2017 to U.S.$2,721.0 million in 2018, primarily due to a 5.8% increase in sales volume, partially offset by a slight average price decrease of 1.7%.

Panel products sales had a 5.0% increase compared to 2017, driven by a 11.2% increase in sales volume, which was partially offset by an average price decrease of 5.6%.

Revenues from sawn timber increased by 2.4%, from U.S.$476.1 million in 2017 to U.S.$487.7 million in 2018 due to a 5.5% increase in average prices, partially offset by a 2.9% decrease in sales volume. Trade tension between China and the United States resulted in lower demand during the second half of 2018 from the Asian markets. Plywood revenues increased by 7.3% from U.S.$238.2 million in 2017 to U.S.$255.5 million in 2018, mainly due to a 14.3% increase in average prices, slightly offset by 6.2% decrease in sales volume.

Forestry products. Revenues from forestry products increased by 1.3% from U.S.$106.0 million in 2017 to U.S.$107.4 million in 2018. This increase was primarily the result of a U.S.$6.2 million increase in chips sales partially offset by a slight decrease in logs sales of 1.1%, explained by a U.S.$3.2 million decrease in sawlogs sales.

 

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Other revenue. Revenues from other sources, consisting mainly of sales of energy, chemicals and other services, increased by 7.1% from U.S.$159.7 million in 2017 to U.S.$171.1 million in 2018, primarily as a result of a U.S.$18.5 million increase in other export sales of fire-damaged wood. This was partially offset by a U.S.$7.0 million decrease in energy sales.

Cost of sales

Cost of sales increased by 4.1% from U.S.$3,574.5 million in 2017 to U.S.$3,722.7 million in 2018, primarily as a result of a 8.3% increase in chemical products and a 6.5% increase in forestry labor cost due to higher production. These increased costs were partially offset by a 4.7% decrease in the cost of timber.

Gross Profit

As a percentage of total revenue, our gross profit increased from 31.8% in 2017 to 37.5% in 2018, primarily as a result of a 13.7% increase in sales revenue, while cost of sales rose slightly by 4.1%.

Other income

Other income increased by 11.5% from U.S.$111.5 million in 2017 to U.S.$124.3 million in 2018. This was mainly due to compensations received in our energy business of U.S.$4.6 million and an increase of profits from changes in the fair value of our biological assets of U.S.$1.4 million.

Distribution costs

Distribution costs increased by 6.4% from U.S.$523.3 million in 2017 to U.S.$556.8 million in 2018, primarily due to an increase of 7.6%, or U.S.$31.1 million in total freight costs. This increase was mainly explained by higher freight tariffs in the United States (due to a certified truck driver shortage), and higher sales volume. As a percentage of revenue, distribution costs remained fairly stable at 9.4% in 2018, compared to 10.0% in 2017.

Administrative expenses

Administrative expenses increased by 7.7% from U.S.$521.3 million in 2017 to U.S.$561.3 million in 2018. As a percentage of revenue, administrative expenses remained stable at 9.4% in 2018, compared to 10.0% in 2017.

Other expenses

Other expenses decreased by 60.0% from U.S.$240.2 million in 2017 to U.S.$95.9 million in 2018 due to lower forestry fires in comparison with the ones affecting our forests during 2017.

Other income (loss)

Other income (loss) reached U.S.$14.2 million in 2018, explained by a profit due to bargain acquisition recognized following the acquisition of Masisa’s assets in Brazil.

Finance costs

Finance costs decreased by 25.4%, from U.S.$287.9 million in 2017 to U.S.$214.8 million in 2018, primarily due to lower incurred costs compared to 2017 when we repurchased our Notes due in 2019, 2021 and 2022, including a premium payment that amounted to approximately U.S.$60 million.

Exchange rate differences

Losses from exchange rate differences totaled U.S.$26.5 million in 2018 compared to the U.S.$0.1 million gain in 2017. These losses were primarily due to the depreciation of the Argentine peso, the Brazilian real and the Chilean peso. See “—Economic Indicators in Chile, Argentina, Brazil, Uruguay, the United States and Canada.”

Income tax

We recorded an income tax expense of U.S.$226.8 million in 2018 compared to a gain of U.S.$31.0 million in 2017. This increase was attributable to our higher income from operational activities in 2018, which is mainly explained by higher revenues in Chile by 18.5%. During 2017 we had a positive effect in deferred taxes, as a result of tax rate reductions in the United States and Argentina which accounted for U.S.$17.6 million and U.S.$62.7 million, respectively.

 

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Net income

Net income in 2018 increased by 168.8% from U.S.$270.4 million in 2017 to U.S.$726.8 million in 2018. This is explained by higher sales in our different business segments, which in the aggregate increased our gross profit by 34.2% or U.S.$568.3 million, as well as a decrease in financial costs and other operating expenses, all of which was partially offset by higher income tax losses.

Year Ended December 31, 2016 Compared to Year Ended December 31, 2017

Revenue

Revenues increased by 10.0% from U.S.$4,761.4 million in 2016 to U.S.$5,238.3 million in 2017, primarily as a result of:

 

   

a 15.4%, or U.S.$314.6 million, increase in revenues from pulp;

 

   

a 5.3%, or U.S.$131.1 million, increase in revenues from wood products;

 

   

a 17.8%, or U.S.$16.0 million, increase in revenues from forestry products

Pulp. Revenues from bleached and unbleached pulp increased by 15.4% from U.S.$2,041.1 million in 2016 to U.S.$2,355.7 million in 2017, reflecting a 2.5% increase in sales volume and a 12.6% increase in average prices. Sales of bleached pulp increased by 15.8% due to a 12.8% increase in average prices and a 2.7% increase in sales volume. 2017 started with a large gap between softwood and hardwood, with both prices increasing. The growth in hardwood prices was greater than the increase in softwood prices, which implied that through the year the gap between both prices decreased significantly. The increase in hardwood prices was driven by lower expected supply capacity of the pulp mill in Indonesia, because the market expected a capacity of 2.8 million tonnes annually and instead we expect the capacity to be stable at 1.7 million tonnes for the next three to four years. Lower capacity due to operational problems in existing mills in the industry also impacted the supply and compensated the new production. Demand has had a steady rise during 2017 as certain policies, including import restrictions of unsorted waste paper, put in place by the Chinese government to stimulate internal consumption, helped support pulp demand in China. Revenues from unbleached pulp increased by 12.6% during 2017, mainly due to a 11.2% increase in average prices and a 1.2% increase in sales volume.

Wood products. Revenues from wood products increased by 5.3% from U.S.$2,485.8 million in 2016 to U.S.$2,616.9 million in 2017. This increase in revenues was primarily due to a 5.1% increase in average prices, and by a 0.2% increase in sales volume. Despite additional supply from Brazil and North America competitors, revenues from panels increased by 7.1%, driven by a 4.7% increase in average prices and a 2.4% increase in sales volume. Argentina showed an increase in prices and sales volume in MDF and PBO, mainly due to better conditions in the economy. In Brazil PBO and MDF average prices improved, due to economic growth compared to a contraction in the two prior years.

Revenues from sawn timber decreased by 0.8%, from U.S.$479.8 million in 2016 to U.S.$476.1 million in 2017 due to a 5.3% decrease in sales volume, partially offset by a 4.7% increase in average prices. During the first quarter of 2017, forestry fires in Chile damaged our El Cruce Sawmill, which stopped its operations. Our other sawmills were able to absorb the lack of production. Demand from Asia and Middle East, our principal customers for these products, have shown improvements during the year. Remanufactured products revenues increased 5.6% from U.S.$245.5 million in 2016 to U.S.$259.3 million in 2017 due to a 4.8% increase in average prices and a 0.8% in sales volume. Plywood revenues increased 5.0% from U.S.$226.9 million in 2016 to U.S.$238.2 million in 2017 with sales volumes increasing 0.5% and prices increasing 4.5%. The North American market showed a high demand in retail, distribution and industrial customers.

Forestry products. Revenues from forestry products increased by 17.8% from U.S.$90.0 million in 2016 to U.S.$106.0 million in 2017. This increase was primarily the result of a U.S.$9.6 million increase in logs sales, driven in turn by a U.S.$8.2 million increase in sales in sawlogs, and a U.S.$1.4 million increase in sales in pulplogs.

Other revenue. Revenues from other sources, consisting mainly of sales of energy and chemicals, increased by 10.5% from U.S.$144.5 million in 2016 to U.S.$159.7 million in 2017. This was primarily the result of a U.S.$24.9 million increase in other services, partially offset by a U.S.$ 9.6 million decrease in energy sales.

 

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Cost of sales

Cost of sales increased by 2.2% from U.S.$3,498.9 million in 2016 to U.S.$3,574.5 million in 2017, primarily as a result of a 33.3% increase in cost of energy and fuel used in our operations mainly driven by higher average prices of fuel. Our forestry labor cost increased by 5.2% due to increased forestry production and our chemical products costs increased by 8.0%. These increased costs were largely offset by a 16.2% decrease in our maintenance costs.

Gross Profit

As a percentage of total revenue, our gross profit increased from 26.5% in 2016 to 31.8% in 2017, primarily as a result of a 10.0% increase in sales revenue, while cost of sales rose slightly by 2.2%.

Other income

Other income decreased by 56.8% from U.S.$257.9 million in 2016 to U.S.$111.5 million in 2017. Profits from changes in the fair value of our biological assets decreased by 60.2% compared to 2016, mainly due to a change in the forest valuation contained in the IFRS forest assessment. This change in estimation originated from forest inventory differences, associated to pruning and thinning that were not carried out according to schedule, climate reasons, and an update in the growth tables considered in the valuation.

Distribution costs

Distribution costs increased by 5.4% from U.S.$496.5 million in 2016 to U.S.$523.3 million in 2017, primarily due to an increase of 7.0%, or U.S.$26.9 million, in total freight costs. This increase was explained by an increase in sales volume in our pulp division. As a percentage of revenue, distribution costs remained fairly stable, at 10.0% in 2017, compared to 10.4% in 2016.

Administrative expenses

Administrative expenses increased by 9.9% from U.S.$474.5 million in 2016 to U.S.$521.3 million in 2017. As a percentage of revenue, administrative expenses remained stable at 10.0% in 2017 and 2016.

Other expenses

Other expenses increased by 210.3% from U.S.$77.4 million in 2016 to U.S.$240.2 million in 2017 due to the forestry fires that affected our forest during 2017. Loss totaled approximately U.S.$173.1 million net of U.S.$35.0 million that we received from the insurance company; thereby the loss was U.S.$138.1 million.

Finance costs

Finance costs increased by 11.4%, from U.S.$258.5 million in 2016 to U.S.$287.9 million in 2017. This increase is explained by our repurchase of Notes due in 2019, 2021 and 2022 in November 2017. The costs incurred in the repurchase primarily included a premium payment that amounted to approximately U.S.$60 million. During 2017 we continued to focus on our deleveraging process.

Exchange rate differences

Gains from exchange rate differences totaled U.S.$0.1 million in 2017, compared to the U.S.$3.9 million loss that we had in 2016. This was primarily due to the appreciation of the Chilean peso which increased our cash and cash equivalents and outstanding debt in this currency. See “—Economic Indicators in Chile, Argentina, Brazil, Uruguay, the United States and Canada.”

Income tax

We recorded an income tax gain of U.S.$31.0 million in 2017 compared to an expense of U.S.$45.6 million in 2016. This increase is attributable to lower income before tax and the effect in deferred taxes a result of the tax rate reduction in United States and Argentina which accounted for U.S.$17.6 million and U.S.$62.7 million.

Net income

Net income in 2017 increased by 24.3% from U.S.$217.6 million in 2016 to U.S.$270.4 million in 2017. Higher sales in all of our business segments increased our gross profit by 31.8% or U.S.$401.3 million and our income tax gain, all of which was partially offset by higher other operating expenses and lower other operating income.

 

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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.

We also have access to two committed credit facility lines, which total U.S.$314.4 million. The first line has an available amount of UF 2,885,000, or approximately U.S.$114.4 million and expires on January 29, 2020. The second line has a maximum available amount of U.S.$200.0 million and expires 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.$1,280.9 million in 2018 and U.S.$1,072.4 million in 2017. This increase was principally due to a U.S.$621.1 million increase in sales of goods and services, partially offset by a U.S.$449.0 million increase in payments to suppliers and employees.

Our net cash flow provided by operating activities was U.S.$1,072.4 million in 2017 and U.S.$773.6 million in 2016. This increase was principally due to a U.S.$488.2 million increase in our collection of sales of goods and services, partially offset by a U.S.$104.0 million increase in other payments for operating activities.

Cash Flow Used in Investing Activities

Our net cash used in investing activities was U.S.$893.9 million in 2018 and U.S.$633.3 million in 2017. This increase was principally due to an increase in capital expenditures of 50.8%, or U.S.$227.7 million, mainly as a result of purchases of property, plant and equipment. Capital expenditures in 2018 included U.S.$196.6 million in the “MDP Grayling” project in Michigan (United States), U.S.$124.9 million in the “MAPA” project, U.S.$52.9 million in the “Dissolving Pulp” project and U.S.$16.2 million in the water treatment plant in the Arauco mill.

Our net cash used in investing activities was U.S.$633.3 million in 2017 and U.S.$640.2 million in 2016. This decrease was principally due to a decrease in capital expenditure, mainly as a result of U.S.$15.9 million increase in cash flows used to purchase in associates. Capital expenditures in 2017, included U.S.$183.4 million in the “MDP Grayling” project in Michigan, U.S.$179.2 million in plantations and U.S.$26.9 million in the water treatment plant in the Arauco mill.

Cash Flow from Financing Activities

Our net cash provided by financing activities was U.S.$129.8 million in 2018, compared to the U.S.$439.1 million used in 2017. During 2018, we received U.S.$863.6 million in loan proceeds, and we paid U.S.$475.2 million of principal of and interest on our debt. In addition, we paid U.S.$257.4 million in dividends.

Our net cash provided by financing activities was U.S.$439.1 million in 2017, compared to U.S.$38.5 million used in 2016. During 2017, we received U.S.$1,312.5 million in loan proceeds, and we paid U.S.$1,627.7 million of principal of and interest on our debt, including U.S.$877.0 million in a U.S. dollar-denominated bonds, U.S.$270.0 million in a U.S. dollar-denominated bond of our subsidiary Arauco Argentina, and U.S.$100.0 million in the prepayment of debt of a credit loan. In addition, we paid U.S.$121.6 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, 2018, 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)

     504,920        957,724        932,115        2,632,108        5,026,867  

Purchase obligations (2)

     352,449        370,427              722,876  

Capital (finance) lease obligations

     30,916        26,296        10,975           68,187  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     888,285        1,354,447        943,090        2,632,108        5,817,930  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Includes estimated interest payments related to debt obligations based on market values as of December 31, 2018. In the case of floating rate debt, interest rate is calculated using the current index setting in place as of December 31, 2018, 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, 2018, the average spread for our U.S. dollar floating rate debt over six-month LIBOR was 1.50%. Approximately 15.6% of our total debt is floating rate debt as December 31, 2018.

(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 2018, our main investment activities were investments in projects; sustaining our panel, sawmill and pulp mills, and sustaining our biological assets. The project capitalization investments included primarily:

 

   

U.S.$219.0 million invested in the “MDP Grayling” project;

 

   

U.S.$128.1 million invested in the “MAPA” project; and

 

   

U.S.$65.0 million invested in the “Dissolving Pulp” project in the Valdivia mill.

Financing Activities

During 2018, our principal financing activities were as follows:

On October 25, 2018, we issued two series of bonds in the local capital markets for a total amount of U.S.$337.2 million. The amount of the issuance of the 10-year Series was UF 3.0 million, equivalent to U.S.$119.0 million as of December 31, 2018, while the amount of the 25-year series was UF 5.5 million, equivalent to U.S.$218.2 million as of December 31, 2018. The proceeds from the issuance were used for the financing of the MAPA project.

On September 27, 2018, we refinanced U.S.$200 million of a loan due in September 28, 2018, extending the final maturity date to September 2023.

As of December 31, 2018, the current portion of our bank debt was U.S.$215 million of which 96.8% was U.S. dollar-denominated. As of December 31, 2018, our total non-current portion of our bank debt was U.S.$725.4 million of which 98.9% was U.S. dollar-denominated.

As of December 31, 2018, we also had total capital markets borrowings (including the current portion of such debt) of U.S.$3.5 billion, 58.9% of which were U.S. dollar-denominated.

As of December 31, 2018, the weighted average maturity of our non-current debt was 8.96 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, 2018, the average spread for our U.S. dollar floating rate debt over six-month LIBOR was 1.50%. As of December 31, 2018, the average interest rate for our U.S. dollar fixed rate debt was 4.75%. These average rates do not reflect the effect of swap agreements.

As of December 31, 2018, we guaranteed obligations of U.S.$322.2 million related to Montes del Plata, U.S.$287.0 million related to Flakeboard America and U.S.$15.2 million related to Arauco Forest Brazil and Mahal.

 

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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, 2018 are as follows:

 

   

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

 

   

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

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

 

   

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

We were in compliance with all bank loan and bond covenants as of December 31, 2018. 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

Our corporate financial policy establishes a set of guidelines, procedures and responsibilities to minimize certain financial risks to which we are exposed and to regulate such policy with a global corporate view. This policy seeks to manage such risks in our best interests, covering all countries where we operate, and is administered by our Corporate Finance Department (based in Chile).

We manage the treasury activities of all our Chilean subsidiaries and certain foreign commercial offices on a centralized basis. In the case of our Argentine, North American and Brazilian subsidiaries, the management of their daily treasury activities is independent from our Corporate Finance Department, although following the same corporate policy.

The treasury activities of our Uruguayan joint operations are governed by a corporate financial policy approved by its board of directors based on the same principles underlying our cash and deposits policy. In addition, the Uruguayan joint operations are supervised by a financial committee integrated by members of both shareholders’ finance departments.

The treasury activities of Sonae Arauco, our joint venture with Sonae, are governed by a corporate financial policy approved by its board of directors, based on the same principles underlying our cash and deposits policy. In addition, they are supervised by a financial committee integrated by members of both shareholders.

 

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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 into 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

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

Deutsche—U.K.

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

JP Morgan—N.A.

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

Deutsche—U.K.

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

Scotiabank—Chile

Scotiabank—Chile

    

1,000,000

1,000,000

 

 

    

38,426,435

38,378,440

 

 

    

10-30-2014

10-30-2014

 

 

    

04-30-2023

04-30-2023

 

 

Santander—Chile

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

BCI—Chile

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

Corpbanca—Chile

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

Scotiabank—Chile

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

Deutsche—U.K.

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

Santander—Spain

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

Scotiabank—Chile

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

Corpbanca—Chile

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

JP Morgan—N.A.

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

Scotiabank—Chile

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

Santander—Chile

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

Deutsche—U.K.

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

Santander—Chile

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

JP Morgan—U.K.

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

Corpbanca—Chile

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

BCI—Chile

     625,000        26,990,765        10-01-2014