20-F 1 f20f2020_cementospacas.htm ANNUAL REPORT

As filed with the Securities and Exchange Commission on April 30, 2021 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 20-F

 

 

 

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2020

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-35401

 

 

 

CEMENTOS PACASMAYO S.A.A.

(Exact name of Registrant as specified in its charter)

 

PACASMAYO CEMENT CORPORATION

(Translation of Registrant’s name into English)

 

Republic of Peru

(Jurisdiction of incorporation or organization)

 

Calle La Colonia 150, Urbanización El Vivero
Surco, Lima
Peru

(Address of principal executive offices)

 

Javier Durand, Esq., General Counsel
Tel. +51-1-317-6000
Calle La Colonia 150
Urb. El Vivero - Lima, Peru

(Name, telephone, email and/or facsimile number and address of company contact person)

 

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

 

Title of each class   Name of each exchange on which registered
Common Shares, par value S/1.00 per share, in the form of American Depositary Shares, each representing five Common Shares   New York Stock Exchange

 

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

 

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

 

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:

 

At December 31, 2020 423,868,449 common shares
4,238,397 investment shares*

 

 
*Excluding 36,040,497 investment shares held in treasury.

 

 

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  

 

Note- Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

 

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

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 203.405 of this chapter) during the preceding 12 months (or for such other period that the registrant was required to submit and post such files).    Yes      No      Note: Not required for Registrant.

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ☒ Accelerated filer   Non-accelerated filer  

 

Indicate by check mark which basis of accounting the Registrant has used to prepare the financial statements 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  

 

 

 

 

 

SECTION 1.01 PART I
INTRODUCTION

 

Certain Definitions

 

All references to “we,” “us,” “our,” “our company” and “Cementos Pacasmayo” in this annual report are to Cementos Pacasmayo S.A.A., a publicly-held corporation (sociedad anónima abierta) organized under the laws of Peru, and, unless the context requires otherwise, its consolidated subsidiaries. The term “U.S. dollar” and the symbol “US$” refer to the legal currency of the United States; and the term “sol” and the symbol “S/” refer to the legal currency of Peru.

 

Financial Information

 

Our consolidated financial statements included in this annual report have been prepared in soles and in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and audited in accordance with the standards of the Public Company Accountings Oversight Board (United States).

 

In this annual report, we present EBITDA and Adjusted EBITDA (only for 2017), which are financial measures that are not recognized under IFRS. We refer to such financial measures as “non-IFRS” financial measures. A non-IFRS financial measure is generally defined as one that purports to measure financial performance; financial position or cash flows of the subject reporting company but excludes or includes amounts that would not be so adjusted in the most comparable IFRS measure. We present EBITDA and Adjusted EBITDA because we believe it provides the reader with a supplemental measure of the financial performance of our core operations that facilitates period-to-period comparisons on a consistent basis. EBITDA and Adjusted EBITDA should not be construed as an alternative to profit or operating profit, as an indicator of operating performance, as an alternative to cash flow provided by operating activities or as a measure of liquidity (in each case, as determined in accordance with IFRS). EBITDA and Adjusted EBITDA, as calculated by us, may not be comparable to similarly titled measures reported by other companies, including those in the cement industry. For a calculation of EBITDA and Adjusted EBITDA and a reconciliation of EBITDA and Adjusted EBITDA to the most directly comparable IFRS financial measure, see “Item 3. Key Information—A. Selected Financial Data.”

 

We have translated some of the soles amounts appearing in this annual report into U.S. dollars for convenience purposes only. Unless the context otherwise requires, the rate used to translate soles amounts to U.S. dollars was S/3.621 to US$1.00, which was the average accounting exchange rate (tipo de cambio contable) reported on December 31, 2020, by the Peruvian Superintendence of Banks, Insurance and Private Pension Fund Administrators (Superintendencia de Banca, Seguros y AFPs, or “SBS”). The Federal Reserve Bank of New York does not report a noon buying rate for soles. The U.S. dollar equivalent information presented in this annual report is provided solely for convenience of the reader and should not be construed as implying that the soles amounts represent, or could have been or could be converted into, U.S. dollars at such rates or at any other rate.

 

Certain figures included in this annual report have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be arithmetic aggregations of the figures that precede them.

 

Market Information

 

We make estimates in this annual report regarding our competitive position and market share, as well as the market size and expected growth of the construction sector and cement industry in Peru. We have made these estimates on the basis of our management’s knowledge and statistics and other information available from the following sources:

 

the Central Bank of Peru (Banco Central de Reserva del Perú or “BCRP”);

 

the National Statistical Institute of Peru (Instituto Nacional de Estadística e Informática, or “INEI”);

 

the Association of Cement Producers of Peru (Asociación de Productores de Cemento, or “ASOCEM”);

 

the Ministry of Housing, Construction and Sanitation;

 

ADUANET, a website administered by the Peruvian Tax Superintendence (Superintendencia Nacional de Administración Tributaria, or “SUNAT”);

 

1

 

the Peruvian Chamber of Construction (Cámara Peruana de la Construcción); and

 

the Global Competitiveness Index prepared by the World Economic Forum.

 

We believe these estimates to be accurate as of the date of this annual report.

 

Forward-Looking Statements

 

This annual report contains forward-looking statements. Forward-looking statements convey our current expectations or forecasts of future events. These statements involve known and unknown risks, uncertainties and other factors, including those listed under “Item 3. Key Information – D. Risk Factors,” which may cause our actual results, performance or achievements to differ materially from the forward-looking statements that we make.

 

Forward-looking statements typically are identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “project,” “plan,” “believe,” “potential,” “continue,” “is/are likely to,” or other similar expressions. Any or all of our forward- looking statements in this annual report may turn out to be inaccurate. Our actual results could differ materially from those contained in forward-looking statements due to a number of factors, including:

 

political economic, political and social risk inherent to conducting business in Peru including as a result of public health crises in Peru, and the Peruvian government’s responses thereto;

 

exchange rates, inflation and interest rates;

 

the entry of new competitors into the market we serve;

 

construction activity levels, particularly in the northern region of Peru;

 

private investment and public spending in construction projects;

 

unpredictable natural disasters, such as floods and earthquakes affecting the northern region of Peru, and global events, such as public health crisis and epidemics/pandemics and the worldwide effects thereof and responses thereto;

 

availability and prices of energy, admixtures and raw materials;

 

changes in the regulatory framework, including tax, environmental and other laws;

 

the successful expansion of our production capacity;

 

our ability to compete with potential substitutes of cement products that may be introduced in the Peruvian construction industry;

 

our ability to maintain and expand our distribution network;

 

the impact of global or local public health events, including pandemics and the severity and duration of the COVID-19 pandemic, including governments’ related responses to the outbreak which could cause business disruptions and continued declines in production of or demand for cement. The availability of vaccines in Peru will play an important role in the country’s economic recovery;

 

our ability to retain and attract skilled employees; and

 

other factors discussed under “Item 3. Key Information—D. Risk Factors.”

 

The forward-looking statements in this annual report represent our expectations and forecasts as of the date of this annual report. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this annual report.

 

2

 

ITEM 1.IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not applicable.

 

ITEM 2.OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3.KEY INFORMATION

 

A.Selected Financial Data

 

The following selected consolidated financial data should be read together with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and the related notes included in this annual report. As of December 31, 2020, the consolidated financial statements comprise the financial statements of Cementos Pacasmayo and its subsidiaries: Cementos Selva S.A. and subsidiaries, Distribuidora Norte Pacasmayo S.R.L., Empresa de Transmisión Guadalupe S.A.C., Calizas del Norte S.A.C. (in liquidation), Salmueras Sudamericanas S.A. and Soluciones Takay S.A.C. Discontinued operations are excluded from the results of continuing operations and are presented as a single amount as profit or loss after tax from discontinued operations in the income statement.

 

3

 

The following selected financial data as of and for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 have been derived from our annual audited consolidated financial statements included in this annual report, which have been prepared in accordance with IFRS as issued by the IASB.

 

   Year ended December 31, 
   2020   2020   2019   2018   2017   2016 
   (in millions of
US$, except
share and per
share data)(1)
   (in millions of S/, except share and per share data)(1) 
Statement of Financial Position:        
Sales of goods   358.0    1,296.3    1,392.7    1,262.9    1,220.8    1,236.8 
Cost of sales   (254.3)   (921.0)   (905.8)   (796.2)   (733.0)   (736.6)
Gross profit   103.7    357.3    486.9    466.7    487.8    500.2 
Operating income (expenses):                              
Administrative expenses   (45.1)   (163.4)   (174.5)   (172.1)   (195.6)   (193.4)
Selling and distribution expenses   (11.1)   (40.1)   (44.5)   (44.1)   (41.7)   (36.5)
Impairment of brine assets                   (47.6)    
Other operating income (expense) net   1.2    4.3    2.6    (8.7)   (4.3)   2.4 
Total operating expenses, net   (54.9)   (199.2)   (216.4)   (224.9)   (289.2)   (227.5)
Operating profit   48.7    176.1    270.5    241.8    198.6    272.7 
                               
Other income (expenses):                              
Finance income   0.8    2.9    2.6    2.3    5.8    3.2 
Finance costs   (24.5)   (88.7)   (77.9)   (87.3)   (73.8)   (75.4)
Gain (loss) on the valuation of trading derivative financial instruments   1.5    5.3    (1.5)   2.6         
Net loss on settlement of derivative financial instruments               (34.9)        
(Loss) gain from exchange difference, net   (2.7)   (9.8)   0.6    (8.4)   (2.2)   (2.4)
Total other expenses, net   (25.0)   (90.2)   (76.2)   (125.7)   (70.2)   (74.6)
Profit before income tax   23.7    85.8    194.3    116.1    128.4    198.1 
Income tax expense   (7.7)   (28.0)   (62.3)   (41.0)   (47.0)   (78.6)
Profit for the year from continuing operations   16.0    57.9    132.0    75.2    81.4    119.5 
Loss for the year from discontinued operations                   (0.8)   (6.6)
                               
Profit for the year   16.0    57.9    132.0    75.1    80.6    112.9 
Attributable to:                              
Equity holders of the parent   16.0    57.9    132.0    76.7    93.8    116.2 
Non-controlling interests                (1.6)   (13.2)   (3.3)
Profit for the year   16.0    57.9    132.0    75.1    93.8    116.2 
Profit per share(2)   0.04    0.14    0.31    0.18    0.21    0.21 
Number of shares outstanding(3)   428,106,846    428,106,846    428,106,846    428,106,846    446,063,120    544,688,023 
Dividends per share   0.063    0.23    0.36    0.38    0.35    0.285 

 

4

 

   Year ended December 31, 
   2020   2020   2019   2018   2017   2016 
   (in millions of
US$)(1)
   (in millions of S/, except share and per share data)(1) 
Balance Sheet Data:        
Current assets                              
Cash and cash equivalents   85.3    308.9    68.3    49.1    49.2    80.2 
Trade and other receivables   23.3    84.4    120.5    102.9    99.5    81.1 
Income tax prepayments   5.0    18.0    30.2    36.7    27.8    46.5 
Inventories   127.2    460.6    519.0    424.8    373.0    346.5 
Prepayments   1.6    5.7    10.3    5.8    3.9    8.0 
Total current assets   242.4    877.7    748.3    619.3    553.4    562.3 
Assets held for distribution                        338.4 
                               
Non-current assets                              
Trade and other receivables   1.4    5.2    4.7    4.5    16.2    25.1 
Prepayments           0.2    0.3    0.5    1.2 
Financial investments designated at fair value through other comprehensive income   0.2    0.7    18.2    26.9    21.2    0.7 
Other financial instruments   11.7    42.2        12.3    0.5    69.9 
Property, plant and equipment, net   556.2    2,014.5    2,100.7    2,152.7    2,208.6    2,273.1 
Intangible assets   13.7    49.6    47.4    40.9    13.4    43.0 
Goodwill   1.2    4.5    4.5    4.5         
Deferred income tax assets   4.3    15.6    7.4    3.1    0.1    6.4 
Right of use assets   1.7    6.0                 
Other assets   0.1    0.2    0.2    0.1    0.2    0.7 
Total non-current assets   590.5    2,138.5    2,183.3    2,245.3    2,260.7    2,420.1 
Total assets   832.9    3,016.2    2,931.6    2,864.6    2,814.1    3,320.8 
                               
Current liabilities                              
Trade and other payables   51.9    187.9    235.4    154.6    178.0    142.8 
Financial obligations   18.0    65.2    98.8    60.8         
Lease liabilities   0.4    1.5                 
Income tax payable   0.3    1.1            2.4    3.5 
Provisions   2.6    9.4    18.5    46.4    24.6    31.7 
Total current liabilities   73.2    265.1    352.7    261.8    205.0    178.0 
Liabilities directly related to assets held for distribution                       2.7 
                               
Non-current liabilities                              
Financial obligations   332.3    1,203.4    1,003.1    1022.6    965.3    998.1 
Other financial instruments            1.3             
Lease liabilities   1.4    5.1    0.1             
Other non-current provisions   7    25.3    7.6    5.4    28.3    22.0 
Deferred income tax liabilities   41.4    149.9    145.1    123.4    108.8    139.8 
Total non-current liabilities   382.1    1,383.7    1,157.2    1,151.4    1,102.4    1,162.6 
Total liabilities   455.3    1,648.8    1,509.9    1,413.2    1,307.4    1,340.6 
                               
Equity:                              
Capital stock   117.1    423.9    423.9    423.9    423.9    531.5 
Investment shares   11.1    40.3    40.3    40.3    40.3    50.5 
Treasury shares   (33.5)   (121.3)   (121.3)   (121.3)   (119.0)   (108.2)
Additional paid-in capital   119.5    432.8    432.8    432.8    432.8    545.2 
Legal reserve   46.6    168.6    168.6    168.4    160.7    188.1 
Other reserves   (9.2)   (33.4)   (19.8)   (12.0)   (43.7)   (16.6)
Retained earnings   126.1    456.6    497.2    519.3    611.6    677.1 
Non-controlling interest                   0.1    112.6 
Total equity   377.7    1,367.5    1,421.7    1,451.4    1,506.7    1,980.2 
Total liabilities and equity   833.0    3,016.2    2,931.6    2,864.6    2,814.1    3,320.8 

 

5

 

   Year ended December 31, 
   2020   2020   2019   2018   2017   2016 
   (in millions
of US$)(1)
   (in millions of S/, except share and per share data) 
Other Financial Information:        
Net working capital(4)   169.2    612.7    395.7    357.6    348.3    384.3 
Capital expenditures(5)   17.3    62.7    87.1    107.3    70.0    120.3 
Depreciation and amortization   38.4    139.2    129.8    129.8    124.2    111.3 
Net cash flows from operating activities   91.5    331.4    205.1    203.6    250.4    241.7 
Net cash flows from (used in) investing activities   (13.4)   (48.4)   (79.6)   (98.8)   (70.6)   (135.6)
Net cash flows from (used in) financing activities   (12.1)   (43.8)   (106.8)   (105.3)   (185.4)   (177.5)
EBITDA/Adjusted EBITDA(6)   87.1    315.3    400.3    371.6    371.5    371.0 
EBITDA/Adjusted EBITDA margin(7)   24.3%   24.3%   28.7%   29.4%   30.5%   29.9%

 

   As of and for the year ended December 31, 
   2020   2019   2018   2017   2016 
Operating Data:                    
Installed capacity (000 metric tons/year):                         
Cement:                         
Pacasmayo   2,900    2,900    2900    2,900    2,900 
Rioja   440    440    440    440    440 
Piura   1,600    1,600    1,600    1,600    1600 
Total   4,940    4,940    4,940    4,940    4,940 
Clinker:                         
Pacasmayo   1,500    1,500    1500    1,500    1,500 
Rioja   280    280    280    280    280 
Piura   1,000    1,000    1,000    1,000    1,000 
Total   2,780    2,780    2,780    2,780    2,780 
Quicklime                         
Pacasmayo   240    240    240    240    240 
Production (000 metric tons/year):                         
Cement:                         
Pacasmayo   1,306    1,368    1,155    1,141    1,177 
Rioja   261    301    273    287    281 
Piura   1,007    954    918    858    817 
Total   2,574    2,623    2,346    2,286    2,275 
Clinker:                         
Pacasmayo   712    864    831    687    887 
Rioja   198    231    211    209    215 
Piura   566    758    676    746    629 
Total   1,477    1,853    1,718    1,642    1,731 
Quicklime                         
Pacasmayo   55    74    105    168    156 

 

 
(1)Calculated based on an average exchange rate of S/3.621 to US$1.00 as of December 31, 2020.

(2)Basic earnings per share amounts are calculated by dividing profit for the year attributable to common shares and investment shares of the equity holders of the Company by the weighted average number of common shares and investment shares outstanding during the year. The weighted average number of shares in 2020, 2019, 2018 and 2017 takes into account the weighted average effect of changes in shares held in treasury. On October 15, 2015, we acquired 37,276,580 of our investment shares. In January 2017, we acquired 7,911,845 of our investment shares.

(3)In addition number of common and investment shares was reduced due to the spin-off of the net assets of Fosfatos del Pacífico S.A. to Fossal S.A.A.

(4)Represents current assets minus current liabilities.

(5)Represents expenditures for the purchase of property, plant, equipment and intangibles.

(6)Adjusted EBITDA for 2017 excludes the impairment of brine assets. For a calculation of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to the most directly comparable IFRS financial measure, see “Item 3. Key Information—A. Selected Financial Data.”

(7)EBITDA/Adjusted EBITDA margin is calculated by dividing EBITDA or Adjusted EBITDA by revenues

 

6

 

Non-IFRS Financial Measure and Reconciliation

 

We define EBITDA as profit minus finance income and plus finance costs, income tax expenses, and depreciation and amortization, and plus or minus gain from exchange difference, net. We define Adjusted EBITDA as EBITDA plus impairment on the brine project.

 

EBITDA and Adjusted EBITDA should not be construed as an alternative to profit or operating profit, as an indicator of operating performance, as an alternative to cash flow provided by operating activities or as a measure of liquidity (in each case, as determined in accordance with IFRS). EBITDA and Adjusted EBITDA, as calculated by us, may not be comparable to similarly titled measures reported by other companies, including those in the cement industry.

 

The following table sets forth the reconciliation of our profit to EBITDA and Adjusted EBITDA:

 

   Year ended December 31, 
   2020   2020   2019   2018   2017   2016 
   (in millions
of US$)(1)
   (in millions of S/) 
Profit   16.0    57.9    132.0    75.1    80.6    112.9 
Finance income   (0.8)   (3.0)   (2.6)   (2.3)   (5.8)   (3.2)
Finance costs   24.5    88.7    78.0    87.3    73.8    75.4 
(Gain) loss from exchange difference, net   2.8    9.8    (0.7)   8.4    2.2    2.4 
Income tax expense   7.7    28.0    62.3    41.0    48.9    72.2 
Liquidation of financial instruments               34.9         
Gain (loss) on the valuation of trading derivative financial instruments   (1.5)   (5.3)   1.5    (2.6)        
Depreciation and amortization   38.4    139.2    129.8    129.8    124.2    111.3 
EBITDA   87.0    315.3    400.3    371.6    323.9    366.1 
Impairment on brine project                   47.6     
Adjusted EBITDA   87.1    315.3    400.3    371.6    371.5    371.0 

 

 
(1)Calculated based on an average exchange rate of S/3.621 to US$1.00 as of December 31, 2020.

 

B.Capitalization and Indebtedness

 

Not applicable.

 

C.Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

Global Risks

 

The extent to which the coronavirus (COVID-19) outbreak and measures taken in response thereto impact our business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted.

 

Global health concerns relating to the COVID-19 coronavirus pandemic have been weighing on the macroeconomic environment, and the outbreak has already caused a global recession and continues to significantly increase economic uncertainty. The outbreak resulted in the Peruvian government, as well as many local governments, declaring a state of emergency, which meant that our plants were shutdown from March 16, 2020, until May 18, 2020. This halt in operations, adversely affected our results of operations, since fixed costs remained unchanged during the months when there was no revenue generation. Despite this loss in income, we did not reduce wages or implement mass layoff measures, since the well-being of all our employees is our main priority. Fortunately, we experienced a very strong recovery in the months following this two-month lockdown, partially offsetting the negative impact on our results of operations generated by the strict lockdown.

 

7

 

The social-distancing and lockdown measures cannot only negatively impact consumer spending and business spending habits, they may also adversely impact our workforce and operations and the operations of our customers, suppliers and business partners. These measures may remain in place for a significant period of time and they are likely to continue to adversely affect our business, results of operations, financial condition and prospects.

 

The spread of the coronavirus has caused us to modify our business practices (including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences), and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners. While these measures have been implemented to reduce the risk of the spread of the virus in our facilities, there can be no assurance that these measures will reduce or limit the impact of COVID-19 on our operations, business, financial condition or results of operations. Our operations could be stopped as a result of, among other reasons, regulatory restrictions or a significant outbreak of the virus among our staff, which could prevent employees from attending work.

 

The extent to which the coronavirus outbreak impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the coronavirus outbreak has subsided, we may continue to experience materially adverse impacts to our business as a result of its global economic impact, including the recession that has already occurred and may continue or intensify in the future.

 

There are no comparable recent events which may provide guidance as to the effect of the spread of the coronavirus and a global pandemic, and, as a result, the ultimate impact of the coronavirus outbreak or a similar health epidemic is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. However, the effects could have a material impact on our results of operations. Further, risks relating to the coronavirus may exacerbate the other risks discussed in this annual report.

 

Global macroeconomic conditions may have an adverse effect on our business, financial condition and results of operations.

 

Our operations and customers are located in Peru. As a result, our business, financial condition and results of operations, like those of most companies in Peru, could be adversely affected by the level of economic activity in the country. Therefore, variations in economic indicators such as inflation, gross domestic product (“GDP”), the balance of payments, the appreciation and depreciation of the currency, access to credit, interest rates, investment and savings, consumption, spending and fiscal income, employment, among other variables, over which we have no control, could affect the development of the Peruvian economy and, therefore, could generate adverse consequences for our business, financial condition and results of operation.

 

Peru’s economy experienced a relatively greater contraction than the economies of other countries in the region as a result of the pandemic, mainly due to the more severe virus containment measures implemented in Peru: a greater number of activities were mandated to be shut down and a strict national stay-at-home order and quarantine lasted more than 100 days. The application of these severe measures aimed at containing the expansion of COVID-19 in the country caused the Peruvian economy to face the greatest annual economic contraction of the last 100 years. With the progressive reopening of the economy and the application of monetary and fiscal stimuli, GDP has been improving from the 39.2% decrease registered in April 2020, to reach an 11.1% decrease for the full year 2020 according to the Inflation Report issued by the BCRP, as of March 2021. In addition, in 2020 the annual inflation rate was 1.5% compared to 1.9% in 2019, and domestic demand decreased 10.2% in 2020, compared to growth of 2.3% in 2019.

 

The extent to which the economy continues its recovery depends on the extent the country is able to combat the adverse impacts of the second wave of pandemic it is currently undergoing and the success of measures the government takes, as well as the availability and timing of vaccines and the ability to vaccinate a percentage of the population that can lead to herd immunity. Starting in February 2021, the Peruvian government has changed the containment measures to a more regional focus, measuring and classifying each region as moderate, high, very high and extreme risk, based on the prevalence of the virus. Lockdown measures and limitation on activities vary by region. Lima and over 20 other provinces were classified as extreme risk during February 2021, which is likely to have a negative effect on GDP growth. The areas where we operate have been classified as both very high and extreme exposure, but this has not affected our ability to produce and commercialize cement and cement related products, nor have we seen a significant effect on demand as of the date of this report.

 

8

 

The cement sector is closely related to the following main macroeconomic variables: (i) the expansion or contraction of the economy as measured by GDP, (ii) domestic demand, (iii) private investment and (iv) public spending. In this regard, prolonged conditions that adversely affect the economic growth of Peru would negatively affect the cement sector, in such a way that the economic situation and our results of operations may not coincide with those presented at the date of this annual report.

 

Risks Relating to Peru

 

Public health crises and epidemics/pandemics, such as the novel COVID-19 have adversely affected Peru’s economy and therefore our business, financial conditions and results of operations.

 

During 2020, the Peruvian government deployed various economic and public health measures to address the pandemic caused by the novel COVID-19 virus. These measures included complete and partial lockdowns throughout the year. From March 16, 2020 to May 18, 2020, all of our operations were shutdown, following the government mandated state of emergency, and our results of operations were affected by these measures. On the other hand, an economic stimulus plan was put in place that included tax incentives, among other tools, intended to address the immediate impacts of the national state of emergency invoked by the government to attempt to contain spread of the virus and lessen the strain on the health care system and the impact on the overall economy. The Ministry of Economy and Finance, the BCRP and the SBS, as well as other government entities, adopted specific measures to provide economic support to segments of the population, such as vulnerable population and small enterprises, which are most at risk in this crisis. Despite these measures, GDP contracted 11.1% in 2020, due to the prolonged lockdown and its strain in the economy.

 

The COVID-19 pandemic has had a material adverse impact on the Peruvian economy resulting in lower prices for primary goods, volatility in the financial markets, reduced international trade and lower activity in certain of the key drivers of the local economy. In addition, social distancing and stay-at-home quarantine measures imposed to minimize pressure on the healthcare system and contain social costs, adversely affected dynamism of various productive sectors of the economy. Reduced activity in these economic sectors has resulted in reduced employment and less income for families and companies. COVID-19 generated a simultaneous shock on supply and demand – a supply shock resulting from the abrupt paralysis of production in multiple sectors and on demand as a result of reduced consumption – which amplifies the negative effects on the economy.

 

Both the primary and secondary sectors of the Peruvian economy have been affected, among the most impacted being: (i) tourism, restaurants and travel agencies, (ii) transportation, warehousing and messengers and (iii) art and entertainment, in particular because of the suspension of group activities and self-isolation/social distancing mandates. As a result, the Government has implemented a plan to counteract the effects of COVID-19, targeted at minimizing the adverse impacts on the population and on economic activity. See “Recent Developments.”

 

In the face of the crisis, Peru has committed to dedicate significant resources to strengthening the public health system. Social support to the neediest families has been approved to provide a public safety net to soften the brunt of the consequences of the virus on Peru’s most vulnerable citizens. Over the long-term, we cannot assure you that the measures adopted by the Peruvian government to counteract the effects of the COVID-19 pandemic will be sufficient to restore public confidence or to restore economic growth.

 

Economic, social and political developments in Peru including political instability, rates of inflation and unemployment could have a material adverse effect on our business, financial condition and results of operations.

 

All of our operations and customers are located in Peru. Accordingly, our business, financial condition and results of operation depend on the level of economic activity in Peru. Our business, financial condition and results of operations could be affected by changes in economic and other policies of the Peruvian government (which has exercised and continues to exercise substantial influence over many aspects of the private sector), and by other economic and political developments in Peru, including devaluation or depreciation, currency exchange controls, inflation, economic downturns, political instability, corruption scandals, social unrest and terrorism.

 

9

 

In the past, Peru has experienced political instability that included a succession of regimes with disparate economic policies and programs that created uncertainty for domestic and foreign investors. During 2020, Peru again experienced a change of President, after Congress voted in favor of the vacancy of Martín Vizcarra on November 10. As there was no Vice President, Manuel Merino, President of Congress, took office, who resigned in the midst of protests 5 days later. On November 16, 2020, Francisco Sagasti was elected President of Congress and, by constitutional succession after the resignation of Manuel Merino, assumed the Presidency of the Republic and he will be in office until July 2021. On April 11, 2021, presidential and congressional elections were held, and since none of the candidates obtained over 50% of the total votes cast, a presidential runoff election is schedule for June 2021, between Keiko Fujimori, representing market-friendly ideas, running in her third runoff election, and Pedro Castillo, currently running on a left-wing platform. It is still too early to tell what the outcome may be, as both candidates will have to form alliances in order to win the election. We cannot assure you that the President elected will continue to promote free market, pro-business policies. Prior Peruvian governments have imposed controls on prices, exchange rates, local and foreign investment and international trade, restricted the ability of companies to dismiss employees, expropriated private sector assets and prohibited the remittance of profits to foreign investors. Due to the COVID-19 pandemic, the Peruvian government has changed its agenda, diverting funds to mitigate the economic impact of a prolonged state of emergency and increased spending for the public health system, among others.

 

During the 1980s and the early 1990s, Peru experienced severe terrorist activity targeted against, among others, the government and the private sector. Since then, terrorist activity in Peru has been mostly confined to small-scale operations in the Huallaga Valley and the Valleys of the Rivers Apurimac, Ene and Mantaro, or “VRAEM,” areas, both in the Eastern part of the country. The Huallaga Valley and VRAEM constitute the largest areas of coca cultivation in the country and thus serve as a hub for the illegal drug trade. Terrorist activity and the illegal drug trade continue to be key challenges for Peruvian authorities. Any violence derived from the drug trade or a resumption of large-scale terrorist activities which may occur could hurt our operations and, could disrupt the economy of Peru and our business. In addition, Peru has, from time to time, experienced social and political turmoil, including riots, nationwide protests, strikes and street demonstrations. Despite Peru’s ongoing economic growth and stabilization, the social and political tensions and high levels of poverty and unemployment continue. Future government policies to preempt or respond to social unrest could include, among other things, expropriation, nationalization, suspension of the enforcement of creditors’ rights and new taxation policies. These policies could adversely and materially affect the Peruvian economy and our business.

 

In April 2019, two former presidents were placed in preliminary detention due to their alleged ties to corruption: Pedro Pablo Kuczynski, who is currently detained, and Alan Garcia, who took his own life when police came to place him under arrest. In July, President Vizcarra proposed to accelerate elections by one year for both the presidency and Congress, a proposal that was rejected by the Congress’ Constitution Commission on September 26, 2019. Simultaneously, Congress initiated a procedure to replace the members of the Constitutional Court, which the Executive considered did not comply with transparency standards, and therefore submitted a vote of confidence to demand that this process be modified. Both issues were to be debated in Congress on September 30, 2019. However, Congress chose to first debate the appointment of the court members, and to elect one of its members, therefore, the Executive considered the vote of confidence had been denied and proceeded to dissolve the Congress and call for legislative elections on January 26, 2020. These elections took place and the new Congress was elected and took office March 16, 2020. Although recent history has shown that the macroeconomic stability of the country remains unaffected by political turmoil, we cannot yet assess the political and economic impact these developments this may have on the political stability of the country. In the recent past, we have seen a greater tendency towards populist measures, which could have an effect on political stability of the country.

 

On March 15, 2020, President Vizcarra declared a state of emergency due to the COVID-19 pandemic, starting March 16, 2020 through May 10, 2020. During the state of emergency, the production and commercialization of cement was suspended. This halt in operations adversely affected our results of operations, but fortunately, we experienced strong recovery in demand for cement in the months following this lockdown, partially offsetting the negative impact generated by over two months of strict lockdown.

 

The foregoing political uncertainty and presidential decisions could further increase interest rates and currency volatility, as well as adversely and materially affect the Peruvian economy and our business, financial condition and results of operations.

 

A depreciation or devaluation of the sol could have a material adverse effect on our business, financial condition and results of operations.

 

A significant depreciation or devaluation of the sol may affect us due to the fact that our revenues are denominated in soles while 42.6% of our indebtedness, as of December 31, 20120 is denominated in U.S. dollars. As a result, we are exposed to currency mismatch risks. As of December 31, 2020, we maintain cross currency swap hedging agreements in aggregate principal amount of 100% of our current U.S. dollar-denominated debt obligations to hedge against the associated foreign exchange risks. Nonetheless, a depreciation or devaluation of the sol against the U.S. dollar and increased exchange rate volatility would increase the cost of our debt service obligations which could have a material adverse effect on our business, financial condition and results of operations.

 

10

 

If the Peruvian government were to implement restrictive exchange rate policies and other similar laws, our business, financial condition and results of operations could be adversely affected.

 

Since 1991, the Peruvian economy has undergone a major transformation from a highly protected and regulated system to a free market economy. During this period, protectionist and interventionist laws and policies have been dismantled. As a result the Peruvian economy had been growing consistently, until 2020 due to the pandemic. Currently, foreign exchange rates are determined by market conditions, with regular open-market operations by the BCRP in the foreign exchange market to reduce volatility in the value of Peru’s currency against the U.S. dollar.

 

We cannot assure you that the Peruvian government will not institute restrictive exchange rate policies in the future. Any such restrictive exchange rate policy could have a material adverse effect on our business, financial condition and results of operations and adversely affect our ability to repay debt or other obligations and restrict our access to international financing.

 

In addition, if the Peruvian government were to institute restrictive exchange rate policies in the future, we might be obligated to seek an authorization from the Peruvian government to make payments on the notes and the guarantees. We cannot assure you that such an authorization would be obtained. Any such exchange rate restrictions or the failure to obtain such an authorization could materially and adversely affect our ability to make payments under our U.S. dollar-denominated debt and to pay dividends on our ADRs.

 

Increased rates of inflation in Peru could have an adverse effect on the Peruvian long-term credit market, as well as the Peruvian economy generally and, therefore, on our business, financial condition and results of operations.

 

In the past, Peru has suffered through periods of high and hyper-inflation, which has materially undermined the Peruvian economy and the government’s ability to create conditions that support economic growth. In response to increased inflation, the BCRP, which sets the Peruvian basic interest rate, may increase or decrease the basic interest rate in an attempt to control inflation or foster economic growth. Increases in the base interest rate could adversely affect our results of operations, increasing the cost of certain funding. Additionally, a return to a high-inflation environment would also undermine Peru’s foreign competitiveness, with negative effects on the level of economic activity and employment, while increasing our operating costs and adversely impacting our operating margins if we are unable to pass the increased costs on to our customers.

 

Changes in tax laws or their interpretation may increase our tax burden and, as a result, negatively affect our business.

 

The Peruvian Congress and government regularly implement changes to tax laws that may increase our tax burden, or the tax burden of our subsidiaries. These changes may include modifications in our taxable base, tax rates and, on occasion, the enactment of temporary taxes that in some cases have become permanent taxes or changes to VAT exemptions applicable to certain of our operations in the Amazonian region. We are unable to estimate the outcomes that these changes may have on business. In that sense, the Peruvian government recently introduced several changes related to transfer pricing rules and formal obligations in order to comply with BEPS (base erosion and profit shifting) Guidelines on transactions performed between related parties or with the intervention of low or no-tax jurisdictions, such as the obligation to file new local-files, master-files and country-by-country reports with the Peruvian tax authority, and to adjust taxable bases accordingly for income tax purposes.

 

The effects of any tax reforms that could be proposed in the future and any other changes that result from the enactment of additional reforms have not been, and cannot be, quantified. However, any changes to our tax regime or interpretations thereof (including in connection with the tax rates, tax base (base imponible), deductions rules, payments in advance regime (regimen de pagos a cuenta), time of payment or the establishment of new taxes thereof) may result in increases in our overall costs and/or our overall compliance costs, which could negatively affect our results of operation.

 

11

 

Our operations could be adversely affected by an earthquake, flood or other natural disasters.

 

Severe weather conditions and other natural disasters in areas in which we operate may materially adversely affect our operations. Peru is affected by El Niño, an oceanic and atmospheric phenomenon that causes a warming of temperatures in the Pacific Ocean, resulting in heavy rains off the coast of Peru and various other effects in other parts of the world. The effects of El Niño, which typically occurs every two to seven years, include flooding and the destruction of fish populations and agriculture, and accordingly have a negative impact on Peru’s economy. For example, in early 2017, El Niño adversely affected agricultural production, transportation and communications services, tourism and commercial activity, caused widespread damage to infrastructure and displaced significant populations. Although our facilities were not significantly affected, our ability to ship cement was compromised by the destruction of infrastructure. Peru also is located in an area that experiences seismic activity and occasionally is affected by earthquakes. For example, in 2007, an earthquake with a magnitude of 7.9 on the Richter scale struck the central coast of Peru, severely damaging the region south of Lima. Such conditions may result in physical damage to our properties, closure of one or more of our shopping centers or our tenants-stores, inadequate work forces in our markets, temporary disruptions in the supply of products to our tenants, delays in the delivery of goods to our tenants’ stores and a reduction in the availability of products in our tenants’ stores. In addition, adverse climate conditions (due to climate change or otherwise) and adverse weather patterns, such as droughts or floods that impact growing conditions and the quantity and quality of crops, may materially adversely affect the availability or cost of certain commodities or other products within our supply chain. Any of these factors may disrupt and materially adversely affect our business, financial condition and results of operations.

 

Our operations could be adversely affected by government-mandated plant closures

 

Public health outbreaks, epidemics or pandemics, as well as other events may result in the government stopping our operations. In March 2020, the Peruvian government ordered a state of emergency due to the outbreak of COVID-19, therefore our operations were closed from March 16, 2020 until May 18, 2020. This had a materially adverse effect on our business, financial conditions and results of operation, mainly during the state of emergency. Although our dispatches recovered well following the lockdown, we do not yet know if the government will take further measure that may have an impact on the economy as a whole, the construction sector, our customers’ ability to purchase cement and cement-based products, and their ability to pay for previously sold products.

 

The Peruvian economy could be adversely affected by economic developments in regional or global markets.

 

Financial and securities markets in Peru are influenced by economic and market conditions in regional and global markets. Although economic conditions vary from country to country, investors’ perceptions of the events occurring in one country may adversely affect cash flows and securities from issuers in other countries, including Peru. For example, the Peruvian economy was adversely affected by the political and economic events that occurred in several emerging economies in the 1990s, including in Mexico in 1994, which impacted the fair value of securities issued by companies from markets throughout Latin America. The crisis in the Asian markets beginning in 1997 also negatively affected markets throughout Latin America. Similar adverse consequences resulted from the economic crisis in Russia in 1998, the Brazilian devaluation in 1999 and the Argentine crisis in 2001. In addition, Peru’s economy continues to be affected by events in the economies of its major regional partners and in developed economies that are trading partners or that affect the global economy.

 

The 2008 and 2009 global economic and financial crisis substantially affected the financial system, including Peru’s securities market and economy. Additionally, the debt crisis in Europe that began with financial crises in Greece, Spain, Italy and Portugal, reduced the confidence of foreign investors, caused volatility in the securities markets and affected the ability of companies to obtain financing globally. Doubts about the pace of global growth, particularly in the United States, contributed to already weak international growth in 2011, 2012 and 2013. Brexit continues to create volatility and uncertainty in a number of financial markets. The global COVID-19 pandemic has resulted in a worldwide recession that we cannot yet accurately measure as it is ongoing. Any interruption to the recovery of developed economies, the continued effects of the global crisis in 2008 and 2009, a worsening or resurgence of the debt crisis in Europe, impacts due to Brexit, the economic impact of COVID-19, or a new economic and/or financial crisis, or a combination of the above, could affect the Peruvian economy, and consequently, materially adversely affect our business. In particular, the Peruvian economy recently has suffered the effects of fluctuating commodity prices in the international markets, a decrease in export volumes, a decrease in foreign direct investment inflows and, as a result, a decline in foreign reserves and an increase in its current account deficit. To date, the United States and China are facing a trade dispute, which has imposed new tariffs that could undermine economic growth and raise costs for manufacturers around the world. Further, the current global COVID-19 pandemic has caused a global recession, that has in turn affected our business, financial conditions and results of operation. See “—Global Risks.”

 

12

 

Additionally, adverse developments in regional or global markets or an increase in the perceived risks associated with investing in emerging markets in the future could adversely affect the Peruvian economy and, as a result, adversely affect our business, financial condition and results of operations. In March 2020, after its annual review, the FTSE announced that, since there is only one Peruvian stock in the FTSE Global All Cap index, it does not meet the requirements of the new minimum investable market cap and securities count requirement criterion. As a result, Peru was reclassified from Secondary Emerging to Frontier market status as of September 2020.

 

A global economic recovery is projected for 2021. The advance of vaccination at the global level and the contained impact of the virus, despite new variants, would promote a recovery in world growth. The BCRP, in its Inflation Report dated March 2021, has revised upwards the global GDP growth rate from 5.4% to 5.8%.

 

A decline in the prices of certain commodities in the international markets could have a material adverse effect on our financial condition and results of operations.

 

In 2020, traditional exports, in particular mineral products, fishing products, agricultural products and petroleum and its derivatives, represented 69.3% of Peru’s total exports, according to the figures published by the BCRP. Changes in commodity prices in the international markets, may have an adverse impact on Peruvian government finances, which could affect both investor confidence and the sustainability of government expenditure and social programs. Thus, a decline in commodity prices could, ultimately, affect the political environment in Peru, especially as regional and local governments are particularly reliant on tax revenue from mining concerns. By potentially affecting private sector demand and investor confidence, lower commodity prices could also affect the retail sector, leading to, for example, a decline in purchasing power and consumer spending.

 

Corruption and ongoing high-profile corruption investigations may hinder the growth of the Peruvian economy and have a negative impact on our business and operations.

 

Peruvian authorities are currently conducting several high-profile corruption investigations relating to the activities of certain companies in the construction and infrastructure sectors, which have resulted in suspension or delay of important infrastructure projects that were otherwise operational and permitted. The overall delay relating to such projects has resulted in a drop in GDP growth and overall infrastructure investment.

 

In July 2017, former President Ollanta Humala and his wife were detained in connection with a corruption probe and in February 2018, a Peruvian judge submitted a request to extradite former president Alejandro Toledo on allegations of bribery, both in connection with Brazilian construction company Odebrecht S.A. Several high-profile politicians are subject to corruption investigations. Corruption and corruption investigations could directly affect the Peruvian government, divert resources that would otherwise be focused on developing the economy, create political instability, and result in slower or negative economic growth, such as has recently happened in Brazil. In turn, this could impact our ability to successfully implement our growth and expansion strategies.

 

On March 21, 2018, President Kuczynski announced his decision to resign his office as president, due to allegations of corruption he faced. On March 23, 2018, Congress accepted his resignation and his first vice president, Martín Vizcarra, was sworn in as acting president. On April 2, 2018, President Vizcarra appointed the members of his cabinet.

 

In July 2018, a set of secretly recorded phone conversations high-court officials in Peru revealed widespread corruption in the judicial system’s top ranks. In February 2019, preventive prison was ordered of four of the involving implicated judges while the investigations continue.

 

In April 2019, two former presidents were placed in preliminary detention due to their alleged ties to corruption: Pedro Pablo Kuczynski, who is currently detained, and Alan Garcia, who took his own life when police came to place him under arrest.

 

During 2020, Peru experienced a new change of President, after Congress voted to impeach Martín Vizcarra on November 10. As there was no Vice-President, Manuel Merino, the President of Congress assumed the Presidency in the midst of protests against the legitimacy of his Government, and had to resign five days later. On November 16, 2020, Francisco Sagasti was elected President of Congress and, due to constitutional succession after Mr. Merino’s resignation, President of Peru. On April 11, 2021, presidential and congressional elections were held, and since none of the candidates obtained over 50% of the total votes cast, a presidential runoff election is schedule for June 2021. The candidates disputing this runoff are Pedro Castillo, representing the left-wing, and Keiko Fujimori, representing market-friendly ideas.

 

13

 

In the first months of 2021, former President Martin Vizcarra has been under investigation for alleged ties to corruption linked to construction companies, as well as of abusing his position to get vaccinated, along with family members and members of this staff.

 

Although recent history has shown that the macroeconomic stability of the country remains unaffected by political turmoil, we cannot yet assess the political and economic impact these developments this may have on the political stability of the country.See “—Economic, social and political developments in Peru including political instability, rates of inflation and unemployment could have a material adverse effect on our business, financial condition and results of operations.”

 

Risks Relating to our Business and Industry

 

We are subject to the possible entry of domestic or international competitors into our market, which could decrease our market share and profitability.

 

The cement market in Peru is competitive and is currently served mainly by three main groups, which together supply most of the cement consumed in the country, although there is one more small producer and some imports. In the cement industry, the location of a production plant tends to limit the market a plant can serve because transportation costs are high, reducing profit margins. Historically, we have supplied the northern region of Peru while two other groups have supplied the central (which includes the Lima metropolitan area) and southern regions of Peru, driven principally by the location of production facilities and distribution focus. However, competition could intensify if other manufacturers decide to enter our market.

 

We may face increased competition if the other Peruvian cement manufacturers, despite incremental freight costs, expand their distribution of cement to the northern region of Peru, or if they develop a cement plant in the north, particularly if the cement markets in Lima or other areas of Peru become saturated. In the past, some foreign cement manufacturers have announced plans to build cement plants in the central region of the country. If competition intensifies in the central region of Peru due to the presence of foreign cement manufacturers or otherwise, it may have price repercussions in our market.

 

We also face the possibility of competition from the entry into our market of imported clinker for grinding facilities, cement or other materials or products from foreign manufacturers, which may have significantly greater financial resources than us, particularly as production capacity continues to exceed depressed demand in other parts of the world and transportation costs decrease.

 

We may not be able to maintain our market share if we cannot match our competitors’ prices or keep pace with the development of new products. If any of these events were to occur, our business, financial condition and results of operations could be adversely affected.

 

Demand for our cement products is highly related to housing construction in northern Peru, which, in turn, is affected by economic conditions in the region.

 

Cement consumption is highly related to construction levels. Demand for our cement products depends, in large part, on residential construction in the north of Peru, which consists mostly of low-income families gradually building or improving their own homes without technical assistance, which we refer to as auto-construcción. We estimate that in 2020, auto-construcción accounted for approximately 70.6% of our cement sales, which proved to be the most resilient sector during the economic crisis generated during 2020 by the COVID-19 pandemic. Residential construction, in turn, is highly correlated to prevailing economic conditions in Peru. A decline in economic conditions would reduce household disposable income and cause a significant reduction in residential construction, leading to a decrease in demand for cement. As a result, a deterioration of economic conditions in the northern region of Peru would have a material adverse effect on our financial performance and results of operations. We cannot assure you that growth in Peru’s GDP, or the contribution to GDP growth attributable to the northern region of the country, will continue at the recent pace or at all. The current global COVID-19 pandemic had a significant impact on the Peruvian economy, but demand for cement remained strong, once we were able to resume operations. However, we cannot assure you that strong sales will remain during 2021 and beyond, as the economy continues to be affected by the crisis.

 

14

 

A reduction in private or public construction projects in the northern region of Peru would have a material adverse effect on our business, financial condition and results of operations.

 

We estimate that in 2020, approximately 13.6% of our cement sales were derived from private construction (other than auto-construcción) and 15.8% from public construction in the north of Peru. Significant interruptions or delays in, or the termination of, private or public construction projects may adversely affect our business, financial condition and results of operations. Private and public construction levels in our market depend on investments in the region which, in turn, are affected by economic conditions. During 2020, we saw a decline in private and public spending, due to the economic crisis because of the COVID-19 pandemic. Both private and public spending are expected to increase in 2021, but probably will not reach pre pandemic levels until 2022.

 

The level of public infrastructure construction also depends, to a great extent, on the priorities and financial resources of the national, regional and local governmental authorities. Although the anticipated increase in Peru’s large infrastructure projects has been delayed, this remains an important growth driver for the country and also a necessity due to Peru’s significant infrastructure deficit. In the North, significant spending will be directed towards reconstruction works to address the damage caused by Coastal El Niño, based on Peru’s “Reconstruction with Changes” Plan. This Plan has an approved budget of S/25.7 billion (US$7.6 billion). In June 2020, the Peruvian government signed an agreement with the government of the United Kingdom, for the execution of a package of S/7 billion to be executed during 2020 and 2021. Through the agreement, the United Kingdom will provide the structure, strategy and governance processes necessary for the timely delivery of all works, promoting efficiency and avoiding corruption. This model has already been used successfully for the construction of the necessary infrastructure for the Lima 2019 Pan American Games, therefore favorable results are expected this time as well. Moreover, during 2021, the Chinchero Airport in the South of Peru was awarded to the government of South Korea, and the Central Highway to the Government of France, using this same model, which shows the commitment to try to accelerate infrastructure development. We cannot assure you that the Peruvian government will continue promoting recent levels of public infrastructure spending in our market, especially considering the current need for funding to fight the COVID-19 outbreak and its subsequent effect in the economy. A reduction in public infrastructure spending in our market would adversely affect our business, financial condition and results of operations.

 

Our business, financial condition and results of operations may be adversely affected by increases in energy prices or shortages in the supply of energy.

 

Energy accounts for a significant percentage of our production costs. Our principal energy sources are coal, gas and electricity. In 2020, the cost of energy represented approximately 28.8% of our cement production costs, compared to 31.4% in 2019. We use a substantial amount of coal as a source of fuel in our production process. Most of the coal we use is anthracite coal which we purchase from domestic suppliers and import a small amount of bituminous coal from suppliers primarily in Colombia, in each case, at market prices. We do not have long-term coal supply agreements, and we do not engage in hedging transactions in connection with the price of coal. Any shortage or interruption in the supply of coal could also disrupt our operations. In addition, the price of coal is largely driven by the price of oil, and, as a result, increases in international oil prices are likely to affect the price of coal and adversely affect our results of operations

 

We have a long-term electricity supply agreement with Electroperú S.A. (“Electroperú”), a government-owned company, to serve the electricity requirements of our Pacasmayo and Piura facilities until 2026. We have also entered into a supply agreement with Electro Oriente S.A. (“ELOR”) to supply the Rioja facility until November 2022. Our business, financial condition and results of operations could be materially and adversely affected by higher costs, interruptions, and unavailability or shortage of electricity. We have no back-up power system at our plants and cannot assure you that, in case of interruption or failure in Electroperú’s or ELOR’s operations, we will have access to other energy sources at the same prices and conditions, which could adversely affect our business, financial condition and results of operations. Moreover, electricity to our plants is transmitted through the Peruvian Electricity Interconnection System (Sistema Eléctrico Interconectado Nacional del Perú, or “SEIN”). Any interruptions or failures in SEIN’s system would also have a material adverse effect on our business, financial condition and results of operations.

 

In the recent past, we have experienced electricity rationing, limiting our use of electricity to certain times of the day. In such cases, we were forced to readjust our production schedules in order to ensure that our production process was not interrupted. In the event of any future rationing of electricity, we may not be able to readjust quickly enough and our production process may be interrupted. Future shortages or efforts to respond to or prevent shortages, such as rationing, may adversely impact the cost or supply of electricity for our operations.

 

15

 

A significant increase in the prices of coal, gas or electricity would increase our costs of production. We may not be able to increase the prices of our cement products in the future if the prices of coal, gas or electricity rises, which would adversely affect our business, financial condition and results of operations

 

Changes in the cost or availability of admixtures and raw materials supplied by third parties may adversely affect our business, financial condition and results of operations.

 

We use certain admixtures and raw materials in the production of cement, such as gypsum, blast furnace slag and iron that we obtain from third parties. In 2020, our cost of admixtures and raw materials supplied by third parties as a percentage of our cement production costs was approximately 4.3% compared to 4.9% in 2019. We do not have long-term contracts for the supply of admixtures or raw materials that we use and if existing suppliers cease operations or reduce or eliminate production of these products, our costs to procure these materials may increase significantly or we may be obligated to procure alternatives to replace these products.

 

We may undertake future acquisitions that may not achieve expected benefits.

 

Our strategic initiatives include pursuing acquisitions that tend to diversify our existing portfolio of products and services and expand our geographic footprint. In the future, we may decide to expand by acquiring other companies in Peru or abroad. Any future acquisitions will depend on our ability to identify suitable candidates, negotiate acceptable terms, and obtain financing for the acquisitions. If future acquisitions are significant, they could change the scale of our business and expose us to new geographic, political, operating and financial risks. In addition, each acquisition involves a number of risks, such as the diversion of our management’s attention from our existing business to integrating the operations and personnel of the acquired business, possible adverse effects on our results of operations during the integration process, our inability to achieve the intended objectives of the combination and potential unknown liabilities associated with the acquired assets.

 

We may not be able to obtain the funding required to implement future strategies.

 

Our strategies to continue to expand our cement production capacity and distribution network require significant capital expenditures. We cannot assure you that we will generate sufficient cash flow from operations, or that we will have access to external financing sources, to adequately fund such capital expenditures. Our access to external sources of financing will depend on many factors, including factors beyond our control, such as conditions in the global capital markets and investors’ risk perception of investing in Peru and in emerging markets generally. Any equity or debt financing, if available, may not be on terms that are favorable to us. If our access to external financing is limited, we may not be able to execute our strategy, which could adversely affect our business, financial condition and results of operations.

 

In addition, the indenture pursuant to which we issued our 4.50% Senior Notes due 2023, as well as the local bonds due 2029 and 2034 contain covenants that limit our ability and that of our restricted subsidiaries to incur additional indebtedness if we do not meet certain financial ratios. If we are unable to incur additional debt to fund our future strategies, our business could be adversely affected.

 

We are subject to risks related to litigation and administrative proceedings that could adversely affect our business and financial performance in the event of an unfavorable ruling.

 

The nature of our business exposes us to litigation relating to product liability claims, labor, health and safety matters, environmental matters, regulatory, tax and administrative proceedings, governmental investigations, tort claims and contract disputes, among other matters. In the past, we have been subject to antitrust and tax proceedings or investigations. While we contest these matters vigorously and make insurance claims when appropriate, litigation is inherently costly and unpredictable, making it difficult to accurately estimate the outcome of actual or potential litigation. Although we establish provisions as we deem necessary, the amounts that we reserve could vary significantly from any amounts we actually pay due to the inherent uncertainties in the estimation process. We cannot assure you that these or other legal proceedings will not materially affect our ability to conduct our business, financial condition and results of operations in the event of an unfavorable ruling.

 

Our business is subject to a number of operational risks, which may adversely affect our business, financial condition and results of operations.

 

Our business is subject to several industry-specific operational risks, including accidents, natural disasters, labor disputes and equipment failures. Such occurrences could result in damage to our production facilities and equipment, and/or the injury or death of our employees and others involved in our production process. Moreover, such accidents or failures could lead to environmental damage, loss of resources or intermediate goods, delays or the interruption of production activities and monetary losses, as well as damage to our reputation. Our insurance may not be sufficient to cover losses from these events, which could adversely affect our business, financial condition and results of operations.

 

16

 

In addition, key equipment at our facilities, such as our mills and kilns, may deteriorate sooner than we currently estimate. Such deterioration of our assets may result in additional maintenance or capital expenditures, and could cause delays or the interruption of our production activities. If these assets do not generate the cash flows we expect, and we are not able to procure replacement assets in an economically feasible manner, our business, financial condition and results of operations may be materially and adversely affected.

 

Our business depends on the continued operation of our Pacasmayo and Piura facilities.

 

Our production facilities in Pacasmayo and Piura are essential to our business. In 2020, approximately 90.0% of our total cement and all of our quicklime was produced at the Pacasmayo and Piura facilities. These plants are subject to normal hazards of operating any cement production facility, including accidents, natural disasters and unexpected malfunctioning of the equipment. Any interruption in our operation of the Pacasmayo or Piura facilities or a decrease in the effective capacity of these facilities would adversely affect our results of operations. On March 15, 2020, President Vizcarra declared a State of Emergency in Peru due to COVID-19, starting March 16, 2020, that continues until the date of this report. During the first stage of the state of emergency, the production and commercialization of cement was shut down from March 16 until May 18, 2020, when we obtained permission to restart our operations. This halt in production and commercialization for over two months had an adverse effect on our business, financial condition and results of operations, which we were able to partially offset during the second half of the year due to strong demand. However, we cannot assure you that demand will continue to be strong during 2021, or that there will not be further shutdowns or closures of significant parts of the economy as the pandemic continues to unravel.

 

The introduction of cement substitutes into the market and the development of new construction techniques could have a material adverse effect on our business, financial condition and results of operations.

 

Materials such as plastic, aluminum, ceramics, glass, wood and steel can be used in construction as a substitute for cement. In addition, other construction techniques, such as the use of drywall, could decrease the demand for cement and concrete. In Peru, drywall has only been introduced into the housing construction market in recent years and it is not widely used. However, the use of drywall for housing construction could increase significantly in the future as it becomes more popular. In addition, research aimed at developing new construction techniques and modern materials may introduce new products in the future. The use of substitutes for cement could cause a significant reduction in the demand and prices for our cement products.

 

Our success depends on key members of our management.

 

Our success depends largely on the efforts and strategic vision of our executive management team and board of directors. The loss of the services of some or all of our executive management team or members of our board of directors could have a material adverse effect on our business, financial condition and results of operations.

 

The execution of our business plan also depends on our ongoing ability to attract and retain additional qualified employees capable of operating our plants. Due to the limited pool of skilled workers in the north of Peru or workers from other regions willing to relocate to the north of Peru, we may not be successful in attracting and retaining the personnel we require. If we are unable to hire, train and retain qualified employees at a reasonable cost, we may be unable to successfully operate our business or reach full planned production levels in a timely manner and, as a result, our business, financial condition and results of operations could be adversely affected.

 

Our operations and sales are highly concentrated in the northern region of Peru.

 

All of our operations are located in the northern region of Peru, including our production facilities and the quarries from where we obtain limestone to produce cement. In addition, substantially all of our cement products are sold to consumers in this market. As a result, any adverse economic, political or social conditions affecting the northern region of Peru, as well as natural disasters and weather conditions, such as the El Niño climate pattern, among other factors that may affect this region, could have a material adverse effect on our business, financial condition and results of operations. In 2017, the north of Peru experienced severe rain, landslides and flooding, which affected the demand for cement, and the ability to ship it, as well as the provision of raw materials since some roads were destroyed. Our plants did not suffer any significant damage as we halted operations to mitigate physical damage.

 

17

 

We are subject to environmental regulations and may be exposed to liability and political cost as a result of our handling of hazardous materials and potential costs for environmental compliance.

 

We are subject to various environmental protection and health and safety laws and regulations that regulate, among other things, the generation, storage, handling, use and transportation of hazardous materials; emissions and discharge of hazardous materials; and the health and safety of our employees. Pursuant to Peruvian law, in order to conduct mining and industrial activities, we are required, among other things, to (i) submit an environmental impact assessment to the Ministry of Production (Ministerio de la Producción) and a mining closure plan to the Ministry of Energy and Mines (Ministerio de Energía y Minas, or “MINEM”) prior to initiating mining activities, (ii) comply with certain air emission and wastewater discharge standards, (iii) obtain approval from the water management authority to discharge wastewater into natural water sources or soil, (iv) dispose solid waste generated by us in special landfills exclusively through companies registered with the environmental agency, and (v) store fuel in compliance with environmental and safety standards. In addition, we are required to have a health and safety committee and develop an internal health and safety code. Although we believe we are in compliance with all these regulations in all material respects, we cannot assure you that we have been or will be at all times in full compliance with these laws and regulations. Any violation of such laws or regulations could result in substantial fines, criminal sanctions, revocations of operating permits and shutdowns of our facilities. In addition, current or future governments may also impose stricter regulations which may require us to incur higher compliance costs.

 

Pursuant to certain applicable environmental laws, we could be held liable for all or substantially all of the damages caused by pollution at our current or former facilities or those of our predecessors or at disposal sites. We could also be held liable for all incidental damages due to the health effects of exposure of individuals to hazardous substances or other environmental damage.

 

We cannot assure you that our costs of complying with current and future environmental and health and safety laws and regulations, and any liabilities arising from past or future releases of, or exposure to, hazardous substances will not adversely affect our business, financial condition and results of operations.

 

Social unrest by local communities may have an adverse effect on our business and results of operation

 

In recent years, Peru has experienced protests against mining projects in several regions around the country. Mining is an important part of the Peruvian economy, with mining and oil and gas as of December 31, 2019, accounted for approximately 16.62% of the country’s GDP according to the BCRP. On several occasions, local communities have opposed these operations and accused them of polluting the environment and hurting agricultural and other traditional economic activities. In late 2011 and throughout 2012, social and political tension peaked around Conga, a gold project in the northern region of Cajamarca. The launch of Conga, which involved investments of approximately US$4.5 billion, failed as a result of the protests. We conduct some extraction activities in our quarries and operate in areas close to local communities. Although we have always had very good relationship with our communities, we cannot assure this will continue to be the case in the future. During 2020 and the first months of 2021, there have been social demands by different groups such as agriculture, transportation, mining, which have temporarily caused instability. Further social demands and conflicts may have an effect on the Peruvian economy, and on our business and results of operation.

 

International agreements related to climate change may result in an increase in our costs.

 

There are ongoing international efforts to address greenhouse emissions. The United Nations and certain international organizations have taken action against activities that may increase the atmospheric concentration of greenhouse gases. Regulatory measures, such as the Kyoto Protocol, aimed at addressing greenhouse gas emissions and climate changes, are in various stages of negotiation and implementation. Such measures may result in increased costs to us for installation of new controls aimed at reducing greenhouse gas emissions, purchase of credits or licenses for atmospheric emissions, and monitoring and registration of greenhouse gas emissions from our operations. These measures, if adopted in Peru, could adversely affect our business, financial condition and results of operations.

 

18

 

Changes in regulations or in the interpretation of regulations may adversely affect our business, financial condition and results of operations.

 

Our business is subject to extensive regulation in Peru, including, among others, relating to tax, environmental, labor, health and safety, and mining matters. We believe that our facilities are currently operating in all material respects in accordance with all applicable concessions, laws and regulations. Future regulatory changes, changes in the interpretation of such regulations or stricter enforcement of such regulations, including changes to our concession agreements, may increase our compliance costs and could potentially require us to alter our operations. We cannot assure you that regulatory changes in the future will not adversely affect our business, financial condition and results of operations.

 

Any dispute with the labor unions that represent our employees could have an adverse effect on our business, financial condition and results of operations.

 

As of December 31, 2020, 16.3% approximately of our employees were members of employee unions. Although we consider our relations with our employees are currently positive, we cannot assure you that we will not experience work slowdowns, work stoppages, strikes or other labor disputes in the future, which could adversely affect our business, financial condition and results of operations.

 

New projects may require the prior approval of local indigenous communities.

 

On September 7, 2011, Peru enacted Law No. 29785, regarding the Prior Consultation Right of Local Indigenous Communities, in accordance with the International Labor Organization Convention No. 169 (Ley del Derecho a la Consulta Previa a los Pueblos Indígenas y Originarios, Reconocido en el Convenio 169 de la Organización Internacional del Trabajo). This law, which became effective on December 6, 2011, establishes a prior consultation procedure (procedimiento de consulta previa) that the Peruvian government must carry out with local indigenous communities, whose rights may be directly affected by new legislative or administrative measures, including the granting of new mining concessions. Local indigenous communities do not have a veto right; upon completion of this prior consultation procedure, the Peruvian government retains the discretion to approve or reject the applicable legislative or administrative measure. However, to the extent that in the future our new projects may require implementation of legislative or administrative measures that impact local indigenous communities, we may not be able to undertake such projects, unless the Peruvian government first conducts the foregoing consultation procedure. We cannot assure you that this law will not adversely affect our new projects and have an adverse effect on our business, financial condition and results of operations.

 

The indenture pursuant to which we issued our 4.50% Senior Notes due 2023 and our two local bond issuances due 2029 and 2034 contain financial covenants, and any default under the indenture may have a material adverse effect on our financial condition and cash flows.

 

The indenture pursuant to which we issued our 4.50% Senior Notes due 2023 contains restrictions and covenants, including restrictions on our and our guarantor subsidiaries’ ability to incur further indebtedness or issue disqualified stock and preferred stock, unless certain conditions are met.

 

Additionally, in January 2019, two issuances were completed under a local bond program in a total principal amount of S/570 million: One for S/260 million with a rate of 6.68750% with a maturity of 10 years, and another for S/310 million with a term of 15 years and a rate of 6.84375%. These issuances contain the same restrictions and covenants as our Senior Notes due 2023. Failure to meet or satisfy any of these covenants could result in an event of default under the indenture.

 

Risks Relating to our Common Shares and ADSs

 

The market price of our ADSs may fluctuate significantly, and you could lose all or part of your investment.

 

Volatility in the market price of our ADSs may prevent you from being able to sell your ADSs at or above the price you paid for them. The market price and liquidity of the market for our ADSs may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include, among others:

 

actual or anticipated changes in our results of operations, or failure to meet expectations of financial market analysts and investors;

 

19

 

investor perceptions of our prospects or our industry;

 

operating performance of companies comparable to us and increased competition in our industry;

 

new laws or regulations or new interpretations of laws and regulations applicable to our business;

 

general economic trends in Peru;

 

catastrophic events, such as earthquakes and other natural disasters; and

 

developments and perceptions of risks in Peru and in other countries.

 

Our controlling shareholder has significant influence over us and his interests could conflict with the interests of other shareholders.

 

As of March 31, 2021, our controlling shareholder beneficially owned 50.01% of our outstanding common shares. As a result, our controlling shareholder has the ability to determine the outcome of substantially all matters submitted for a vote to our shareholders and thus exercise control over our business policies and affairs, including, among others, the following:

 

the composition of our board of directors and, consequently, any determinations of our board with respect to our business direction and policy, including the appointment and removal of our executive officers;

 

determinations with respect to mergers, other business combinations and other transactions, including those that may result in a change of control;

 

whether dividends are paid or other distributions are made and the amount of any such dividends or distributions;

 

whether we offer preemptive and accretion rights to holders of our common shares in the event of a capital increase;

 

sales and dispositions of our assets; and

 

the amount of debt financing we incur.

 

Our controlling shareholder may direct us to take actions that could be contrary to the interests of our other shareholders and may be able to prevent other shareholders from blocking these actions or from causing different actions to be taken. Also, our controlling shareholder may prevent change of control transactions that might otherwise provide the shareholders with an opportunity to dispose of or realize a premium on their investment in our common shares and ADSs. We cannot assure you that our controlling shareholder will act in a manner consistent with our other shareholders’ best interests.

 

Holders of ADSs may be unable to exercise voting rights with respect to our common shares underlying the ADSs at our shareholders’ meetings.

 

Holders of ADSs may exercise voting rights with respect to the common shares represented by the ADSs only in accordance with the deposit agreement relating to the ADSs. Holders of our common shares will receive notice of shareholders’ meetings through publication of a notice 25 days in advance, pursuant to Peruvian law, in the official gazette in Peru, a Peruvian newspaper of general circulation, the bulletin of the Lima Stock Exchange and the website of the Superintendencia del Mercado de Valores (the “Peruvian Securities Commission”), and will be able to exercise their voting rights by either attending the meeting in person or voting by proxy. ADS holders will not receive notice directly from us. Instead, pursuant to the deposit agreement, we will notify the depositary, which will mail to holders of ADSs the notice of the meeting and a statement as to the manner in which voting instructions may be given. To exercise their voting rights, ADS holders must instruct the depositary how to exercise the voting rights for the common shares which underlie their ADSs. Due to these additional procedural steps involving the depositary, the process for exercising voting rights may take longer for ADS holders than for holders of our common shares.

 

20

 

Holders of ADSs also may not receive voting materials in time to instruct the depositary to vote the common shares underlying their ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions of the holders of ADS or for the manner of carrying out such instructions, unless such failure can be attribute to gross negligence, bad faith or willful misconduct on the part of the depositary or its agents. Accordingly, holders of ADSs may not be able to exercise voting rights, and they will have little, if any, recourse if the underlying common shares are not voted as requested.

 

The ability of holders of our ADSs to receive payments of cash dividends may be limited.

 

Our shareholders’ ability to receive cash dividends may be limited by the ability of the depositary to convert cash dividends paid in soles into U.S. dollars. Under the terms of our deposit agreement with the depositary for the ADSs, the depositary will convert any cash dividend or other cash distribution we pay on the common shares underlying the ADSs into U.S. dollars, if it can do so on a reasonable basis and can transfer the U.S. dollars to the United States. If this conversion is not possible or if any government approval is needed and cannot be obtained, the deposit agreement allows the depositary to distribute the foreign currency only to those ADS holders to whom it is possible to do so. If the exchange rate fluctuates significantly during a time when the depositary cannot convert the foreign currency, holders of ADSs may lose some or all of the value of the dividend distribution.

 

Holders of ADSs may be unable to exercise pre-emptive or accretion rights with respect to the common shares underlying their ADSs.

 

Under Peruvian corporate law, if we issue new common shares as part of a capital increase, unless otherwise agreed to by holders of 40% of our outstanding common shares, our shareholders will generally have the right to subscribe to a proportional number of common shares of the class held by them to maintain their existing ownership percentage, which is known as preemptive rights. In addition, shareholders are entitled to the right to subscribe for the unsubscribed common shares of either the class held by them or other classes which remain unsubscribed at the end of a preemptive rights offering, on a pro rata basis, which is known as accretion rights. Holders of ADSs may not be able to exercise the preemptive or accretion rights relating to common shares underlying the ADSs unless a registration statement under the U.S. Securities Act of 1933, as amended (the “Securities Act”), is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement with respect to the common shares relating to these preemptive and accretion rights and we cannot assure you that we will file any such registration statement. Unless we file a registration statement or an exemption from registration is available, holders of ADSs may receive only the net proceeds from the sale of their preemptive and accretion rights by the depositary or, if the preemptive and accretion rights cannot be sold, they will be allowed to lapse. As a result, U.S. holders of our ADSs may suffer dilution of their interest in our company upon future capital increases.

 

We are entitled to amend the deposit agreement under which our ADSs were issued, and to change the rights of ADS holders under the terms of such agreement, without the prior consent of the ADS holders.

 

We are entitled to amend the deposit agreement and to change the rights of the ADS holders under the terms of such agreement, without the prior consent of the ADS holders. Any change related to an increase in deposits or charges for book-entry securities services or any modification that might hinder the rights of the ADS holders will be effective within 30 days after the ADS holders have received notice of such change or modification and such holders will have no right to any compensation whatsoever.

 

Our status as a foreign private issuer allows us to follow alternate standards to the corporate governance standards of the New York Stock Exchange, which may limit the protections afforded to investors.

 

We are a “foreign private issuer” within the meaning of the New York Stock Exchange corporate governance standards. Under New York Stock Exchange rules, a foreign private issuer may elect to comply with the practices of its home country and not to comply with certain corporate governance requirements applicable to U.S. companies with securities listed on the exchange. We currently follow certain Peruvian practices concerning corporate governance and intend to continue to do so. Accordingly, holders of our ADSs will not have the same protections afforded to shareholders of companies that are subject to all New York Stock Exchange corporate governance requirements.

 

For example, the New York Stock Exchange listing standards provide that the board of directors of a U.S. listed company must have a majority of independent directors at the time the company ceases to be a “controlled company.” Under Peruvian corporate governance practices, a Peruvian company is not required to have a majority of independent members on its board of directors.

 

21

 

The listing standards for the New York Stock Exchange also require that U.S. listed companies; at the time they cease to be “controlled companies,” have a nominating/corporate governance committee and a compensation committee (in addition to an audit committee). Each of these committees must consist solely of independent directors and must have a written charter that addresses certain matters specified in the listing standards. Under Peruvian law, a Peruvian company may, but is not required to, form special governance committees, which may be composed partially or entirely of non-independent directors.

 

In addition, New York Stock Exchange rules require the independent non-executive directors of U.S. listed companies to meet on a regular basis without management being present. There is no similar requirement under Peruvian law.

 

The New York Stock Exchange’s listing standards also require U.S. listed companies to adopt and disclose corporate governance guidelines. In November 2013, the Peruvian Securities Commission and a committee comprised of regulatory agencies and associations prepared and published a list of suggested non-mandatory corporate governance guidelines called the “Good Corporate Governance Code for Peruvian Companies.” Although we have implemented a number of these measures, we are not required to comply with the corporate governance guidelines by law or regulation, only to disclose whether or not we are in compliance.

 

Minority shareholders in Peru are not afforded equivalent protections as minority shareholders in other jurisdictions and investors may face difficulties in commencing judicial and arbitration proceedings against our company or the controlling shareholder.

 

Our company is organized and existing under the laws of Peru, and our controlling shareholder is resident in Peru. Accordingly, investors may face difficulties in serving process on our company, our officers and directors or the controlling shareholder in other jurisdictions, and in enforcing decisions granted by courts located in other jurisdictions against our company, our officers and directors or the controlling shareholder that are based on securities laws of jurisdictions other than Peru.

 

In Peru, there are no proceedings to file class action suits or shareholder derivative actions with respect to issues arising between minority shareholders and an issuer, its controlling shareholders or directors and officers. Furthermore, the procedural requirements to file actions by shareholders differ from those of other jurisdictions, such as in the United States. As a result, it may be more difficult for our minority shareholders to enforce their rights against us, our directors, officers or controlling shareholder as compared to the shareholders of a U.S. company. The deposit agreement provides that the depositary has no obligation to commence or become involved in any judicial proceedings and any other legal actions relating to the ADSs or the deposit agreement, either on behalf of the ADS holders or on behalf of any other person.

 

The ability of investors to enforce civil liabilities under U.S. securities laws may be limited.

 

Most of our directors or executive officers are not residents of the United States. All or a substantial portion of our assets and those of our directors and executive officers are located outside of the United States. As a result, it may not be possible for investors in our securities to affect service of process within the United States upon such persons or to enforce in U.S. courts or outside of the United States judgments obtained against such persons outside of the United States.

 

We are a company organized and existing under the laws of Peru, and there is no existing treaty between the United States and Peru for the reciprocal enforcement of foreign judgments. It is not clear whether a Peruvian court would accept jurisdiction and impose civil liability if proceedings were commenced in a foreign jurisdiction predicated solely upon U.S. federal securities laws.

 

ITEM 4.INFORMATION ON THE COMPANY

 

A.History and Development of the Company

 

Our History

 

Cementos Pacasmayo S.A.A. began its operations in 1957 and is a publicly-held corporation (sociedad anónima abierta) organized under the laws of Peru. Our executive offices are located at Calle La Colonia 150, Urbanización El Vivero, Surco, Lima, Peru. Our telephone number at this location is + (511) 317-6000. Our website address is www.cementospacasmayo.com.pe. Information on or accessible through our website is not a part of, nor incorporated by reference in, this annual report.

 

22

 

Cementos Pacasmayo S.A.A. and Hochschild Mining plc together constitute the two businesses of the Hochschild Group, which has operated in Latin America for more than 100 years. Hochschild Mining plc is incorporated in the United Kingdom and its shares have been listed on the London Stock Exchange since 2006. Cementos Pacasmayo S.A.A. has been listed on the Lima Stock Exchange since 1995. As of March 31, 2021, Eduardo Hochschild, directly and indirectly, owned and controlled 38.32% of the shares of Hochschild Mining plc. Through Inversiones ASPI S.A. (“ASPI”), as of that same date Eduardo Hochschild, directly and indirectly, owns and controls 50.01% of the outstanding common shares of Cementos Pacasmayo S.A.A.

 

The Hochschild Group traces its origins to 1911, when Mauricio Hochschild, a German mining engineer, founded a group of companies in South America that came to be known as the Hochschild Group. Following World War I, the Hochschild Group expanded into Bolivia where it developed significant interests in tin. The Hochschild Group commenced operations in Peru in 1925 and in 1945 Luis Hochschild, the nephew of Mauricio Hochschild (and the father of Eduardo Hochschild), joined the Hochschild Group’s Peruvian operations.

 

During the first decades of its operations, the Hochschild Group focused on the commercialization of minerals, although it later began operating its own mines and other industrial companies. During World War II, the Hochschild Group was a key supplier of tin and other metals to the allied forces.

 

Cementos Pacasmayo, was incorporated in Lima, Peru in 1949, by a group of private investors that founded the company to serve the cement market in the northern region of Peru. The Hochschild Group acquired its initial ownership interest in us in 1956. Set forth below are key developments in our company’s history.

 

  In 1957, we began our operations with the installation of our first clinker line with an installed production capacity of approximately 110,000 metric tons per year.  In 1966 and 1977, we added a second and third clinker line, respectively, increasing our installed clinker production capacity to approximately 830,000 metric tons per year.
     
  In November 1984, the South American mining and industrial operations of the Hochschild Group were sold to the Anglo American Corporation of South Africa which, in the same month, sold the Peruvian operations of the Hochschild Group, including its interest in Cementos Pacasmayo and predecessors of Hochschild Mining plc, to a group of companies controlled by Luis Hochschild.
     
  In 1995, we launched our distribution network to commercialize and distribute our products throughout the northern region of Peru.  In that same year, we also listed our common shares for trading on the Lima Stock Exchange, currently under the ticker symbol “CPACASC1.”
     
  In 1998, we acquired from the Peruvian government our Rioja facility, located in the northeast of Peru.  At the time, the Rioja facility had one clinker line with an installed cement production capacity of approximately 35,000 metric tons per year.
     
  In 2003, we acquired Zemex Corporation, a U.S. company engaged in non-metallic mining and industrial activities in the United States and Canada, which we sold in 2007 in a series of transactions.
     
  In 2009, we created Fosfatos del Pacífico in order to explore phosphate rock deposits from our concession at Bayóvar in the north of Peru.

 

23

 

  In 2010, we reached an aggregate total installed cement production capacity of 3.1 million in our Pacasmayo and Rioja facilities and completed the conversion of our Waelz kiln, retrofitting it to produce quicklime or calcine zinc interchangeably.  That same year, we also sold our copper mining concessions in the central region of Peru known as “Mina Raul,” which were previously leased to a third party, for US$28.0 million.
     
  In December 2011, we sold a minority equity interest in Fosfatos to an affiliate of Mitsubishi to develop our phosphate deposits in the Bayóvar fields, in the northwest of Peru.
     
  In March 2012, we completed our initial equity offering of 22,296,800 ADSs in the United States and listed our ADSs on the New York Stock Exchange.
     
  In February 2013, we issued US$300 million of our, in our inaugural international bond offering.  A portion of the proceeds from this offering were used to prepay amounts outstanding on our secured loan agreement with BBVA Banco Continental, and the remaining proceeds were used to fund a portion of the capital expenditures related to the construction and operation of our new Piura plant and our cement business.
     
  In September 2015, we began producing cement at our new plant in Piura.  This was a very important milestone for us, since we have been investing in this project since 2012 and we have begun to reap the benefits of this investment.
     
  In January 2016, we began producing clinker at our new plant in Piura, finishing the start-up of the plant, adding one million metric tons of annual clinker production capacity.
     
  In March 2017, Cementos Pacasmayo consummated the spin-off of Fostatos del Pacífico.
     
  In December 2017, our board of directors resolved to focus our strategy on our core business of developing cement and building solutions.  In furtherance of this strategy, we have focused on disposing our non-core investments.  In the fourth quarter of 2017, we discontinued our brine project.
     
  In March 2018, Cementos Pacasmayo launched its new brand image and updated its vision:  to further enhance our position as a leader in developing building solutions and innovations that anticipate the needs of our clients and that contributes to the progress of our country.
     
  During 2018, Cementos Pacasmayo implemented the ISO 37001 anti-bribery management systems, obtaining certification in January 2019.  This certification confirms that our management systems are designed to help prevent, detect and respond to bribery and comply with anti-bribery laws and voluntary commitments applicable to its activities.  This certification and related initiatives reiterates our commitment to global anti-bribery best practices and high standards of transparency and good corporate governance.
     
  In November 2018, Cementos Pacasmayo launched an offer to purchase for cash a portion of the US$300 million principal amount international bond outstanding.  The offer expired on December 7, 2018 with a total of US$168,388,000, or approximately 56.13% of the total outstanding amount, tendered and repurchased by Cementos Pacasmayo.
     
  On January 8, 2019, the General Shareholders’ Meeting approved the issuance of a local bond program in an aggregate principal amount up to S/1,000 million.  On January 31, 2019, two issuances were completed under the program for a total principal amount of S/570 million:  One for S/260 million accruing interest at a rate of 6.68750% per annum with term to maturity of 10 years, and another for S/310 million accruing interest at a rate of 6.84375% per annum with a term to maturity of 15 years.  The proceeds were used to purchase part of our outstanding 4.50% Senior Notes due 2023.  The rates and terms obtained reduce our financial cost structure, with lower cost of capital, an extended maturity and less exposure to exchange rate fluctuations.
     
  In 2020, we were included on the Dow Jones MILA Sustainability Index for the second consecutive year.  This Index is made up of those companies that demonstrate superior performance among their peers based on social, environmental and economic criteria.
     
  In February 2021, we were chosen to be part of The Sustainability Yearbook 2021.  To appear in the Yearbook, companies must score within the top 15% of their industry globally and have a gap of less than 30% from the leader’s Global ESG score.  Moreover, we were awarded with the Industry Mover distinction, since we showed the strongest year on year score improvement in our industry.

 

24

 

Capital Expenditures

 

We expect to spend over the next three years approximately US$25 million per year on recurring capital expenditures necessary to maintain our plants and equipment. We expect to finance these investments with our current and future cash flows.

 

The table below sets forth our total capital expenditures incurred in 2020, 2019 and 2018.

 

   Year ended December 31, 
(in millions of S/)  2020   2019   2018 
                
Concrete and aggregates equipment   24.9    44.6    50.7 
Piura plant projects   17.0    12.3    28.0 
Pacasmayo plant projects   16.9    25.0    26.2 
Rioja plant projects   3.4    5.2    2.4 
Other investing activities   0.5         
Total   62.7    87.1    107.3 

 

B. Business Overview

 

Overview

 

We are a leading Peruvian cement company, and the only cement manufacturer in the northern region of Peru. With more than 63 years of operating history, we produce, distribute and sell cement and cement-related materials, such as precast products and ready-mix concrete. Our products are primarily used in construction, which has been one of the fastest growing segments of the Peruvian economy in recent years. We also produce and sell quicklime for use in mining operations, although it represents a very small percentage of our overall revenues.

 

In 2020, our cement shipments were approximately 2.6 million metric tons, representing an estimated 25.6% share of Peru’s total cement shipments. Cement volumes in 2020 decreased by 1.2% compared to 2019, despite the halt in our operations for more than two months. The moderation in the decline in volumes was mainly due to the strong recovery of the self-construction segment, reaching record sales volume levels during the second half of the year. We believe the construction sector has significant potential to grow with the continued deficit in infrastructure and the persistent housing deficit in the country, as well as the reconstruction of northern Peru following the impact of El Niño weather conditions in the first four months of 2017.

 

We own three cement production facilities, our flagship Pacasmayo facility located in the northwest region of Peru, our new plant in Piura and our smaller Rioja facility located in the northeast. Our facilities have total installed annual cement production capacity of approximately 4.9 million metric tons. We also have installed annual production capacity of 240,000 metric tons of quicklime. We own concession rights to several quarries with reserves of limestone and other raw materials located near our facilities. We estimate that our existing quarries have sufficient reserves to supply our limestone and seashells needs for approximately 73 years, based on our estimated annual extraction of limestone and seashell.

 

We completed an expansion of our Rioja plant in April 2013. We more than doubled the cement production capacity of our Rioja facility by installing a new production line with 240,000 metric tons of installed annual cement production capacity. We finished construction of our plant in Piura in 2015. This facility has annual production capacity of 1.6 million metric tons of cement. In September 2015, we began cement production, and clinker production began in January 2016.

 

We provide consumers with high-quality and value-added cement products and, as a result, we believe we have developed strong brand recognition and customer loyalty in our market. We have developed one of the largest independent retail distribution networks for construction materials in Peru. Through our network of 269 independent retailers and 405 hardware stores as of March 31, 2021, we distribute our cement products as well as other construction materials manufactured by third parties, such as steel rebar, cables and pipes, in the northern region of Peru. We also sell our cement products directly to other retailers that are not part of our distribution network and to private construction companies and government entities.

 

25

 

The following table sets forth certain macroeconomic data for Peru and operating and financial data for our company for the periods indicated.

 

   As of and for the year ended December 31, 
   2020   2019   2018 
Economic data(1):               
Change in GDP   (11.1)%   2.2%   4.0%
Change in construction sector in Peru   (15.6)%   1.5%   4.7%
Operating data:               
Capacity (thousands metric tons per year):               
Installed cement capacity   4,940    4,940    4,940 
Installed clinker capacity   2,780    2,780    2,780 
Production (thousands metric tons):               
Cement production   2,590    2,623    2,346 
Clinker production   1,477    1,853    1,719 
Utilization rate at Pacasmayo plant(2):               
Cement   45.1%   47.2%   39.8%
Clinker   47.5%   57.6%   55.4%
Utilization rate at Rioja plant(2):               
Cement   59.8%   68.4%   62.0%
Clinker   70.9%   82.5%   75.5%
Utilization rate at Piura plant(2):               
Cement   63.7%   59.7%   57.4%
Clinker   56.6%   75.8%   67.6%
                
Gross profit (S/ million)   375.3    486.9    466.7 
Gross profit margin   29.0%   35.0%   37.0%
EBITDA (S/ million)   315.3    400.3    371.6 
EBITDA margin   24.3%   28.7%   29.4%
Profit (S/ million)   57.9    132.0    75.2 
Profit margin   4.5%   9.5%   6.0%

 

 
(1) Source:  BCRP.
(2) Utilization rate is calculated by dividing production for the specified period by installed capacity.

 

Peruvian Cement Market

 

Peru had experienced sustained economic growth over the past decade, but the effects of the pandemic in 2020 resulted in the greatest annual economic contraction of the last 100 years. From 2016 to 2020, GDP contracted at a compound annual growth rate, or “CAGR”, of 0.9%. Growth during this period was accompanied by low inflation, which averaged 2.32% per year. In addition, as of November 30, 2020, the government had accumulated foreign exchange reserves of approximately US$71.7 billion, and the sovereign long-term debt rating was investment grade from each of the three major international credit rating agencies. This economic growth has resulted, among other key trends, in significant poverty reduction, with a decrease in the percentage of the country’s population living below the poverty line from approximately 48.6% in 2004 to approximately 20.2% in 2019. According to the BCRP, Peruvian GDP contracted 11.1% in 2020 as a result of the economic effects resulting from the COVID-19 pandemic, but it is expected to grow 10.7% in 2021.

 

We sell substantially all our cement in the northern region of Peru, which in 2020 accounted for approximately 28.9% of the country’s population and 14.9% of national GDP. Two other groups sold most of the cement consumed in each of the central and southern regions of Peru, with 7.3% of all the cement consumed in the country coming from imports, and approximately 3.9% coming from a small domestic producer. From 2016 to 2020, total cement consumption in Peru decreased 1.5% according to the INEI. Peru continues to have a significant housing deficit, estimated by the INEI at 1.9 million homes nationwide. In Peru, cement is mainly sold to a highly fragmented consumer base, consisting primarily of households that buy cement in bags to gradually build or improve their own homes without professional technical assistance, a segment known in our industry as auto-construcción. We estimate that in 2020 sales to the auto-construcción segment accounted for approximately 70.6% of our total sales of cement, private construction projects accounted for 15.8%, and public construction projects accounted for the remaining 13.6%. Approximately 91.4% of our total cement sales in 2020 were in the form of bagged cement, substantially all of which was sold through retailers.

 

Even though our ready mix sales are still a small proportion of our sales, we expect this trend to change as infrastructure becomes a bigger driver of demand in the upcoming years.

 

26

 

Brine Project Impairment

 

In 2017, our board of directors resolved to prioritize investments in the development of products related to the manufacture and sale of cement and building solutions. In furtherance of this strategy, we have pursued the sale or other disposition of investments that are not central to our core cement production business. As a result of this decision, during the fourth quarter of 2017 we discontinued the brine project.

 

Competitive Strengths

 

Our principal competitive strengths include the following:

 

Strong corporate governance standards and international recognition

 

Our common shares are listed on the Lima Stock Exchange and our ADSs are listed on the New York Stock Exchange. We are subject to the disclosure requirements of the U.S. Securities and Exchange Commission (the “SEC”) and the Peruvian Securities Commission and we must comply with and adopt internal compliance standards to increase transparency and improve corporate governance standards including an audit committee and appointment of independent directors. Since 2009, every year we have been selected as part of the Good Corporate Governance Index of the Lima Stock Exchange. Furthermore, in 2020, we received the Top Social Responsibility Award (Distintivo de Empresa Socialmente Responsable) for the eighth consecutive year, in recognition of our achievement of corporate goals in a socially responsible manner, principle that is ingrained in our corporate culture and business strategy. Also, we were included for the second consecutive year as part of the 2020 Dow Jones MILA Sustainability Index. This Index is made up of those companies that demonstrate superior performance among their peers under social, environmental and economic criteria. This achievement comes as a result of Pacasmayo’s effort to improve in all of these criteria and to work towards ambitious goals in terms of long-term sustainability. We are committed not only to remain in the Index but to improve our performance, as we are convinced that the focus on sustainability is key to our business and our stakeholders.

 

In February 2021, we were selected to be part of The Sustainability Yearbook 2021. To appear in the Yearbook, companies must score within the top 15% of their industry globally and have a gap of less than 30% from the leader’s Global ESG score. Moreover, we have been awarded with the Industry Mover distinction, since we showed the strongest year on year score improvement in our industry. This is the first year that Peruvian companies have been included as part of the Yearbook, and we are one of only two Peruvian companies included, and the only one to be awarded a special recognition. With around 7,000 companies evaluated around the world, an inclusion in the yearbook is a true statement of excellence in corporate sustainability.

 

Track record of cash flow generation and strong results through multiple business cycles

 

We have historically generated strong cash flow and high profit margins mainly due to the following key factors:

 

  our leadership position in the northern region of Peru; and
     
  our extensive distribution network, operational flexibility and efficiency, and focus on innovation.

 

2020 was an extraordinary year globally due to the COVID-19 pandemic. Peru’s GDP contracted an estimated 11.1% according to the BCRP. Despite these challenging times, we generated cash flow from operating activities of S/331.4 million (US$91.5 million) and EBITDA of S/315.3 million (US$87.1 million), recorded profit for the year of S/57.9 million (US$16.0 million), and our operating margin and EBITDA margins were 13.6% and 24.3%, respectively. EBITDA for 2020 was 21.2% lower than 2019, mainly due to the halt in production and commercialization during over two months because of the state of emergency declared by the government to prevent the spread of COVID-19. Nonetheless, it is important to note that, during the second half of the year, EBITDA increased 12.4% compared to the same period of 2019, showing the quick recovery.

 

This solid financial position and our ability to consistently generate operating cash flow also allows us to obtain relatively low interest rates.

 

Leader in attractive and expanding market with solid macroeconomic fundamentals

 

We are currently the only cement manufacturer in the northern region of Peru and we produce and sell substantially all of our cement in the region. In 2020, the northern region accounted for approximately 28.9% of the country’s population and 14.9% of its GDP. From 2016 to 2020, GDP in the northern region increased at a CAGR of 1.9%, despite the significant decrease during 2020. During the same period, our cement sales volume grew at a CAGR of 3.0%, above northern region GDP mainly due to increased public spending resulting from the government’s reconstruction plan after El Niño in 2017.

 

27

 

Best-in-class operating efficiencies with vertical integration and strong brand recognition

 

Our quarries are located in close proximity to our plants, enabling us to minimize transportation costs. We strive to enhance our operational efficiency by focusing on lowering costs and improving profitability. We also benefit from our vertically integrated operations, participating in the entire chain of production from the quarries, which we own directly, to the related products such as quicklime, ready–mix, precast and our large distribution network. We have developed one of the largest independent retail distribution networks for construction materials in Peru, known as “DINO,” consisting of 286 independent retailers and 413 hardware stores as of December 31, 2020, primarily small, local stores in the northern region, through which we distribute our cement products as well as construction materials manufactured by third parties. We use our distribution network, together with our strategically located commercial offices, to promote our products and stay abreast of market developments. We have developed this network through years of fostering relationships with retailers in the region, which we believe would be difficult for a competitor to replicate. Our distribution network has enabled us to build strong recognition for our Pacasmayo brand among retailers and end-consumers in our market, which we believe is important to our business, particularly because our cement is principally sold in bags to retail consumers.

 

Disciplined capital expenditure plan with attractive risk / return profile

 

We seek to minimize risk while securing an adequate return on our development projects. In 2015, we completed construction of our new plant in Piura, the third largest city in northern Peru, which has an annual production capacity of 1.6 million metric tons of cement. The first ton of cement from the Piura plant was produced and shipped on September 17, 2015. The Piura plant improves our competitive position in the northern region of Peru. With production from three plants, we are able to serve our market more efficiently. This state-of-the-art plant is one of the most modern in Latin America. It also reduces transportation costs by enabling the dispatching of cement from plants within closer proximity to the point of sale.

 

Emphasis on innovation

 

We place significant emphasis on research and development to ensure our products meet the needs of consumers in our market and to improve the efficiency of our operations. For example, we have developed cement products suitable to coastal construction that tend to be more exposed to erosion from sulfate. We believe that, by educating retailers and end consumers of these attributes of our products, we have been successful in building demand and realizing higher margins for our differentiated product offering.

 

In July 2016, we created the Innovation Department with the main objective of systematizing the continuous transformation process of the business in order to ensure a sustainable growth for Cementos Pacasmayo and the improvement of its margins. To achieve this objective it is necessary to:

 

  Put the customer at the center of all our processes.
     
  Design a management innovation model.
     
  Promote an organizational culture that encourages entrepreneurship and innovation.

 

Given that customers, and consumption patterns can change quickly and unexpectedly we must quickly adapt in order to retain our customers.

 

28

 

In 2019 we worked hard to develop new value propositions, that will enable us to offer our clients the best experiences. We designed Journey Maps together with the commercial and Marketing areas wherein we detailed the experience of our various clients to identify our strengths and those aspects that we need to improve. Under this approach, in 2019 we began to develop (and in some cases) to consolidate our digital platforms:

 

Name of the project   Description
EGIPTO   Digital platform aimed at delivering value to Construction companies. Through this digital application, our clients will be able to check the status of their dispatches, re-schedule them and display the GPS location of their shipments in real time.
MOCHE   Digital platform aimed at delivering value to the hardware stores by managing sales and orders.
BURGOS   Digital consultation channel aimed at giving technical support to Master Builders.
SISPLAN   Digitization of the request, approval and issuance processes for the discount on plans and promotions, negotiation, tenders and sale, giving visibility to our clients and sales force.
RPAs Pilot   Three automated processes were launched for the Credit and Collections, DINO Operations and Distribution areas.
BIM   Digital catalogue of company products, aimed at facilitating the transition from traditional construction processes to the implementation of building information modeling.The initiative includes team training and use of BIM as a virtual design tool in the Engineering Department.
Cellular Concrete   Project development in conjunction with the R&D and Marketing Departments that involves the design of a new type of concrete with innovative properties such as lighter weight and high thermal and acoustic performance.
CHINCHAY   Delivery Project aimed at delivering value to the hardware stores by taking care of their costumers shipments.
AYU   The project focuses on getting to know Peruvian families to design a value proposition that enhances the fulfillment of their plans through financial inclusion.
ISICOM   The project is aimed at the commercial management carried out by the sales force (CRM), in which we cover all the activities of its roadmap to be able to fulfill its commercial management of sales, registration of construction projects and contact with customers.

 

29

 

Strong relationship with local communities

 

Since we began operations 63 years ago, we have been committed to improving the quality of life of the communities surrounding our plants, whose members we regularly employ. We have developed close and cooperative relationships with the local communities, which are supported by several social responsibility initiatives we have undertaken. For example, the family of our controlling shareholder founded, Asociación Tecsup, a leading non-profit institute in Peru that provides technical education to students as well as UTEC, a leading technical university. We provide scholarships and financial aid to local qualified students interested in studying at Tecsup. Through its three campuses in Peru, as of December 31, 2020, Tecsup had graduated over 11,531 students in various technical fields, some of whom currently work for us and our affiliates.

 

Highly experienced and professional management and board of directors

 

Our management team, with an average of 16 years of experience in the cement industry in Peru, has extensive technical and local market expertise and has led our company through our recent growth. We have developed a strong professional business culture and a team of highly qualified executives. We also have a well-regarded and experienced board of directors that includes some of Peru’s business leaders and former senior government officials. Since 2009, we have been selected to form part of the Best Corporate Governance Practices Index of the Lima Stock Exchange, and in 2020 we were selected as part of the Dow Jones MILA Sustainability Index for the second consecutive year.

 

Our Strategies

 

Our objective is to maximize shareholder value, while honoring our commitment to the environment and abiding by our social responsibility goals. We aim to be a leading company that provides building solutions anticipating the needs of our clients and that contributes to the continued development of our country. We intend to achieve our objective through the following principal strategies:

 

Continue to focus on our core business of supplying the rising demand for cement

 

We plan to continue to meet the increasing demand for cement in our market, while controlling production costs. We intend to increase our production capacity while we continue to serve the current cement market, as well as increasing cement demand through the production of new cement-based products. Our principal goal is to maintain our market share in the northern region of Peru without reducing the profitability of our business.

 

Deepen our commercial relationship with retailers and end-consumers

 

We plan to enhance our commercial relationships with retailers and end-consumers in our market, both to maintain brand loyalty and to foster demand for our cement products. We will continue to support retailers in our DINO distribution network by providing product education, training sessions, rewards programs, and assistance in financing purchases of our products. In addition, we continue with our door-to-door commercial strategy for cement sales. We believe that these initiatives have been successful in strengthening our relationship with retailers and end-consumers.

 

Continue to focus on being the preferred provider of building solutions

 

We strive to be the supplier of choice for cement consumers in the northern region of Peru, whether its individuals building their homes or private construction companies or governmental entities undertaking projects of any size. We continue to focus on providing consumers with efficient and customized building solutions for their construction needs. Over the past several years, we have evolved from being a single type cement manufacturer to offering five different types of cement products, under 2 brands, and other building solutions, such as assembly gravity walls, sheet piles, precast beams, among others. Moreover, in 2018 we launched a new corporate image and future vision, transforming ourselves from a cement producer to a building solutions company. We focus on innovation and are constantly searching for ways to improve building practices, inspired by our culture based on sustainability. For example, we offer cement that contains special properties that protect against sulfate erosion, as well as other products designed to meet the needs of consumers in the northern region of Peru. In order to provide a portfolio of specialized solutions for our clients, we have developed Pacasmayo Profesional, a business unit focused on the development and commercialization of building solutions. Our mission is to provide a comprehensive solution for all project types and thus respond to the unique needs of each client, generating savings and efficiencies in the construction processes.

 

30

 

Selectively pursue acquisitions

 

We will continue to evaluate and may selectively pursue strategic acquisitions of cement and complementary businesses that expand our geographic footprint and diversify our portfolio of products. Our management team has significant operating experience and industry knowledge in the production and commercialization of cement and cement-related materials, and we believe this experience will enable us to identify and pursue attractive acquisitions that will maximize shareholder value.

 

Continue to strengthen our enterprise risk management

 

We continue to strengthen our enterprise risk management methods and processes that allow us to identify, assess and monitor the legal, commercial, operational, financial and reputational risks, as well as fraud, corruption, bribery and money laundering and financing of terrorism risks, determining the existing controls and establishing a plan along with other areas in order to mitigate existing risks. Along these lines, during 2018, we implemented the ISO 37001 Anti-bribery management systems obtaining the certification in January 2019. This certification confirms that our management system are designed to help prevent, detect and respond to bribery and comply with anti-bribery laws and voluntary commitments applicable to its activities. We believe this certification reiterates our commitment to global anti-bribery best practices and high standards of transparency and good corporate governance.

 

Maintain high environmental, social and governance standards

 

We are committed to maintaining high environment, social and corporate governance standards. We are focused on developing and strengthening a favorable social environment for the continuity and growth of our operations, prioritizing our social investment in innovative education, health and local development programs in coordination with other stakeholders to contribute to sustainable development. Since 2009, we have been selected as part of the Good Corporate Governance Index of the Lima Stock Exchange. Furthermore, in 2020, we received the Top Social Responsibility Award (Distintivo de Empresa Socialmente Responsable) for the eighth consecutive year, in recognition of our achievement corporate goals in a socially responsible manner, principle that is ingrained in our corporate culture and business strategy. We were included for the second consecutive year as part of the Dow Jones MILA Sustainability Index. This Index is made up of those companies that demonstrate superior performance among their peers under social, environmental and economic criteria.

 

In February 2021, we were chosen to be part of The Sustainability Yearbook 2021. To appear in the Yearbook, companies must score within the top 15% of their industry globally and have a gap of less than 30% from the leader’s Global ESG score. Moreover, we have been awarded with the Industry Mover distinction, since we showed the strongest year on year score improvement in our industry. This is the first year that Peruvian companies have been included as part of the Yearbook, and we are one of only two Peruvian companies included, and the only one to be awarded a special recognition. With around 7,000 companies evaluated around the world, an inclusion in the yearbook is a true statement of excellence in corporate sustainability. This achievement is a recognition of our extraordinary efforts to improve in all of these criteria and to work towards ambitious goals in terms of long-term sustainability. We are committed not only to remain in the Index but to improve our performance, as we are convinced that the focus on sustainability is key to our business and our stakeholders.

 

Our Products

 

Our core products are cement and other cement-related materials. We also produce quicklime. In 2020, cement, concrete and precast accounted for 91.1% of our net sales and quicklime accounted for 2.5%. We also sell and distribute construction materials, such as steel rebar, cables and pipes, manufactured by large third-party manufacturing companies, and others which in 2020 represented 3.9% of our net sales.

 

31

 

The following table sets forth a breakdown of our shipments by type of product for the periods indicated:

 

   Year ended December 31, 
(in thousands of metric tons)  2020   2019   2018 
Cement, concrete and precast   2,581    2,614    2,364 
Quicklime   59    66    120 

 

The following table sets forth a breakdown of our total net sales by product for the periods indicated:

 

   Year ended December 31, 
(in millions of S/)  2020   2019   2018 
Cement, concrete and precast   1,181.2    1,289.0    1,134.7 
Quicklime   32.5    36.1    57.6 
Construction supplies(1)   82.2    67.2    69.0 
Others   0.4    0.4    1.6 
Total   1,296.3    1,392.7    1,262.9 

 

 
 (1) Refers to construction materials manufactured by third parties that we distribute. Construction supplies include the following products:  steel rebar, wires, nails, corrugated iron, electric conductors, plastic tubes and accessories, among others.

 

Cement

 

Cement is a powdered mixture of ground minerals that, when mixed with water, adheres to other materials and hardens to form a rock-like substance. Cement is generally mixed with other materials, such as gravel and sand, forming concrete with a high degree of compressive strength that is able to withstand substantial pressure.

 

Cement types are generally classified as either Portland cement or blended hydraulic cement. Portland cement is a hydraulic cement produced by pulverizing clinker, consisting essentially of crystalline hydraulic calcium silicates and calcium sulfate. Blended hydraulic cement consists of a mixture of Portland cement clinker and mineral admixtures, such as blast furnace slag, pozzolanic materials and limestone.

 

We produce predominantly blended cement, which represented 86.7% of our cement sales in 2020. This type of cement requires less clinker and reduces carbon dioxide emissions of our operations and production. Our global clinker/cement ratio is estimated at 71.7%, below the average value for similar producers globally of approximately 76.0%

 

We produce a range of cement products suitable for various uses, such as residential and commercial construction and civil engineering. We currently offer the following six types of cement products designed for specific uses:

 

  Type ICo.  This type of cement is used for general purposes and is similar to Portland Type I cement.  It is widely used in our market due to its effectiveness and low hydration heat.
     
  Type MS/MH/R (called Fortimax3).  This is the new formula for the type of cement that is used to protect against moderate sulfate action, such as drainage structures, with higher-than-normal, but not unusually severe, sulfate concentrations in ground water.  It is designed for sites and structures in humid areas that are exposed to sulfates and sea water.  It also prevents thermal contraction cracking due to moderate heat hydration, and is resistant to contact with alkaline reagents.

 

  Type I.  This type of cement is for general purposes and suitable if special properties are not needed.  It is generally used for constructing pavements, floors, reinforced concrete buildings, bridges, reservoirs, pipes, masonry units and precast concrete products.
     
  Type V.  Type V cement is used in concrete exposed to severe sulfate action, principally in places where soil or ground water has high sulfate content.  It is generally used in hydraulic construction, such as irrigation canals, tunnels, water conduits and drains.
     
  Type HS.  Type HS cement is used in concrete that is exposed to severe sulfate action, principally where soil or ground water has high sulfate content.  It is recommended for port construction, industrial plants and construction of sewage sites.  Our Portland Type HS cement has low reactivity with alkali-reactive aggregates, making it more durable than other types of cement.
     
  Type IL.  Type IL cement is a blended Portland limestone cement.  These cements are more environmentally friendly than Portland cements and have very similar performance to Portland Type I/II cements

 

32

 

We believe that our Type V, Fortimax and HS cement products are particularly suitable for construction in the northern coastal region of Peru, where sulfate and chloride concentrations from soil, ground water and sea water affect the durability of construction structures. By educating retailers about the different cement characteristics and conducting marketing campaigns, we believe we have been successful in building demand for our cement products. Our research and development department is also equipped to produce custom-tailored cement products on demand. In addition, through our dedicated team of geologists and scientists, we have significantly reduced the amount of clinker required for cement production minimizing our capital expenditures and significantly reducing our carbon dioxide emissions (CO2).

 

We market and distribute our cement primarily in 42.5 kilogram bags. Most of our bagged cement is sold to the retail sector consisting primarily of households that buy bags of cement to build or expand their own homes over time with little or no formal technical assistance (commonly referred to as auto-construcción). The bags are made of Kraft paper to preserve the quality of the cement. Our bags include information relating to the composition of our cement, handling instructions, production dates and storage instructions. Our cement bags have different colors to easily identify the different types of cement. Once bagged at our Pacasmayo, Rioja and Piura facilities, our cement is loaded onto trucks operated by third parties. Cement in bulk is sold to large industrial consumers.

 

Concrete Products

 

We also produce and sell concrete products principally in the form of ready-mix concrete used in large construction sites, as well as precast, bricks, pavers and other precast materials.

 

  Ready-mix concrete.  Ready-mix is a blend of cement, aggregates (sand and stone), admixtures and water.  It is manufactured and delivered to construction sites in a form that is ready to use.  This mixture hardens to form a building material, ranging from sidewalks to skyscrapers.  We have 19 fixed and mobile ready-mix plants.
     
  Concrete precast.  We produce and sell concrete precast, such as paving units, or paver stones for pedestrian walkways, as well as other bricks for partition walls and concrete precast for structural and non-structural uses.
     
  New cement based products.  We have developed, and are in the process of developing more cement-based products that are innovative and easy building solutions.  Some of these products are:

 

  Ø Mortar for brick laying:  Pre-dosed and bagged dry masonry mortar for block and brick laying.
     
  Ø Mortar for plaster:  Pre-dosed mortar to plaster interiors and exteriors, walls and ceilings.  Allows smooth finishes and thin applications
     
  Ø Caravista Concrete:  Concrete designed to be exposed without any additional coating or paint.
     
  Ø Tremie Concrete:  Concrete designed to be placed under water at depths greater than 1.5 meters.
     
  Ø New Jersey Walls:  safety barriers used to separate traffic flows
     
  Ø Mortar for brick laying:  Pre-dosed and bagged dry masonry mortar for block and brick laying.
     
  Ø Viaforte Type MH:  Cement of moderate heat of special hydration for stabilization of soils and road bases.  The cement provides greater workability and less risk of cracking on site, also ensuring greater durability to the structure
     
  Ø Bagged Dry Concrete:  Pre-dosed mixture of cement, aggregates (Stone and Sand) and additives, that only requires the addition of water indicated on the package and mixing (manual or mechanical) to be used immediately
     
  Ø Corner block:  Product that complements the structures built with our precast, giving better functionality to any corner.
     
  Ø Beam block:  Product that is used to confine the upper part of walls built with our precast.
     
  Ø Concrete driving pipes:  precast reinforced concrete pipes that are installed without the need to open pit ditches or dredging of maritime floors.  The main use of the driving pipe is to collect seawater (inlet pipe) and to bring brackish water back out to sea (outfall pipe).  We are building a 1.5 kilometer long underwater outfall project for the Talara Refinery, where it is necessary to build a water collection system for its fire and cooling system.
     
  Ø Sheet piles presented and assembled:  concrete piles that can be pre-stressed or reinforced (they are two different types of manufacturing) that sink one alongside the other, forming a containment structure, used as riparian defenses.  We are manufacturing 40,000 ml pre-stressed and reinforced sheet piles that will form a coastal defense for the Piura River, ensuring the containment of water during rainy events, reducing the vulnerability of the city to floods.

 

33

 

Quicklime

 

We produce and distribute quicklime, which has several industrial uses. Quicklime serves as a neutralizer, lubricant, drying and absorbing material, disinfectant, and as a raw material. Quicklime has various applications, including in the steel, food, fishing and chemical industries. It is also used in mining operations to treat water and industrial residues, in agriculture as a fertilizer enhancer and, to a lesser extent, in other industries. In Peru, quicklime is mainly used in the mining industry, as an additive to treat water residues. We produce quicklime in finely and coarsely ground varieties and sell it either in bags of one metric ton or in bulk, according to clients’ requirement.

 

Production Process

 

Cement Production Process

 

The diagram below depicts the standard cement production process, which consists of the following main stages:

 

  extraction and transportation of limestone or seashells from the quarry;
     
  grinding and homogenization to make the raw material of consistent quality;
     
  clinkerization;
     
  cement grinding;
     
  storage in silos; and
     
  packaging, loading and distribution.

 

 

Extraction of raw materials. To produce cement, limestone/seashells are extracted from our quarries. We use explosives to loosen the limestone and deploy bulldozers to remove dirt and the overburden covering the limestone. We crush the limestone in our primary and secondary cone crusher and the resulting limestone is loaded into trucks and hauled to our Pacasmayo or Rioja facilities from the adjacent quarry where it is stored. In the case of Piura, our surface miner drills out our seashell quarry and then it is also loaded into trucks and hauled to the Piura plant.

 

34

 

Grinding and homogenization. Limestone/seashells, clay and sand are mixed with iron that is acquired from third parties. The quality of the resulting raw meal is monitored by examining samples of each batch and processing them through our quality control x-ray software that automatically measures the mix of materials to confirm the blend is in compliance with our quality standards. Subsequently, the raw meal is sent to a blending silo and then to a storage silo from where it is fed into the pre-heater.

 

Clinkerization. The raw meal is heated at a temperature of approximately 1,450 degrees Celsius in our kilns. The intense heat causes the limestone and other materials in the mixture to react inside the kiln, turning the mixture into clinker. Clinker is then cooled to a temperature of approximately 200 degrees Celsius and stored in a silo or in an outdoor yard.

 

Cement grinding. After being cooled, clinker, together with gypsum and some admixtures, is fed into a ball mill or into a vertical roller mill where it is ground into a fine powder to produce cement. In this form, cement reacts as a binding agent that, when mixed with water, sand, stone and other aggregates, is transformed into concrete or mortar.

 

Storage in silos. After passing through the ball mills, the cement is transferred on conveyor belts and stored in concrete silos in order to preserve its quality until distribution.

 

Packaging, loading and transport. Cement is transferred through another conveyor belt from the silo to be packaged in 42.5 kilogram bags and then loaded into trucks operated by third parties to be transported for distribution. Bulk cement may be transported (unpackaged) on especially designed trucks that deliver large amounts of cement directly to the work site.

 

Quicklime Production Process

 

Quicklime is produced by crushing limestone with a calcium carbonate content of at least 95% by calcinating it in a rotary kiln. The limestone for quicklime comes from our quarries. The crushing of the limestone is done at the quarry and the calcination process takes place only at our Pacasmayo facility. We produce quicklime in finely and coarsely ground varieties and sell both varieties in bags of 40 kilograms and up to one metric ton, as well as in bulk.

 

Raw Materials and Energy Sources

 

Limestone and Other Calcareous Resources

 

We obtain limestone required to produce clinker and quicklime principally from land where we have concession rights. For our Pacasmayo plant, we extract limestone from our Acumulación Tembladera quarry located approximately 60 kilometers from the plant, and for our Rioja plant, we extract limestone from our Calizas Tioyacu quarry which is adjacent to our Rioja plant. For our Piura plant, we extract seashells from our Bayovar 4 and Virrilá quarries, located approximately 140 and 120 kilometers, respectively, from the plant.

 

Acumulación Tembladera. We have a concession with an indefinite term to extract limestone and other minerals from our Acumulación Tembladera quarry, a 3,390 hectare open-pit mine located in the district of Yonan, in the department of Cajamarca. We acquired this concession in November 2002.

 

Calizas Tioyacu. For our Rioja production, we have a concession with an indefinite term to extract limestone and other minerals from a 400 hectare open-pit mine near our Rioja facility in the district of Elias Soplin Vargas, in the department of San Martín. We acquired this concession in February 1998.

 

Bayovar 4. For our Piura production, we have a concession with an indefinite term to extract seashells and other minerals from our Bayovar 4 quarry, a 22,326 hectare open-pit mine located in the district of Sechura, in the department of Piura. We acquired this concession in 2008

 

Virrilá. For our Piura production, we also have a group of concessions with an indefinite term to extract seashells and other minerals from our Virrilá quarry, a 931 hectare open-pit mine located in the district of Sechura, in the department of Piura. We acquired these concessions between 2000 and 2008.

 

In each of our limestone and seashell concessions, the term of the concession is indefinite, provided we pay an annual concession fee and a penalty fee if we fail to meet required minimum annual production levels. Failure to pay timely pay these fees for two consecutive years will result in forfeiture of our concession. As of the date of this annual report, we have fully paid all applicable fees on our operating concessions.

 

35

 

We extracted from our Acumulación Tembladera quarry approximately 1.9 million metric tons in 2018, 1.5 million metric tons in 2019 and 0.8 million metric tons in 2020 which were used for cement and quicklime production at our Pacasmayo facility. We extracted from our Calizas Tioyacu quarry approximately 359,529 metric tons in 2018, 400,520 metric tons in 2019 and 208,935 in 2020 which were used for cement production at our Rioja plant. We extracted from our Bayovar 4 quarry approximately 43,786 metric tons in 2018, 41,531 metric tons in 2019 and 42,564 in 2020 which were used for cement production at our Piura facility. We extracted from our Virrilá quarry approximately 1.3 million metric tons in 2018, 1.0 million metric tons in 2019 and 748,724 metric tons in 2020 which were used for cement production at our Piura plant.

 

We estimate that as of December 31, 2020, our Acumulación Tembladera quarry contains approximately 152 million metric tons of proven and probable limestone reserves with an average grade of 85.7% of calcium carbonate; our Calizas Tioyacu quarry contains approximately 16 million metric tons of proven limestone reserves with an average grade of 90.3% of calcium carbonate; our Bayovar 4 quarry contains approximately 4.4 million metric tons of proven seashells reserves with an average grade of 87.2 % of calcium carbonate; and our Virrilá quarry contains approximately 88 million metric tons of proven seashells reserves with an average grade of 90.1% of calcium carbonate. Based on our estimated annual extraction levels, we estimate that our limestone reserves at our Acumulación Tembladera quarry have a remaining life of approximately 87 years and our limestone reserves at our Calizas Tioyacu quarry have a remaining life of approximately 22 years. Based on our estimated annual seashells extraction levels, we estimate that our seashells reserves at our Bayovar 4 and Virrilá quarries have a remaining life of approximately 169 years. Our estimates were prepared by our internal engineers and geologist and are reviewed periodically.

 

In addition to our Acumulación Tembladera, Calizas Tioyacu, Bayovar 4 and Virrilá quarries, we also own concession rights to various other calcareous material quarries consisting, in total, of approximately 40,767 hectares located in the northern region of Peru. None of these quarries are in operation as of the date of this annual report.

 

Clay, Sand and Other Raw Materials and Admixtures

 

The other raw materials that we use to produce clinker are clay, sand, iron and diatomite.

 

Clay

 

For cement production in our Pacasmayo facility, we extract clay from our Cerro Pintura quarry, a 400 hectare open-pit concession located in the district and province of Pacasmayo, department of La Libertad. We were granted this concession by the MEM in 1996. The term of the concession is indefinite, provided we pay an annual concession fee and meet minimum annual production requirements. We extracted from this quarry approximately 44,636 in 2018 and in 2019 and 2020 there was no extraction of clay.

 

For cement production in our Rioja facility, we extract clay from our Pajonal quarry, a 400 hectares open-pit concession located in the district and province of Rioja, department of San Martin. This concession was granted to us by the MEM in 1998. The term of the concession is indefinite, provided we pay an annual concession fee and meet minimum annual production requirements. We extracted from our Pajonal 2 quarry approximately 42,227 metric tons in 2018, 57,129 metric tons in 2019 and 46,057 in 2020.

 

We have not calculated our clay reserves, as we believe there is an abundant supply of clay in our concessions and more broadly in the northern region where we operate.

 

Sand

 

For cement production in our Pacasmayo facility, we use sand extracted from our Cerro Pintura quarry. We extract approximately 120,000 metric tons of sand per year on average for use at our Pacasmayo facility. Our Rioja facility does not utilize sand as a raw material given the type of cement it produces.

 

We have not calculated our sand reserves, as we believe there is an abundant supply of sand in our concessions and more broadly in the northern region where we operate.

 

Iron

 

We use small quantities of iron in our cement production, which we purchase from third parties at market prices.

 

36

 

Pozzolanic Materials and Other Admixtures

 

Our cement production also requires small amounts of other admixtures, such as pozzolanic materials, gypsum and blast furnace slag.

 

For cement production in our Pacasmayo facility, we use pozzolanic materials obtained from our Cunyac quarry, a 200 hectare open-pit concession located in the district of Sexi, province of Santa Cruz, department of Cajamarca. The concession was granted to us by the MEM in 2008. The term of the concession is indefinite, provided we pay an annual concession fee and meet minimum annual production requirements. We began using pozzolanic material at our Pacasmayo facility in 2010 and in 2018, 2019 and 2020 we consumed pozzolanic material from our stock.

 

For cement production in our Rioja facility, we use pozzolanic materials obtained from our Fila Larga quarry, a 1,000 hectare open-pit concession located in the district of El Milagro, province of Utcubamba, department of Amazonas. The concession was granted to us by the MEM in 1998. We did not use pozzolanic materials to produce cement in 2017 or 2018. In 2019 we extracted 1,000 metric tons of pozzolanic from our Fila Larga quarry and in 2020 we consumed pozzolanic material from our stock.

 

We also own several other concessions containing pozzolanic material which have not been exploited. In addition, our use of pozzolanic materials may be substituted with clinker or other admixtures. Other admixtures, such as gypsum and blast furnace slag, are purchased at market prices from third-party suppliers. If we are unable to acquire raw materials or admixtures from current suppliers, we believe that other sources of raw materials and admixtures would be available without significant interruption to our business.

 

Energy Sources

 

Our main energy sources are fuel in the form of coal and electricity. Our production processes consume significant amounts of energy, because our kilns must reach extreme temperatures to produce clinker and quicklime. In addition, milling operations, homogenization and transportation of materials consume significant amounts of energy.

 

Coal

 

We purchase mostly anthracite coal from local suppliers and import small amounts of bituminous coal from suppliers mainly in Colombia, in each case at spot market prices. Anthracite coal tends to be less expensive than bituminous coal. We store coal at our premises and in our warehouse facility adjacent to the Salaverry port, located approximately 130 kilometers south of our Pacasmayo facility, where we have sufficient stock of coal to maintain our production levels for the next year.

 

In December 2009 and February 2010, we entered into option agreements to acquire coal mining concessions as a means to secure a steady and reliable source for our coal requirements and to reduce the volatility in costs related to coal. In 2011, we exercised certain options under these agreements to acquire coal mining concessions for 908.5 hectares near our Pacasmayo facility for a total purchase price of US$4.5 million. In 2013, we exercised our remaining options to purchase an additional coal mining concession for 501.2 hectares for US$1.0 million, thereby completing the acquisition of the related coal mining concessions.

 

Gas

 

During July 2019 we started using gas in our Piura plant. We had a long-term contract with Olympic Peru for the supply of gas that expired in 2036 to cover most of our energy needs in the Piura plant. The contract had two phases, beginning with the spot phase, during which there is no obligation on us to buy a set amount and the contract may be terminated at any time by either party, and ending with a take or pay phase. In 2020, we decided to terminate the contract. However, we will continue to look for cost efficient alternatives that would allow us to use gas in our Piura facility in the future

 

Electricity

 

As of December 31, 2020, all of the electricity requirements for our Pacasmayo and Piura facilities were supplied by Electroperú and for our Rioja facility by ELOR.

 

We have a long-term electricity supply contract with Electroperú currently valid until 2026. Electroperú has agreed to provide us with sufficient energy to operate our Pacasmayo and Piura facilities at pre-determined maximum amounts during the term of the contract. Payments for electricity are based on a formula that takes into consideration our energy consumption and certain market variables, such as the U.S. purchase price index, the global price of oil, the local price of natural gas and the import price of bituminous coal.

 

37

 

In addition, we have a medium-term electricity supply contract with ELOR to supply the Rioja facility, which was recently extended until November 2022. ELOR supplies the Rioja facility with six megawatts of electricity at peak hours and eight megawatts at non-peak hours. Payments for electricity are based on a formula that takes into consideration our energy consumption and certain market variables, such as the U.S. dollar price, the local price of natural gas, the global price of oil and the import price of bituminous coal.

 

Other Production Materials

 

We use other materials in the cement production process, including paper bags to package cement, which we purchase principally from local suppliers; plastic bags used to package quicklime, which we purchase from local suppliers; and water to cool the kiln exhaust gases and for our crushing operations at our Acumulación Tembladera quarry, which we obtain principally from a well located at our Pacasmayo facility and from the Jequetepeque river. Water used in our production process is maintained in a closed system at our plants and re-processed for utilization in our production process.

 

Consumer Base

 

The retail cement sector in Peru is characterized by households that purchase single bags of cement to gradually build or improve their homes with little or no professional assistance. This sector is known as auto-construcción. Families in this sector tend to invest a large portion of their savings in building or improving their own homes. Auto-construcción is often conducted with the help of a foreman (maestro de obra) who generally has experience in construction. Our retail marketing plans typically target the maestro de obra who is usually the decision maker when buying cement and other related construction materials.

 

We also sell directly to small, medium and large private construction companies working on a variety of construction projects, from housing complexes to commercial developments. In the public sector, we provide cement for national, regional and local governments carrying out construction projects including housing complexes and public construction, ranging from local schools and hospitals to large infrastructure.

 

Sales and Distribution

 

Distribution

 

Our market extends from the Ecuadorian border in the north of Peru to the city of Barranca in the south (approximately 180 kilometers north of Lima), to the rainforest in the east and the Pacific Ocean in the west. Our market covers the provinces of Amazonas, Cajamarca, La Libertad, Lambayeque, Piura and Tumbes in the north; and San Martín and Loreto in the northeast.

 

Our Pacasmayo, Piura and Rioja facilities supply the entire northern region of Peru, interchangeably subject to where it is most efficient to ship from at the moment, depending on the distance and type of cement being produced, among other factors.

 

In 2020, approximately 91.4% of our total cement shipments were in the form of bagged cement, substantially all of which was sold through retailers both within and outside of our distribution network. The remaining 8.6% of our cement was sold in bulk or in shipments of precast products or ready-mix concrete directly to large construction companies.

 

We have developed one of the largest independent retail distribution networks for construction materials in Peru, consisting of more than 413 local hardware stores, with which we have a distribution agreement. In addition, we also distribute to other independent retailers located throughout the northern region of Peru with whom we do not have contractual relationships. We have built our distribution network by investing in strengthening our relationship with retailers.

 

Even though our ready mix sales are still a small proportion of our sales, we expect this trend to change as infrastructure becomes a bigger driver of demand in the upcoming years. Additionally, we sell and distribute other construction materials manufactured by third parties that are used alongside cement, such as steel rebar, plastic pipes and electrical wires, among others.

 

38

 

Marketing and Brand Awareness

 

We use our distribution network, together with our strategically located local commercial offices, to promote our products and brands, as well as to keep us informed of market developments. We believe our distribution network has enabled us to build strong recognition for our Pacasmayo brand among maestros de obra, retailers and end consumers which we believe is important to our business, particularly because our cement is principally sold in bags to retail consumers.

 

Our marketing expenses in 2020 were approximately S/3.3 million, or 0.3% of our sales. Historically, our marketing strategy has been to develop brand loyalty by providing high-quality products, tailored to the needs of our customers, and customer service accompanied by complimentary training for the maestros de obra, who are typically the decision makers in the auto-construcción segment.

 

We develop strong ties with our distributors by promoting income generating opportunities for them. For instance, we give them priority when hiring transportation to distribute our cement throughout our territory. Also, our large salesforce has the ability to cover most of the construction sites in northern Peru generating business opportunities that are then channeled through our distributors. Finally, our distributors enjoy various commercial and marketing benefits such as rebates, special promotions, special credit conditions, and loyalty programs.

 

We have been working consistently in recent years to focus time and attention on our client’s needs, in an effort to go beyond just selling cement and its byproducts, to providing solutions and innovating. Consequently, we were well-positioned to leverage these initiatives during the ongoing pandemic period. The self-construction segment has been the primary driver behind the growth in volume sales during the second half of 2020. We have focused on several fronts to enhance the customer experience and to facilitate access to our solutions. We have developed Mundo Experto, which is a virtual ecosystem made up of digital solutions that serves to join supply and demand and offers a superior purchasing experience leveraged on intensive use of technology to generate more value for our users. The digital solutions are targeted and customized for the different users, such as foremen, hardware stores, and the self-builder.

 

Quality Control

 

In Peru, cement production is subject to standardization (normalización) regulations approved by the National Institute for the Protection of Competition and Intellectual Property (Instituto Nacional de Defensa de la Competencia y de la Protección de la Propiedad Intelectual, or “INDECOPI”). Although the standardization regulations are not mandatory, they are useful in achieving an optimum level of management. As of the date of this annual report, we comply with all standardization regulations applicable to our products.

 

We have established a quality assurance program in accordance with ISO Standard 9001-2008, certified by SGS del Perú S.A.C., a company that provides inspection, verification, testing and certification services. We monitor quality at every stage of the cement production process. In our facilities, we periodically test the quality of our raw materials. These tests include chemical, physical and x-ray tests. We perform similar examinations of the clinker we produce. Additionally, we also perform regular quality tests on our finished products.

 

We have a quality control area with computerized systems to access real-time information on the quality of our products. As part of our quality control process, we monitor the performance of our different cement products, monitor the performance of additives in our cement and review monthly statistical analysis on the resistance of cement, among other things.

 

Competitive Position

 

Peru’s cement production is segmented into three main geographic regions: the northern region, the central region, including Lima’s metropolitan area, and the southern region. We are the only cement manufacturer in the northern region of Peru. The central region is principally served by UNACEM (formerly known as Cementos Lima and Cemento Andino), some imports, and Caliza Cemento Inca. The south is principally served by Cementos Yura and Cementos Sur. In 2020, our cement shipments were approximately 2.6 million metric tons, representing an estimated 26.1% share of total cement shipments in Peru.

 

39

 

Regulatory Matters

 

Overview

 

Although our core business is the production of cement, we hold a number of mining concessions granted by the Peruvian government for the supply of limestone and other raw materials required for cement production. As a result, we are subject both to the mining and the general industrial legal framework in Peru. The regulatory framework applicable to our cement production may be divided into rules and regulations relating to (i) the mining and crushing of limestone and clay, and (ii) the production process.

 

Mining Regulations

 

The General Mining Law (Texto Único Ordenado de la Ley General de la Minería) approved by Supreme Decree No. 014-92-EM, published in the Peruvian Official Gazette, El Peruano, on June 3, 1992, is the primary law governing both metallic and non-metallic mining activities in Peru and is supplemented by implementing guidelines and policies regarding mining and the processing of minerals enacted by the MEM. Under the General Mining Law, mining activities (except storage, reconnaissance, prospecting and trade) are carried out exclusively through various forms of concessions. Mining concessions are granted by the Geological, Mining and Metallurgical Institute (Instituto Geológico Minero y Metalúrgico, or “INGEMMET”), and all other concessions, including our mineral processing concessions, are granted by the Directorate General for Mining of the MEM. Any act, transfer, termination or agreement related to these concessions must be registered with the Mining Rights Registry, which is part of the National Public Registry System, to be effective against the Peruvian government and third parties.

 

Holders of concessions or mining claims must comply with several obligations, including the payment of an annual concession fee (derecho de vigencia) of US$3.00 per applicable hectare. The annual concession fee is due and payable on or prior to June 30 of each year. Failure to pay the annual concession fee for two consecutive years will result in the termination of the mining concession.

 

Mining activities require holders to obtain title to the surface land from individual landowners, peasant communities or the Peruvian government. Mining concessions are granted for an unlimited period, subject to the achievement of minimum annual production levels. Two different regimes apply depending on the date the concession was granted:

 

Under Legislative Decree 1320 and Supreme Decree No. 011-2017-EM, since January 1, 2019, if the annual minimum production or investment has not been met, the annual penalty and the causes to terminate a mining concession will be determined by the General Mining Law for all concessions, as described below.

 

For concessions granted until 2008, the following rules apply:

 

  the minimum annual production target is equivalent to one tax unit (approximately US$1,187) per year per hectare, in case of metallic mining concessions, and 10% of one tax unit (approximately US$119) per year per hectare, in the case of non-metallic mining concessions;
     
  the minimum production level is to be achieved no later than the end of the tenth year from the date of grant;
     
  if the minimum production level is not achieved within that period, an annual penalty equivalent to 2% of the minimum annual production level is due until such level is achieved;
     
  if the minimum production level is not achieved by the end of the fifteenth year, an annual penalty equivalent to 5% of the minimum annual production level is due until such level is achieved;
     
  if the minimum production level is not achieved by the end of the twentieth year, an annual penalty equivalent to 10% of the minimum annual production level is due until such level is achieved; and
     
  if the minimum production level is not achieved by the end of the thirtieth year, the mining concession expires.

 

Any penalty must be paid prior to June 30 of each year. Failure to pay the penalty for two consecutive years results in the termination of the mining concession.

 

40

 

Since January 1, 2020, these penalties will be applied for concessions granted in 2009 and thereafter.

 

The foregoing penalties and fines are not applicable to mining concessions granted by the government through private investment promotion initiatives, which will be subject to the minimum production and investment levels set forth in such contracts.

 

In addition to the payment of the annual concession fee and the penalty, holders of mining concessions must, pursuant to the Mining Royalty Law, pay a royalty for the exploitation of metallic and non-metallic resources. Prior to the amendment of the Mining Royalty Law described below, the amount of the royalty was determined on a monthly basis. For those minerals with an international market price (gold, silver, copper, zinc, lead and tin), the amounts were computed by applying the rates to the value of the concentrate or its equivalent, according to the applicable international market price. The historic rate scales were established in the Mining Royalty Law’s regulations as shown in the following table:

 

Annual sales
(in millions of US$)
  Rate 
Up to 60   1%
Between 60 and up to 120   2%
More than 120   3%

 

In case of minerals without an international reference market price (minerals other than gold, silver, copper, zinc, lead and tin), the mining royalty amounted to 1% of the value of the final product obtained from the mineral separation process, net of any costs incurred in the mineral separation process (componente minero).

 

However, the Mining Royalty Law was amended on September 29, 2011 to increase the tax payable on metallic and non-metallic mineral resources. Effective October 1, 2011, the royalty for the exploitation of metallic and non-metallic resources is payable on a quarterly basis in an amount equal to the greater of (i) an amount determined in accordance with the following statutory scale of tax rates based on a company’s operating profit margin and applied to the company’s operating profit, as adjusted by certain non-deductible expenses, and (ii) 1% of a company’s net sales, in each case, during the applicable quarter. The royalty rate applied to the company’s operating profit is based on its operating profit margin according to the following statutory scale of rates:

 

Operating Margin  Applicable Rate (%)
0% - 10%  1.00
10% - 15%  1.75
15% - 20%  2.50
20% - 25%  3.25
25% - 30%  4.00
30% - 35%  4.75
35% - 40%  5.50
40% - 45%  6.25
45% - 50%  7.00
50% - 55%  7.75
55% - 60%  8.50
60% - 65%  9.25
65% - 70%  10.00
70% - 75%  10.75
75% - 80%  11.50
More than 80%  12.00

 

Mining royalty payments will be deductible for income tax purposes in the fiscal year in which such payments are made.

 

We believed that certain portions of the regulations of the Mining Royalty Law were unconstitutional, because they impose a mining royalty tax on non-mining activities. For instance, for cement companies, the amended Mining Royalty Law and its regulations established that the mining royalty tax was calculated based on the total operating profit or net sales, as opposed to operating profit or net sales attributable exclusively to mining products, such as limestone, used to produce cement. Accordingly, in December 2011, we filed a claim to declare that the mining royalty tax applicable for the exploitation of non-metallic mining resources be calculated based on the value of the final product obtained from the mineral separation process, net of any costs incurred in the mineral separation process (“componente minero”).

 

41

 

In November 2013, the Peruvian Constitutional Court affirmed the constitutional challenge we filed against the new regulation of the Mining Royalty Law, in a final and unappealable ruling, on the grounds that the new regulation violates the constitutional right of property, as well as the principles of legal reserve and proportionality. Therefore, the new regulation is rendered inapplicable to our operation. As a result, we will continue to use as a basis for the calculation of the mining royalty the value of the concentrate or mining component, and not the value of the product obtained from the industrial or manufacturing process.

 

Finally, holders of mining concessions are required at the beginning of their operations to submit a mining closure plan that must contain a description of the steps to restore the areas and facilities of each mining operation area to pre-mining condition. Holders of mining concessions are required to secure completion of the restorative measures by means of the following guarantees: (i) banking guarantee or credit insurance; (ii) cash guarantees; (iii) trusts; or (iv) those indicated in the Peruvian Civil Code.

 

As of the date of this annual report, we primarily owned non-metallic mining concessions and limited metallic mining concessions with respect to iron. Substantially all of our concessions were granted prior to 2008. Our mining rights and concessions are in full force and effect under applicable Peruvian laws. We believe that we are in compliance in all material respects with the terms and requirements applicable to our mining rights and concessions.

 

Production Process

 

The cement production process along with other manufacturing activities are governed by General Industry Law (Ley General de Industrias), Law No. 23407, published in El Peruano on May 29, 1982, which establishes basic rules that promote and regulate activities in the manufacturing industry. The Ministry of Production is vested with authority to promote private investments in connection with industrial, processing and manufacturing activities, the surveillance of sustainable exploitation of natural resources (except for those extractive activities involving primary transformation of natural products), the protection of the environment, and the supervision of the quality of manufactured products. All industrial companies are subject to the General Industry Law and its regulations to the extent that the company’s gross income is primarily derived from industrial activities. Pursuant to Supreme Decree No. 009-2011-MINAM, the supervisory and monitoring functions of the Ministry of Production were transferred to the OEFA in 2013.

 

Environmental Regulations

 

Industrial companies and particularly cement companies are required to comply with several environmental regulations. Pursuant to Article 50 of Legislative Decree No. 757, the competent environmental authority is that corresponding to the activity of the company which generates the higher gross annual income. For that reason, the environmental authority that monitors our operations, considering that cement production represents the highest proportion of our gross profit, is the Ministry of Production.

 

The Environmental Regulations for Manufacturing Industries (Reglamento de Protección Ambiental para el Desarrollo de Actividades de la Industria Manufacturera—Supreme Decree No. 019-97-ITINCI, or the “Environmental Regulations”), set forth different environmental obligations depending on the date of commencement of the subject company’s industrial activities. Thus, companies with industrial cement activities operational at the time these regulations entered into force (September 1997) were obliged to submit an Environmental Adaptation Management Plan (Programa de Adecuación y Manejo Ambiental, or “PAMA”) to the Ministry of Production; while companies with industrial activities starting from that date onwards are obliged to submit either an environmental impact assessment or an environmental impact declaration depending on the level of risk and the impact of their activities on the environment. Furthermore, the Environmental Regulations establish that the Ministry of Production may require a mining closure plan (as an independent environmental assessment) with environmental measures that all companies must comply with before closing their operations to prevent any negative effects on the environment.

 

With regard to air emissions and wastewater discharges, the Ministry of Production has adopted legally binding environmental quality standards (Limites Máximos Permisibles, or “LMPs”) for cement industries (approved by Supreme Decree No. 001-2020-MINAM). These standards are legally enforceable and all cement industry operations are required to comply with them.

 

42

 

A violation of the Environmental Regulations is subject to different types of administrative sanctions, as determined in the Environmental Sanctions Regime of the Ministry of Production (Régimen de Sanciones e Incentivos del Reglamento de Protección Ambiental para el Desarrollo de Actividades de la Industria Manufacturera—Supreme Decree No. 025-2001-ITINCI), including warnings notices; fines of up to 600 UIT (US$711,920); restrictions, suspensions or cancellation of the authorization or concession; and total or partial closing of the industrial facilities. The type of sanction imposed ultimately depends on the seriousness of the violation. Although the environmental competent authority for industrial activities is the Ministry of Production, other government agencies may impose fines in case of non-compliance with applicable permits.

 

By Directing Council Resolution No. 023-2013-OEFA/CD, of the Organismo de Evaluación y Fiscalización Ambiental (the Environmental Monitoring and Enforcement Agency or “OEFA”), OEFA assumes the functions of monitoring, supervision, control and sanctioning of environmental matters in the Cement Sector of the Manufacturing Industry, of the Industrial Subsector of the Ministry of Production - PRODUCE.

 

In 2016, by Ministerial Resolution No. 201-2016-MINAM, the “National Protocol of Continuous Emission Monitoring Systems – CEMS” was approved. Its objective is to standardize the process of continuous monitoring of polluting gases and particles emitted into the atmosphere by manufacturing activities. It establishes the technical criteria for the selection of continuous monitoring methodologies, as well as the location of the monitoring points, the operation of the equipment and the calibration tests required for the assurance of the quality of the measurements.

 

By Ministerial Resolution Nº 191-2016-MINAM, the “National Plan for the Integral Management of Solid Waste - PLANRES 2016-2024” was approved. It establishes among other things, obligations to managers regarding the management of non-municipal solid waste, as well as the modification of the environmental studies in case it is planned to carry out co-processing.

 

Prior Consultation with Local Indigenous Communities

 

On September 7, 2011, Peru enacted Law No. 29785, Prior Consultation Right of Local Indigenous Communities. The law was enacted in order to implement Convention No. 169 of the International Labor Organization on Local Indigenous Communities in Independent Countries, previously ratified by Peru through Legislative Decree No. 26253. This law, which became effective on December 6, 2011, establishes a prior consultation procedure to be undertaken by the Peruvian government in favor of local indigenous communities, whose collective rights may be directly affected by new legislative or administrative measures, including the granting of new mining concessions. Regulation implementing this law was approved on April 3, 2012, by Supreme Decree No. 001-2012-MC, which defines the local indigenous communities that are entitled to the prior consultation rights and establishes the different stages that comprise the prior consultation procedure.

 

Consultation procedures for mining and processing concessions are carried out by the MEM prior to the granting of a new processing concession.

 

According to the recent practice of the Geologic Institute of Mining and Metallurgy (Instituto Geológico Minero Metalúrgico), the granting of mining concessions does not qualify as an “administrative measure” that potentially affects the rights of indigenous people because it does not grant per se a right to explore and exploit mineral deposits. Accordingly, the granting of mining concessions has not been included among measures that require consultation procedures with indigenous people. According to Ministerial Resolution No. 003-2013-MEM-DM, the MEM has established that consultation procedures are applicable prior to the commencement of: (i) exploration activities (Autorización de inicio de actividades de exploración); (ii) exploitation activities (Autorización de inicio o reinicio de las actividades de desarrollo, preparación y explotación - incluye plan de minado y botaderos); and (iii) processing concessions (otorgamiento de concesión de beneficio).

 

Local indigenous communities do not have a veto right; upon completion of this prior consultation procedure, the Peruvian government can discretionarily approve or reject the applicable legislative or administrative measure. In addition, any sale, lease or other act of disposal of surface land owned by local indigenous communities is subject to the approval of an assembly composed of the members of such communities according to the following rules:

 

  for local indigenous communities located on the coast, approval of not less than 50% of members attending the assembly is required; and
     
  for local indigenous communities located in the highlands and the Amazon region, approval of at least 2/3 of all members attending the assembly is required.
     
43

 

Permits and Licenses

 

Mining Concessions

 

According to the General Mining Law, a mining concession is required in order to extract mineral resources needed to produce cement. The mining concession grants the right to explore and exploit the mineral resources located in a solid of indefinite depth, limited by the vertical plane corresponding to the sides of square, rectangle or polygon referred to by the Universal Transversal Mercator coordinates. The Geological Mining and Metallurgical Institute (Instituto Geológico Minero y Metalúrgico) is in charge of managing the procedure of granting mining concessions, which includes the receipt of the request, the granting and the termination of mining concessions.

 

Explosives. Mining concessionaires are required to obtain the following permits to operate and store explosives:

 

  Certificate of Mining Operation (Certificado de Operación Minera), granted by the MEM;
     
  Semiannual Authorization for Use of Explosives, granted by the General Bureau of Explosives of the Ministry of Interior (Superintendencia Nacional de Control de Servicios de Seguridad, Armas, Municiones y Explosivos de Uso Civil, or “SUCAMEC”);
     
  Manipulation of Explosives License for each individual that intends to handle explosives, granted by the SUCAMEC; and
     
  Explosive’s Warehouse Operation License, granted by SUCAMEC.

 

Water and Wastewaters

 

To use water resources in cement industry activities, it is necessary to obtain a water right granted by the Water Management Authority (Autoridad Nacional del Agua, or “ANA”) prior to the use of underground or fresh water sources. If the proposed activities will generate domestic or industrial wastewaters, which will be discharged into natural water sources or soil, authorization from ANA is required, with a favorable opinion of the General Bureau of Environmental Health (Dirección General de Salud Ambiental, or “DIGESA”).

 

Hazardous Waste

 

Hazardous waste generated as a consequence of cement production activities must be disposed of in specialized landfills. The transportation of solid waste outside the limits of the industrial complex must be conducted exclusively through specialized companies registered with DIGESA and MINAM. Industries are free to contract with an EO-RS (a company that provides solid waste services such as transportation, treatment or disposal) or with an EC-RS (a company that carries out commercialization activities aiming at the reuse of solid waste). Yet in order to limit their liability in case of environmental harm, industries must make sure the EO-RS and EC-RS they retain count with all necessary permits to collect, transport and dispose hazardous wastes.

 

Chemical Feedstock

 

The commercialization, transportation and use of controlled chemical feedstock (Insumos Químicos y Productos Fiscalizados, or “IQPF”) is restricted, because of their potential use in the production of illegal drugs or controlled substances. Companies that require an IQPF must obtain an IQPF User Certificate (Certificado de Usuario de IQPF) from the General Bureau of Chemical Feedstock of the Ministry of Interior (Unidad Antidrogas de la Policía Nacional del Perú, or “DIRANDRO”). Companies such as ours are also required to register with the Ministry of Production any IQPF activities they plan to carry out (Registro Único para el Control de IQPF).

 

Fuel Storage

 

Any company that purchases fuels for its own activities and has facilities to receive and store fuel with a minimum capacity of one meter cubed (264,170 gallons) is required to (i) receive from the Mining and Energy Investment Supervision Body (Organismo Supervisor de la Inversión en Energía y Minería, or “OSINERGMIN”) prior permission to build and operate said installations, and (ii) be registered with the Registry of Direct Fuel Consumers, in order to obtain the SCOP Code (Código del Sistema de Control de Órdenes de Pedido) necessary to purchase fuel.

 

44

 

Cultural Heritage Protection

 

If the design and development of cement industry activities involves the removal of topsoil, a Certificate of Non-Existence of Archaeological Ruins (Certificado de Inexistencia de Restos Arqueológicos, or “CIRA”) from the Ministry of Culture (Ministerio de Cultura) with respect to the area under construction must be obtained. The CIRA will either certify that on the surface of the evaluated area no archaeological sites or features were discovered, or will identify their exact location and extent in order to implement precautionary measures to protect the archaeological artifact. The CIRA is valid for an unlimited period, but will become void should any archaeological artifacts be accidentally discovered during the construction works or due to any natural cause. In such an instance, the company must stop the construction work immediately and notify the Ministry of Culture. Failure to stop the construction work may generate civil and criminal liabilities. Under certain exceptional circumstances, Peruvian legislation allows the removal of archeological artifacts when the area is required for development of projects that are of national interest.

 

Labor Regulations

 

Peruvian legislation allows hiring employees through: (i) a fixed-term contract, (ii) a contract for an indefinite duration; or (iii) a contract for part-time employment.

 

The minimum wage established in Peru is S/930.00 per month. Peruvian labor legislation establishes a maximum 8-hour work day or 48 hours per week for employees older than 18 years. For overtime, employers must pay at least an additional 25% and an additional 35% over the regular hourly wage for the first two hours and for any additional hours, respectively. Employees are entitled to a minimum rest of 24 consecutive hours per week.

 

Regardless of the type of employment contract, pursuant to Peruvian law full-time employees are entitled to receive:

 

(i) an additional 10% of the minimum wage, provided that they are responsible for (a) one or more children under the age of 18 or (b) persons who are up to 24 years of age if they are pursuing higher education,

 

(ii) two additional months’ salary per year, one in July and one in December (pursuant to Law No. 29351, said payments were not subject to any social contribution, except for Income Tax; consequently, until December 2015, employers paid directly to their employees as an Extraordinary Bonus, the amount of the contribution to the Social Health Insurance (ESSALUD) for such payments, equivalent to 9% of the bonus paid),

 

(iii) thirty calendar days of annual paid vacation per year,

 

(iv) life insurance, since the first day at work,

 

(v) a compensation for years of service (CTS) equal to 1.16% of a monthly salary and is deposited each year in May and November, provided they work an average of at least four hours per day for the same employer,

 

(vi) benefits from the Peruvian Social Health Insurance (ESSALUD) to which employers must contribute a rate equivalent to 9% of their employees’ income, and

 

(vii) a percentage of the company’s annual income net of taxes (10% in the case of income derived from industrial cement operations, and 8% in the case of income derived from our mining or commercial activities), provided the company has twenty or more employees.

 

Free and Fair Competition Protection

 

In Peru, businesses are generally not required to receive the prior authorization of the antitrust authority, which in Peru is INDECOPI. However, in order to promote economic efficiency and protect consumers, anti-competitive behavior is subject to sanctions under applicable law. Behavior that is prohibited according to national law includes: (i) the abuse of a dominant market position, (ii) concerted horizontal practices and (iii) concerted vertical practices. Moreover, under the Unfair Competition Law it is illegal to act in a way that may hinder the competitive process. An unfair behavior is one that is objectively contrary to the entrepreneurial good faith, ethical behavior and efficiency in a market economy.

 

45

 

C. Organizational Structure

 

All of our operating subsidiaries are incorporated in Peru. The following chart sets forth our simplified corporate structure, operating subsidiaries only, as of the date of this annual report.

 

 

The following is a brief description of the principal activities of our consolidated subsidiaries.

 

  Cementos Selva S.A. is engaged in the production and marketing of cement and other construction materials in the northeast region of Peru.  It also owns all of the equity shares of Dinoselva Iquitos S.A.C. (a cement and construction materials distributor in the north of Peru, which also produces and sells precast, cement bricks and ready-mix concrete) and in Acuícola Los Paiches S.A.C. (a fish farm entity).
     
  Distribuidora Norte Pacasmayo S.R.L. is mainly engaged in selling cement produced by the Company.  Additionally, it produces and sells precast, cement bricks and ready-mix concrete.
     
  Empresa de Transmisión Guadalupe S.A.C. is mainly engaged in providing electric energy transmission services to the Company.
     
  Other non.relevant, non-operating subsidiaries
     
  Calizas del Norte S.A.C. (on liquidation).  On May 31, 2016, the Company decided to liquidate the subsidiary Calizas del Norte S.A.C.
     
  Salmueras Sudamericanas S.A. (“Salmueras”) was engaged in the exploration of a brine project located in the northern region of Peru.  In December 2017, the Company decided not to continue with the activities related to this project, as explained in note 1.4 to our annual audited consolidated financial statements included in this annual report.
     
  Soluciones Takay S.A.C is a platform that connects families that want to build with certified professionals.

 

D. Property, Plant and Equipment

 

Properties

 

We own our headquarters office in Lima, Peru, at Calle La Colonia 150, Urbanización El Vivero, Surco. We also own our plants, warehouses, transportation facilities and the office space at our production facilities, including our workers’ facilities occupying approximately 50,000 square meters at our Pacasmayo facility and a warehouse occupying approximately 25,000 square meters at the Salaverry port facility.

 

46

 

Area of Operation

 

We own and operate three cement production facilities. Our largest facility is located in the city of Pacasmayo, department of La Libertad, approximately 667 kilometers north of Lima. The second facility is located in the city of Piura, department of Piura, approximately 330 kilometers north of Pacasmayo. This facility started cement production in September 2015. We also own and operate a smaller cement facility, located in the city of Rioja, department of San Martín, approximately 468 kilometers east of the Panamericana Norte highway. From the Pacasmayo and Piura facilities we supply cement principally to the coastal and highland regions of northern Peru, including the cities of Piura, Chiclayo, Cajamarca, Trujillo and Chimbote. From our Rioja facility, we supply cement to the northeastern region of Peru, including the cities of Moyobamba, Tarapoto, Loreto, among others among others.

 

 

Pacasmayo Facility

 

As of December 31, 2020, our Pacasmayo facility had 10 kilns, which produce clinker (one of which is also equipped to produce quicklime), and an additional Waelz rotary kiln that produces quicklime. Additionally, our facility has a primary and secondary cone crusher located near our Acumulación Tembladera limestone quarry. The main crusher has installed crushing capacity of 800 metric tons per hour and the secondary crusher has installed crushing capacity of 170 metric tons per hour. Our Pacasmayo facility operates with three horizontal rotary kilns with total installed annual clinker production capacity of 1,034,880 metric tons and six vertical shaft kilns with total installed annual clinker production capacity of 465,120 metric tons. The total installed annual clinker production capacity at our Pacasmayo facility is 1.5 million metric tons. Our Pacasmayo facility also features three cement finishing mills with installed annual cement production capacity of 2.9 million metric. Our Pacasmayo facility is also equipped with silos containing storage capacity for 26,700 metric tons of cement.

 

As of December 31, 2020, our Pacasmayo facility had installed production capacity of approximately 240,000 metric tons of quicklime per year, including the annual installed capacity of one of our clinker kilns and our Waelz rotary kiln, which are equipped to also produce quicklime.

 

Piura Facility

 

Annual installed production capacity of our Piura plant is 1.6 million metric tons of cement and 1 million metric tons of clinker.Our Piura plant operates with a horizontal kiln with installed clinker production capacity of 1 million metric tons per year, as well as a cement mill with installed cement production capacity of 1.6 million metric tons per year. Our Piura plant also has two storage silos with storage capacity of 240,000 metric tons of cement.

 

During 2020, we invested in the construction of a new silo, with a capacity of 1,300 MT, which will reduce transportation costs as we will be able to serve the areas of influence from the Piura plant.

 

Rioja Facility

 

Annual installed production capacity of our Rioja plant is 440,000 metric tons of cement and 280,000 metric tons of clinker.

 

Our Rioja facility currently operates with a small cone crusher and four vertical shaft kilns with total annual installed clinker production capacity of 280,000 metric tons and three cement finishing mills with total annual installed cement production capacity of 440,000 metric tons. Our Rioja plant is also equipped with silos with storage capacity of 1,750 metric tons of cement.

 

47

 

Ready-Mix Concrete Facilities

 

We also have 22 fixed and mobile ready-mix concrete and precast facilities located in the northern cities of Chimbote, Trujillo, Chiclayo, Piura, Cajamarca, Pacasmayo, Tarapoto, Iquitos and Moyobamba among others. These facilities allow us to supply ready-mix concrete and precast materials to small, medium and large construction projects throughout the entire northern region of Peru. As of December 31, 2020, our ready-mix operations had 186 mixer trucks and 30 concrete pumps available to deliver ready-mix concrete.

 

Capacity and Volumes

 

The table below sets forth our clinker, cement and quicklime production capacity and volumes in our Pacasmayo and Rioja facilities for the periods indicated.

 

(in thousands of  As of and for the year ended December 31, 
metric tons,  2020   2019   2018 
except percentages)  Capacity   Production   Utilization
rate(1)
   Capacity   Production   Utilization
rate(1)
   Capacity   Production   Utilization
rate(1)
 
Cement:                                    
Pacasmayo facility   2,900    1,307    45.1%   2,900    1,368    47.2%   2,900    1,155.3    39.8%
Piura facility   1,600    1,020    59.8%   1,600    954    59.7%   1,600    918    57.4%
Rioja facility   440    263    63.7%   440    301    68.4%   440    272.9    62.0%
Total   4,940    2,590    52.4%   4,940    2,623    53.1%   4,940    2,346.2    47.5%
Clinker:                                             
Pacasmayo facility   1,500    712    47.5%   1,500    864    57.6%   1,500    831.4    55.4%
Piura facility   1,000    566    56.6%   1,000    758    75.8%   1,000    676.2    67.6%
Rioja facility   280    198    70.9%   280    231    82.5%   280    211.3    75.5%
Total   2,780    1,477    53.1%   2,780    1,853    66.6%   2,780    1,718.9    61.8%
Quicklime(2):                                             
Pacasmayo facility   240    54.4    22.7%   240    73.6    30.7%   240    105.3    43.9%

 

 

(1) Utilization rate is calculated by dividing production for the specified period by installed capacity.
(2) Our Rioja facility does not produce quicklime.  In addition, one of our clinker kilns and our Waelz rotary kiln are equipped to produce quicklime.

 

Insurance

 

We maintain a comprehensive insurance program that protects us from certain types of property and casualty losses. Our plants and equipment are insured against losses. Additionally, our insurance policy provides coverage for business interruption in our cement manufacturing facilities. We also purchase commercial insurance to cover risks associated with workers’ compensation and other general liabilities. We believe our insurance programs and policy limits and deductibles are appropriate for the risks associated with our business and are in line with the insurance policies of similar cement manufactures that operate in Peru.

 

Sustainability Performance

 

We report our sustainability performance information to the GNR (Getting the Numbers Right) database, inspired by the guiding principles of the Cement Sustainability Initiative (CSI), a sector-project of the World Business Council for Sustainable Development (WBCSD) among other cement companies in Latin America through the Inter-American Cement Federation (FICEM).

 

In August 2018, we joined the Global Cement and Concrete Association (GCCA) and become members of the GCCA and the GCCA announced the formation of a strategic partnership with WBCSD to facilitate sustainable development of the cement and concrete sectors and their value chains. As part of a new agreement, the work carried out by the CSI and the GNR database was transfer from WBCSD to the GCCA on 1 January 2019.

 

We are part of Innovandi, the Global Cement and Concrete Research Network, which was recently launched by the Global Cement and Concrete Association (GCCA). The network ties together the cement and concrete industry with scientific institutions to drive and support global innovation with actionable research. It aims to decisively build on the industry’s sustainability progress and Pacasmayo is one of the 24 companies from across the world, including cement and concrete manufacturers, admixture specialists and equipment suppliers that have already committed to the initiative.

 

In 2020, we were included for the second consecutive year as part of the Dow Jones MILA Sustainability Index. This Index is made up of those companies that demonstrate superior performance among their peers under social, environmental and economic criteria. This achievement comes as a result of Pacasmayo’s effort to improve in all of these criteria and to work towards ambitious goals in terms of long-term sustainability. We are committed not only to remain in the Index but to improve our performance, as we are convinced that the focus on sustainability is key to our business and our stakeholders.

 

48

 

In February 2021, we were selected to be part of The Sustainability Yearbook 2021. To appear in the Yearbook, companies must score within the top 15% of their industry globally and have a gap of less than 30% from the leader’s Global ESG score. Moreover, we have been awarded with the Industry Mover distinction, since we showed the strongest year on year score improvement in our industry. This is the first year that Peruvian companies have been included as part of the Yearbook, and we are one of only two Peruvian companies included, and the only one to be awarded a special recognition. With around 7,000 companies evaluated around the world, an inclusion in the yearbook is a true statement of excellence in corporate sustainability.

 

Social Performance

 

We are committed to the development and quality of life of communities that surround the area where we operate. We have developed a good relationship with the local communities surrounding our plant facilities since we started operations in Pacasmayo. We have a number of social responsibility programs aimed at improving health and education in the area. Below is a brief description of a few of our social initiatives.

 

Tecsup. Tecsup is a leading not-for-profit institute in Peru that provides technical education. It was founded by the family of our controlling shareholder, and we support it by providing scholarships to promising students living near our plants to study at the Trujillo campus of Tecsup. Through its three campuses in Peru, Tecsup has graduated over 11,285 students in various technical fields, some of whom currently work for us and our affiliated companies.

 

Center for Technological Training. We have three training centers at our facilities where we teach students and adults business and technical skills. Our centers are staffed with instructors from Tecsup. The goal of the center is to help develop the professional skills of the local population, especially of students and teachers at the educational institutions in the towns of Tembladera, Pacasmayo and Sechura. In 2020, this program benefited over 1,700 stakeholders.

 

Abilities Strengthening. This program seeks to provide training to local stakeholders such as grassroots organizations, local entrepreneurs, teachers, journalists, among others. The objective of the program is to strengthen their skills and knowledge by providing courses and seminars especially designed for that purpose. The program is funded by us, in coordination with local governments and social institutions, and in 2020 benefited 125 stakeholders.

 

Universidad de Ingeniería y Tecnología – UTEC (University of Engineering and Technology) is an educational nonprofit proposal that since 2012 is aimed at the development of people in the engineering field, looking to satisfy the need for these types of professionals in the labor market by implementing a curriculum in line with the trends and demands that globalization poses to modern engineering, with an integrated approach to innovative teaching models. We support it by providing financial aid for its operations. To enhance students’ knowledge, UTEC also has various national and international alliances with top organizations.

 

Acuícola Los Paiches. Through our social venture, Acuícola Los Paiches S.A.C., we studied the reproductive forms of the “paiche” (arapaima giga), a native fish species that was on the edge of extinction. After years of studies and scientific testing, we have successfully bred this species in captivity, and we have obtained thousands of fingerlings.

 

Actions to fight against COVID-19 in our communities. 2020 was one of the most challenging periods in Pacasmayo’s history. The global COVID-19 pandemic has created unprecedented impacts in Peru and on the national economy, namely a collapsed healthcare system, more than 37,000 thousand dead, strict confinement measures that paralyzed the country’s country’s main economic activities and which caused a contraction decrease in GDP of 11.1%, as well as the loss of millions of jobs. In order to mitigate this these impacts and help support our communities, we did implemented the following programs and actions:

 

  We benefited more than 8,000 families by delivering 168 MT of food in partnership with local authorities and neighborhood boards.
     
  Over 700,000 people benefited from the S/ 2.3 million we allocated to meet the health needs of the northern region and jungle area of Peru. This allowed us to donate protective equipment, oxygen, rapid tests, and biomedical devices to medical personnel, police, and other public servants with high exposure.

 

49

 

  Over 16.7 km of public roads were disinfected with the support of our mixers, equipment, and volunteer personnel in the cities of Pacasmayo, Scrapie, San Pedro de Lloc, Piura, Sechura and Trujillo.
     
  18,000 homes were disinfected and fumigated with the help of non-profit organizations.
     
  We reached 3.5 million people by disseminating messages in different local media promoting hygiene habits, social distancing, and the use of masks.

 

Risk Management

 

Risk Management Description

 

Corporate Risk Management (GRC) is a structured approach that allows managing all of the important risks that could affect our long-term objectives. The purpose of this approach is to support senior management in the decision-making process, in order to reduce adverse impacts and take advantage of opportunities; as well as managing the action plans to mitigate the risks.

 

Therefore, Pacasmayo has processes and systems that analyze and evaluate the management of the its business units, encouraging continuous improvement. Our management control systems include:

 

  Mapping of new emerging risks and definition of impact, probability and design of controls;
     
  Periodic review of current risks and update of Impact Probability and Controls information;
     
  Quantification and effect of risk on EBITDA;
     
  Evaluation of external factors; and
     
  Periodic review of policies, procedures, regular internal audits and employee training.
     
  Risk Management Process
     
  The following are highlights of our risk management process.
     
  The Risks are mapped considering the impact on profit, revenues, resources, employees, communities where we operate and our suppliers.
     
  An integrated risk management system and tools are used to collect information collaboratively with the functional areas and external sources of the company.
     
  These processes include the evaluation of risks related to Operations, Human Rights, Sustainability, Fraud and Corruption, in different areas such as commercial, operations, environment, health and safety, among others.
     
  The development of a risk management culture throughout the company in a decentralized manner, integrating the processes to the mapping of risks and the identification and mitigation of risks from the strategic level to the operational level.
     
  The foregoing is reinforced with training for employees and suppliers and communication plans for the entire company.

 

50

 

Risk Management Organization

 

Managers responsible
for risk Metrics
  Risk Management Team   Risks committee   Audit Committee

●     Those responsible for the evaluation, management and prevention of the risk metrics of each area.

 

●     Risk management coordinates with them for the development and monitoring of these metrics.

  ●     Group responsible for the implementation of the corporate risk management strategy, which includes activities such as risk identification, evaluation, quantification, and promotion of a risk management culture, among others.  

●     Group created to establish and supervise the implementation of the risk management strategy at the corporate level.

 

●     It is made up by the CEO, the VPs and the Risks Manager

 

●     the Risks Committee reports to the Audit Committee

 

●     Made up by 3 independent board members, reports directly to the Board

 

●     The participants are the external auditors, the internal auditor, the compliance officer, the CFO and the Risk Manager

 

●     Evaluates improvement opportunities and plans for the risk metrics.

 

Due to the outbreak of COVID-19, we have activated three plans that are key to the continuity of our business:

 

  Incident response plan – focused on the immediate response.  It includes employee safety and asset protection in each location.
     
  Crisis management plan – focus on leadership and the response to manage business impact, including communication with stakeholders.
     
  Business recovery plan – Focus on the actions and knowledge needed to recover operations and maintain uninterrupted service.

 

Based on these plans, we have prepared a restart protocol for the restart of operations that include new safety measures and measures for the protection of and we have updated all of our protocols relating to health and safety to include measures needed to stop the spread of COVID-19.

 

Emerging risks

 

Emerging risks are those that have an impact in the long-term. The risks considered here include all recently identified risks that could have a long-term impact on the company’s business or industry, although in some cases they may have already begun to impact the company’s business.

 

51

 

Risk Description   Potential Impact   Mitigation actions   Evidence of mitigation actions
Economic risk: Market share, pricing or placement could be negatively impacted by the entrance of incumbent sellers, resellers or new business models within the construction industry   Medium to high: Although disruption in the Construction industry is still low due to new digital business models or the use of intense technology, we acknowledge that it is not a matter of whether the industry will be impacted but rather a matter of when  

ü Several in house projects, pilots and Proof of Concept are underway and planned to explore complementary business models

 

ü Investing in a corporate entrepreneurship initiative (startup)

 

ü Open innovation initiatives to explore investment in startups in the region

 

 

ü integrating horizontally developing digital solutions to work better with small and medium size hardware stores (Project Moche), looking into digitizing a good part of the order to cash process with Construction Companies (Project Egypt) and exploring new sales channels (Project Canal Propio)

 

ü Provide seed capital and technical assistance to Soluciones Takay, a venture founded in late 2018 and managed by former employees of Cementos Pacasmayo, who are currently developing a marketplace that connects customers planning to build a house with top-quality, pre-screened independent professionals. This investment provides Pacasmayo with a unique opportunity to explore different business-to-consumer models and gather relevant information straight from the end consume.

 

ü Working with startups that focus on last mile delivery and solutions at points of sales. 

Reputational and economic: Increased environmental regulation

 

  Medium to high: Although we comply with all current environmental regulations, we acknowledge that, if regulation changes, we can have a an impact due to the absence of new environmental permits and non-compliance with new regulations and sanctions, fines and stoppage of activities because of it.  

ü Identification and management in advance of environmental permits for projects

 

ü Exceed current regulations

 

ü Constant supervision of all operating units

 

ü Identification of additional regulations in other countries, which could be adopted in Peru. 

 

ü Environmental commitments compliance program

 

ü Diagnosis of the impact of a Nationally Appropriate Mitigation Action (NAMA) currently under discussion with the Peruvian government to mitigate greenhouse gas emissions

 

ü Development of an Environmental Information System under which environmental management will be planned

  

ü Execution of Internal Control Measures to exceed maximum allowed levels

 

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

52

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

A.Operating Results

 

Overview

 

We are a leading Peruvian cement company, and the only cement manufacturer in the northern region of Peru. With more than 62 years of operating history, we produce, distribute and sell cement and cement-related materials, such as precast products and ready-mix concrete. Our products are primarily used in construction. We also produce and sell quicklime for use in mining operations.

 

In 2020, our cement sales volume were approximately 2.6 million metric tons, representing an estimated 26.1% share of Peru’s total cement sales that year. That same year, we also sold approximately 58 thousand metric tons of quicklime.

 

We own three cement production facilities, our Pacasmayo and Piura facilities located in the northwest region of, Peru, and our smaller Rioja facility located in the northeast. Our facilities have total installed annual cement production capacity of approximately 4.9 million metric tons. We also have installed annual production capacity of 240,000 metric tons of quicklime. We own concession rights to several quarries with reserves of limestone/seashells and other raw materials located near our facilities. We estimate that our existing quarries have sufficient reserves to supply our limestone and seashell needs for approximately 73 years, based on our estimated annual extraction of limestone/seashell consumption levels. We completed an expansion of our Rioja plant in April 2013. We more than doubled the cement production capacity of our Rioja facility by installing a new production line that added 240,000 metric tons of installed annual cement production capacity. In 2015, we completed construction of our cement plant in Piura, the third largest city in northern Peru, which has an annual production capacity of 1.6 million metric tons of cement. The first ton of cement from the Piura facility was produced and shipped on September 17, 2015, and clinker production started in January 2016. The Piura plant improved our competitive position in the northern region of Peru. With production from three plants, we are able to serve our market more efficiently. This state-of-the-art plant in Piura is one of the most modern in Latin America. It also reduces transportation costs by enabling the dispatching of cement from plants within closer proximity to the point of sale.

 

Factors Affecting our Results of Operations

 

Revenue Drivers

 

In 2020, approximately 91.4% of our total cement sales were in the form of bagged cement, substantially all of which was sold through retailers both within and outside of our distribution network. The remaining 8.6% of our cement was sold in bulk or in shipments of precast products or ready-mix concrete directly to large construction companies. Our retail sales are directed to both the auto-construcción segment and construction companies that buy cement for a variety of small construction works, including minor residential, commercial and infrastructure projects. Cement destined for large private and public projects, such as housing complexes, highways, irrigation channels, hospitals, schools, mining and industrial facilities, is typically sold in bulk or in shipments of precast products or ready-mix concrete.

 

Based on our estimates, sales to the auto-construcción segment accounted for approximately 70.6% of our total cement sales in 2020, 60.3% in 2019, 58.7% in 2018; private construction projects, both large and small, accounted for approximately 13.6% of our total cement sales in 2020, 19.9% in 2019, 24.4% in 2018; and public construction projects accounted for the remaining 15.8% in of our total cement sales in 2020, 19.8% in 2019, and 16.9% in 2018. During 2020 we saw an increase in auto-construcción compared to other segments, mainly due to its resilience in times of crisis. As the Peruvian economy starts to recover from the impact of the COVID-19 pandemic and continues to become less informal, private construction projects and infrastructure are expected to become increasingly more important to our business.

 

Our cement sales are largely driven by residential construction (both auto-construcción and small and large housing developments undertaken by construction companies), which is generally affected by economic conditions in the northern region of Peru. Auto-construcción is particularly affected by levels of disposable household income, as low-income families tend to invest most of their savings in developing their homes. Larger residential construction is more susceptible to the economic outlook, the availability of financing and prevailing investment levels in the region. GDP in the northern region of Peru is estimated to have contracted by 9.7% in 2020, grown 3.2% in 2019 and 4.7% in 2018. Our cement volumes, which represented most of the cement sales in the northern region of Peru, contracted by 1.3% in 2020, grew 10.6% in 2019 and 4.3% in 2018, in terms of metric tons of cement shipments.

 

53

 

Our cement sales are also driven, to a lesser extent, by commercial developments and infrastructure projects. Commercial and other private construction projects are also affected by the level of public and private investment in the region, while public infrastructure projects depend on the priorities and financial resources of the national, regional and local governments. During 2020, there was a significant reduction in activity relating to these projects, due primarily to the economic impact of the COVID-19 pandemic.

 

Cost Drivers

 

Coal is the main source of energy used in our production process, in particular to fuel our kilns. We purchase anthracite coal from nearby coal mines and import a small amount of bituminous coal primarily from Colombia. We do not have long-term coal supply agreements, and we do not engage in hedging transactions in connection with the price of coal. In the past, the price of bituminous coal has been related to the international price of oil, as it is used as a substitute for oil. Coal accounted for an estimated 12.6% of our costs of production in 2020, 13.7% in 2019 and 16.2% in 2018. In 2011, we exercised certain of our options to purchase coal mining concessions, which we intend to use to continue to reduce our use of bituminous coal sourced by third-party producers.

 

During the first months of 2020 we used gas in our Piura facility to fuel our kiln. We had a long-term gas supply agreement with Olympic Peru which we decided to terminate in 2020. Gas accounted for an estimated 1.5% of our costs of production in 2020, since we only used gas during the first half of the year.

 

Electricity is used in our facilities mainly to power our cement mills. We power our Pacasmayo facility with electricity purchased from Electroperú, with which we have a long-term supply agreement expiring in 2026. Our Rioja facility is powered primarily with electricity from ELOR, with which we have a medium-term supply agreement expiring in 2022. Under these agreements, the price of electricity is based on a formula that takes into consideration our consumption of electricity and certain market variables, including the international price of oil. Electricity accounted for approximately 14.6% of our cost of production in 2020, 14.4% in 2019 and 14.8% in 2018. Electricity costs tend to be lower during the rainy season, from January to March of each year, as our region is served primarily by hydro-electric power plants.

 

In addition, we purchase from third parties admixtures and certain raw materials that we use in our production process, including gypsum, blast furnace slag, iron and other materials. Admixtures and raw materials used in our cement production process do not include construction supplies that we acquire from third-parties for resale through our distribution network along with our cement products. The cost of admixtures and raw materials purchased from third parties accounted for approximately 4.3% of our cost of production in 2020, 4.6% in 2019 and 4.6% in 2018.

 

Personnel expenses represented 14.8% of our total costs and expenses in 2020, 18.9% in 2019, and 16.5% in 2018.

 

Third-Party Construction Supplies

 

In addition to selling our own products, we also sell and distribute construction supplies manufactured by third parties, such as steel rebar, wires and pipes that are typically used in construction along with our cement. Our profit margins from the sale of third party construction supplies are significantly lower than the margins on our cement products and they are affected by fluctuations in product prices and the exchange rate between the sol and the U.S. dollar between the time we purchase these products and the time we resell them. We sell these products primarily as a service to retailers in our distribution network in an effort to support the sale of our cement products.

 

Mining Royalty Tax

 

The mining royalty tax for the exploitation of metallic and non-metallic minerals is payable on a quarterly basis in an amount equal to the greater of (i) an amount determined in accordance with a statutory scale of tax rates based on a company’s operating profit margin that is applied to its operating profit, as adjusted by certain non-deductible expenses and (ii) 1% of a company’s net sales, in each case during the applicable quarter. These amounts are determined based on our unconsolidated financial statements and those of our subsidiaries with operations that are under the scope of the Mining Royalty Law. Mining royalty payments are deductible for income tax purposes in the fiscal year in which such payments are made. For additional information, see note 29 to our annual audited consolidated financial statements included in this annual report.

 

54

 

Operating Segments

 

We have three operating segments: (i) cement, concrete and precast, (ii) quicklime and (iii) sales of construction supplies. For additional information on our operating segments, see note 32 to our annual audited consolidated financial statements included in this annual report.

 

New Accounting Pronouncements

 

For a description of new interpretations and improvements to IFRS in effect since 2020, see note 2.3.19 and 4 to our annual audited consolidated financial statements included in this annual report.

 

Critical Accounting Policies

 

The following is a discussion of our application of critical accounting policies that require our management to make certain assumptions about matters that are uncertain at the time the accounting estimate is made, where our management could reasonably use different estimates, or where accounting changes may reasonably occur from period to period, and in each case would have a material effect on our financial statements. For additional information, see note 2.3 to our annual audited consolidated financial statements included in this annual report.

 

Determination of Useful Live of Assets for Depreciation and Amortization Purposes

 

Depreciation of mining concessions and mine development costs are charged to cost of production on a units-of-production basis using proved reserves. Other assets are depreciated on a straight-line-basis over their estimated useful lives, as follows:

 

Buildings and other constructions:

 

Years

Administrative facilities   Between 20 and 51
Main production structures   Between 20 and 56
Minor production structures   Between 20 and 35
Machinery and equipment:    
Mills and horizontal furnaces   Between 24 and 45
Vertical furnaces, crushers and grinders   Between 23 and 36
Electricity facilities and other minors   Between 10 and 35
Furniture and fixtures   10
Transportation units:    
Heavy units   Between 5 and 15
Light units   Between 5 and 10
Computer equipment   Between 3 and 10
Tools   Between 5 and 10

 

The assets’ residual value, useful lives and methods of depreciation/amortization are reviewed at each reporting period, and adjusted prospectively, if appropriate.

 

An item of property, plant and equipment and any significant part initially recognized is derecognized upon disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the consolidated income statement when recognition of the asset is derecognized.

 

Revenue Recognition

 

Revenue is measured at the fair value of the consideration received or receivable, taking into account contractually defined terms of payment and excluding taxes or duty.

 

The following specific recognition criteria must also be met before revenue is recognized:

 

55

 

Sales of goods

 

Revenue from sale of goods is recognized at the point in time when control of the asset is transferred to the customer, generally on delivery of the goods.

 

We consider whether there are other promises in the contract that are separate performance obligations to which a portion of the transaction price needs to be allocated. In determining the transaction price for the sale of goods, we consider the effects of variable consideration, the existence of significant financing components, noncash consideration, and consideration payable to the customer (if any).

 

Rendering of services

 

In the businesses segments cement, quicklime, concrete, precast and construction supplies, we provide transportation services. These services are sold together with the sale of the goods to the customer.

 

Transportation services are satisfied when the transport service is concluded, which coincides with the moment of delivery of the goods to the customers.

 

Operating lease income

 

Income from operating lease of land and office was recognized on a monthly accrual basis during the term of the lease.

 

Interest income

 

For all financial instruments measured at amortized cost and interest-bearing financial assets, interest income is recorded using the effective interest rate (EIR). EIR is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial instrument or a shorter period, where appropriate, to the net carrying amount of the financial asset or liability. Interest income is included in finance income in the consolidated statement of profit or loss.

 

Impairment of Non-Financial Assets

 

We assess at each reporting date whether there is an indication that an asset may be impaired. If any indication exists, or when annual impairment testing for an asset is required, (goodwill and Intangible assets with indefinite useful lives), we estimate the asset’s recoverable amount. An asset’s recoverable value is the higher of an asset’s or cash-generating unit’s fair value less costs of disposal and its value in use, and is determined for an individual asset, unless the asset does not generate net cash inflows that are largely independent of those from other assets or groups of assets. Where the carrying amount of an asset’s cash-generating unit exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. In determining fair value less costs of disposal, recent market transactions are taken into account. If no such transactions can be identified, an appropriate valuation model is used. These calculations are corroborated by valuation multiples, quoted share prices for publicly traded companies or other available fair value indicators.

 

As of December 31, 2020 and 2019, goodwill related to the acquisition of assets made by our subsidiary Distribuidora Norte Pacasmayo S.R.L. amounted to S/4,459,000. See note 1.2 to our annual audited consolidated financial statements. We have assessed the recoverable amount of our goodwill and has determined that there are no indicators of an impairment loss of this asset as of December 31, 2020 and 2019.

 

We base our impairment calculation on detailed budgets and forecast calculations, which are prepared separately from our cash generation units to which the individual assets are allocated. Impairment losses of continuing operations, including impairment on inventories, are recognized in the consolidated statement of profit or loss in expense categories consistent with the function of the impaired asset.

 

An assessment is made at each reporting date as to whether there is any indication that previously recognized impairment losses may no longer exist or have decreased. If such indication exists, we estimate the asset’s or cash-generating unit’s recoverable amount. A previously recognized impairment loss is reversed only if there has been a change in the assumptions used to determine the asset’s recoverable amount since the last impairment loss was recognized. The reversal is limited so that the carrying amount of the asset does not exceed its recoverable amount, nor exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognized for the asset in prior years. Such reversal is recognized in the consolidated statement of profit or loss. Exploration and evaluation assets are tested for impairment annually as of December 31, either individually or at the cash-generating unit level, as appropriate and when circumstances indicate that the carrying value may be impaired.

 

56

 

Deferred Tax

 

Deferred tax is provisioned using the liability method on temporary differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes at the reporting date.

 

Deferred tax liabilities are recognized for all taxable temporary differences, except in respect of taxable temporary differences associated with investments in subsidiaries, associates and interests in joint arrangements, when the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future.

 

Deferred tax assets are recognized for all deductible temporary differences, the carry forward of unused tax credits and unused tax losses. Deferred tax assets are recognized to the extent that it is probable that taxable profit will be available against which the deductible temporary differences, and the carry forward of unused tax credits and unused tax losses can be utilized, except in respect of deductible temporary differences associated with investments in subsidiaries, where deferred assets are recognized only to the extent that it is probable that the temporary differences will reverse in the foreseeable future and taxable profit will be available against which the temporary differences can be utilized.

 

The carrying amount of deferred tax assets is reviewed at each reporting date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred tax asset to be utilized. Unrecognized deferred tax assets are re-assessed at each reporting date and are recognized to the extent that it has become probable that future taxable profits will allow the deferred tax asset to be recovered.

 

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the reporting date. Deferred tax related to items recognized outside profit or loss is recognized outside profit or loss. Deferred tax items are recognized in correlation to the underlying transaction either in other comprehensive income or directly in equity.

 

Deferred tax assets and deferred tax liabilities are offset if a legally enforceable right exists to set off current tax assets against current income tax liabilities and the deferred taxes relate to the same taxable entity and the same taxation authority.

 

Derivative Financial Instruments and Hedge Accounting

 

Initial Recognition and Subsequent Measurement

 

We use derivative financial instruments, such as cross-currency swaps (CCS), to hedge our foreign currency exchange rate risk. Such derivative financial instruments are initially recognized at their fair value on the date on which the derivative contract is entered into and subsequently remeasured at their fair value. Derivatives are carried as financial assets when the fair value is positive and as financial liabilities when fair value is negative.

 

For the purpose of hedge accounting, hedges are classified as follows:

 

“Fair value hedges” are those that hedge the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment.

 

“Cash flow hedges” are those that hedge the exposure to variability in cash flows that is either attributable to a particular risk associated with a recognized asset or liability or a highly probable forecast transaction or the foreign currency risk in an unrecognized firm commitment.

 

“Hedges of a net investment in a foreign operation.”

 

57

 

At the inception of a hedge relationship, we formally designate and document the hedge relationship to which we wish to apply hedge accounting and the risk management objective and strategy for undertaking the hedge.

 

The documentation includes identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how our management will assess the effectiveness of changes in the hedging instrument’s fair value in offsetting the exposure to changes in the hedged item’s fair value or cash flows attributable to the hedged risk. Such hedges are expected to be highly effective in achieving offsetting changes in fair value or cash flows and are assessed on an ongoing basis to determine that they actually have been highly effective throughout the financial reporting periods for which they were designated.

 

A hedging relationship qualifies for hedge accounting if it meets all of the following effectiveness requirements:

 

there is ‘an economic relationship’ between the hedged item and the hedging instrument;

 

the effect of credit risk does not ‘dominate the value changes’ that result from that economic relationship; and

 

the hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item that the Group actually hedges and the quantity of the hedging instrument that the Group actually uses to hedge that quantity of hedged item.

 

Hedges that meet all the qualifying criteria for hedge accounting are recorded as cash flow hedges.

 

Cash flow hedges

 

Any gains or losses arising from changes in the fair value of derivatives is taken directly to profit or loss, except for the effective portion of cash flow hedges, which is recognized in other comprehensive income (OCI) and later reclassified to profit or loss when the hedge item affects profit or loss.

 

For any other cash flow hedges, the amount accumulated in OCI is reclassified to profit or loss as a reclassification adjustment in the same period or periods during which the hedged cash flows affect profit or loss.

 

If the cash flow hedge is discontinued, the amount accumulated in other comprehensive income must remain in other comprehensive income accumulated if the covered cash flows are still expected to occur. Otherwise, the amount will be immediately reclassified to profit or loss as a reclassification adjustment. After discontinuation, once the covered cash flows are given, any amount that remains in other comprehensive accumulated results must be recorded considering the nature of the underlying transaction.

 

58

 

Results of Operations

 

Comparison of Year Ended December 31, 2020 to Year Ended December 31, 2019

 

   Year ended December 31,     
(amounts in millions of S/)  2020   2019   Variation
%
 
Sales of goods   1,296.3    1,392.7    (6.9)
Cost of sales   (921.0)   (905.8)   1.7 
Gross profit   375.3    486.9    (22.9)
Operating income (expense):               
Administrative expenses   (163.4)   (174.5)   (6.4)
Selling and distribution expenses   (40.1)   (44.5)   (9.9)
Other operating income (loss) or (expense), net   4.3    2.6    65.4