Company Quick10K Filing
Quick10K
Cosan
20-F 2018-12-31 Annual: 2018-12-31
20-F 2017-12-31 Annual: 2017-12-31
20-F 2016-12-31 Annual: 2016-12-31
20-F 2015-12-31 Annual: 2015-12-31
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DECK Deckers Outdoor 4,166
JJSF J&J Snack Foods 3,558
TR Tootsie Roll 2,412
JBSS Sanfilippo John B & Son 1,026
ITRN Ituran Location & Control 608
BRID Bridgford Foods 308
LND Brasilagro - Brazilian Agricultural Real Estate 199
RMCF Rocky Mountain Chocolate Factory 55
TLF Tandy Leather Factory 40
CZZ 2018-12-31
Part I
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 4. Information on The Company
Item 4A. Unresolved Staff Comments
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Item 12. Description of Securities Other Than Equity Securities
Part II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications To The Rights of Security Holders
Item 15. Controls and Procedures
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions From The Listing Standards for Audit Committees
Item 16E. Purchases of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F. Change in Registrant's Certifying Accountant
Item 16G. Corporate Governance
Item 16H. Mine Safety Disclosure
Part III
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Exhibits
EX-8.1 d655063dex81.htm
EX-12.1 d655063dex121.htm
EX-12.2 d655063dex122.htm
EX-13.1 d655063dex131.htm
EX-13.2 d655063dex132.htm

Cosan Earnings 2018-12-31

CZZ 20F Annual Report

Balance SheetIncome StatementCash Flow

20-F 1 d655063d20f.htm FORM 20-F Form 20-F
Table of Contents

 

 

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, 2018

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: 1-33659

COSAN LIMITED

(Exact name of Registrant as specified in its charter)

N/A

(Translation of Registrant’s name into English)

Bermuda

(Jurisdiction of incorporation or organization)

Av. Faria Lima, 4,100 – 16th floor

São Paulo – SP, 04543-011, Brazil

(55)(11) 3897-9797

(Address of principal executive offices)

Marcelo Eduardo Martins

(55)(11) 3897-9797

ri@cosan.com

Av. Faria Lima, 4,100 – 16th floor

São Paulo – SP, 04543-011, Brazil

(Name, Telephone, E-Mail and/or Facsimile number and Address of Company Contact Person)

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

 

Title of each class

  

Name of each exchange on which registered

Class A Common Shares    New York Stock Exchange

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

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

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.

The number of outstanding shares as of December 31, 2018 was:

 

Title of Class

  

Number of Shares Outstanding

Class A Common Shares, par value $.01 per share

   148,343,668

Class B – series 1 – Common Shares, par value $.01 per share

   96,332,044

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes  ☒    No  ☐

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

Large Accelerated Filer  ☒            Accelerated Filer  ☐            Non-accelerated Filer  ☐            Emerging growth company  ☐

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

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

Indicate by check mark which basis of accounting the registrant has used to prepare the financial 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  ☒

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page  
PART I      1  

Item  1.   Identity of Directors, Senior Management and Advisers

     1  

Item 2.   Offer Statistics and Expected Timetable

     1  

Item 3.   Key Information

     1  

A. Selected Financial Data

     1  

B. Capitalization and Indebtedness

     5  

C. Reasons for the Offer and Use of Proceeds

     5  

D. Risk Factors

     5  

Item 4.   Information on the Company

     49  

A. History and Development of the Company

     49  

B. Business Overview

     53  

C. Organizational Structure

     68  

D. Property, Plant and Equipment

     69  

E.  Supplemental Information About Joint Venture

     72  

Item 4A.   Unresolved Staff Comments

     80  

Item  5.   Operating and Financial Review and Prospects

     80  

A. Operating Results

     91  

B. Liquidity and Capital Resources

     103  

C. Research and Development, Patents, Licenses, etc.

     106  

D. Trend Information

     106  

E.  Off-Balance Sheet Arrangements

     107  

F.  Tabular Disclosure of Contractual Obligations

     107  

G. Safe Harbor

     108  

Item  6.   Directors, Senior Management and Employees

     108  

A. Directors and Senior Management

     108  

B. Compensation

     114  

C. Summary of Significant Differences of Corporate Governance Practices

     114  

D. Employees

     116  

E.  Share Ownership

     117  

Item  7.   Major Shareholders and Related Party Transactions

     119  

A. Major Shareholders

     119  

B. Related Party Transactions

     126  

C. Interests of Experts and Counsel

     126  

Item 8.   Financial Information

     126  

A. Consolidated Statements and Other Financial Information

     126  

B. Significant Changes

     138  

Item 9.   The Offer and Listing

     138  

A. Offer and Listing Details

     138  

B. Plan of Distribution

     139  

C. Markets

     139  

D. Selling Shareholders

     139  

E.  Dilution

     139  

F.  Expenses of the Issue

     139  

 

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Item 10.   Additional Information

     140  

A. Share Capital

     140  

B. Memorandum and By-laws

     140  

C. Material Contracts

     147  

D. Exchange Controls

     148  

E.  Taxation

     148  

F.  Dividends and Paying Agents

     150  

G. Statement by Experts

     150  

H. Documents on Display

     150  

I.   Subsidiary Information

     150  

Item  11.   Quantitative and Qualitative Disclosures About Market Risk

     151  

Item  12.   Description of Securities other than Equity Securities

     153  
PART II      154  

Item  13.   Defaults, Dividend Arrearages and Delinquencies

     154  

Item  14.   Material Modifications to the Rights of Security Holders

     154  

Item 15.   Controls and Procedures

     154  

Item 16A.   Audit Committee Financial Expert

     154  

Item 16B.   Code of Ethics

     155  

Item 16C.   Principal Accountant Fees and Services

     155  

Item  16D.   Exemptions from the Listing Standards for Audit Committees

     155  

Item  16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers

     156  

Item  16F.  Change in Registrant’s Certifying Accountant

     156  

Item 16G.   Corporate Governance

     156  

Item 16H.   Mine Safety Disclosure

     156  
PART III      157  

Item 17.   Financial Statements

     157  

Item 18.   Financial Statements

     157  

Item 19.   Exhibits

     157  

 

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Presentation of Financial and Other Information

We present our consolidated financial statements in accordance with International Financial Reporting Standards, or “IFRS,” as issued by the International Accounting Standards Board, or “IASB,” for Securities and Exchange Commission, or “SEC,” filings.

The consolidated financial statements are presented in Brazilian reais. However, the functional currency of Cosan Limited is the U.S. dollar. The Brazilian real is the currency of the primary economic environment in which Cosan S.A., or “Cosan” or “Cosan S.A.,” Cosan Logística S.A., or “Cosan Logística,” and their respective subsidiaries and jointly-controlled entities, located in Brazil, operate and generate and expend cash. The functional currency for the subsidiaries located outside Brazil is the U.S. dollar, British pound or the Euro. Cosan Limited, Cosan S.A., Cosan Logística and its subsidiaries are collectively referred to as the “Company.”

We have presented our consolidated financial statements for the years ended December 31, 2018, 2017 and 2016, in accordance with IFRS as issued by the IASB. Our consolidated financial statements as of December 31, 2018, 2017 and 2016 and for the years then ended have been audited by KPMG Auditores Independentes, or “KPMG.” KPMG is an independent registered public accounting firm, whose report is included herein.

On June 1, 2011, we and Shell Brazil Holdings B.V., or “Shell,” formed two joint ventures, or the “Joint Venture,” for a combined 50/50 investment, under the names Raízen Combustíveis S.A., or “Raízen Combustíveis” and Raízen Energia e Participações S.A. (currently Raízen Energia S.A.), or “Raízen Energia,” collectively referred to as “Raízen.” Our management evaluates the results of Raízen Energia and Raízen Combustíveis on the same basis as they are evaluated by the management of Raízen, which is on a 100% basis. Accordingly, unless the context requires otherwise, operational information pertaining to Raízen Energia and Raízen Combustíveis included in this annual report refers to 100% of the operations of these businesses. Upon the application of IFRS 11- Joint Arrangements, or “IFRS 11,” the Company retrospectively changed the accounting for its investments in Raízen Combustíveis and Raízen Energia, classifying them as investments in joint ventures. As disclosed in “Item 5. Operating and Financial Review and Prospects,” following the adoption of IFRS 11, starting in April 2013 Cosan S.A. no longer proportionally consolidates Raízen Energia and Raízen Combustíveis in its consolidated statement of financial position, statement of profit or loss and comprehensive income and statement of cash flows, and the results of these investments have been presented using the equity method of accounting in accordance with IAS 28R—“Investments in Associates and Joint Ventures.” For further details, see note 9 to our financial statements.

On April 1, 2015, Cosan S.A., through its then subsidiary Rumo Logística Operadora Multimodal S.A. or “Rumo Logística,” acquired 100% of the common shares of ALL – América Latina Logística S.A., or “ALL.” Accordingly, we began consolidating ALL’s results within our own results of operations as from that date.

On September 30, 2016, Cosan S.A. entered into a Share Purchase Agreement with Mansilla Participações Ltda. (a vehicle of TIAA Teachers Insurance and Annuity Association of America), another shareholder in Radar Propriedades Agrícolas S.A. and Radar II Propriedades Agrícolas S.A., or “Radar and Radar II,” through which Cosan S.A. sold part of its shares in Radar and Radar II for an amount of R$1,053.8 million. The consideration was received on November 4, 2016. As a result of this transaction, Cosan S.A. reduced its equity interest in Radar and Radar II from 37.7% to 3.0%. Cosan S.A. retains significant influence over Radar and Radar II through a shareholders’ agreement as described in “Item 7. Major Shareholders and Related Party Transactions.” The criteria used to measure the remaining stake of the investment was the equity method, in accordance with IAS 28, although it is not consolidated due to the limitation on Cosan S.A.’s decision-making power set forth the shareholders’ agreement. The comparative consolidated statement of profit or loss and statements of cash flows have been restated to show the discontinued operation separately from continuing operations.

On October 8, 2016, ALL – América Latina Logística S.A. changed its corporate name to Rumo S.A. or “Rumo.” Subsequently, on December 31, 2016, Rumo Logística was merged into its wholly-owned subsidiary Rumo, as a result of which Rumo S.A. is the successor entity to Rumo Logística.

In 2016, amendments to IAS 16 and IAS 41 changed the accounting requirements for biological assets that fall within the definition of “bearer plants.” These amendments substantially impact Raízen Energia, and the following line items: “Investments in Joint Ventures” in our statement of financial position and “Equity in Earnings of Joint Ventures” in our statement statements of profit or loss.

 

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Furthermore, during 2016, Cosan S.A. identified an immaterial error related to the recognition of tax installment liabilities, related to federal taxes other than income tax, referring to 2011. Cosan S.A. has determined that it was appropriate to revise its financial statements for the years ended December 31, 2016, 2015 and 2014. The revisions to correct the error in the applicable fiscal years are reflected in the financial information herein and will be reflected in future filings containing such information.

On December 12, 2017, we exercised a put option with Shell relating to shares in Companhia de Gás de São Paulo – COMGÁS, or “Comgás,” and bought a total of 21,805,645 shares, which represents 16.77% of Comgás’s share capital for R$1,042 million. As part of the payment, we delivered to Shell 17,187,937 common shares issued by Cosan S.A., representing 4.21% of its capital stock, and also made a cash payment of R$208.7 million. Additionally, we recognized accounts payable referring to the second installment to be settled within one year after the closing of the transaction in the amount of R$208.7 million (plus interest accruing at rate of 3% per year). As a result, Shell ceased to be a shareholder in Comgás.

On December 22, 2017, Cosan S.A. entered into a definitive agreement with Jus Capital Gestão de Recursos Ltda. and Farallon Latin America Investimentos Ltda., for the purchase and sale of credit rights arising from severance claims filed against the Brazilian federal government, which was required to pay compensation for material damages resulting from the fixing of sugar and alcohol prices below their cost of production, in a total amount of R$1,340 million. In addition to the acquisition price, Cosan S.A. will be entitled to receive certain additional payments which are contingent upon the purchaser’s actual receipts from the receivables.

On March 19, 2018, CLE entered into an agreement with ExxonMobil pursuant to which CLE has received exclusive production, import, distribution and marketing rights in Brazil, Bolivia, Paraguay and Uruguay for lubricants and certain other related products under the Mobil brand until November 30, 2038. This agreement came into force on December 1, 2018.

On April 24, 2018, Raízen Combustíveis and its subsidiary Raízen Argentina Holdings S.A.U. entered into a contract for the acquisition of Shell’s downstream business in Argentina. Pursuant to the above-mentioned agreement, Raízen Argentina Holdings S.A.U. acquired 100% of the outstanding share capital of Shell Compañía Argentina de Petróleo S.A and Energina Compañía Argentina de Petróleo S.A., or “Shell Argentina,” for an amount of U.S.$916 million. The acquisition process was completed on October 1, 2018.

On December 21, 2018, Cosan Lubes Investments Limited, or “CLI,” and CVC Fund VII, or “CVC,” entered into an investment agreement pursuant to which CVC will subscribe for shares in Moove’s capital in a total amount of R$562 million (which is equivalent to approximately 30% of Moove’s capital). Following the satisfaction of the applicable conditions provided in the investment agreement, the transaction closed on March 29, 2019. As a result and pursuant to the terms of the investment agreement, Moove received R$434 million at the closing of the transaction and may receive up to approximately R$128 million until 2021, if certain targets set forth in the investment agreement are met.

Forward-Looking Statements

This annual report contains estimates and forward-looking statements, mainly under “Item 3. Key Information—D. Risk Factors,” “Item 4. Information on the Company—B. Business Overview” and “Item 5. Operating and Financial Review and Prospects.” Some of the matters discussed concerning our business and financial performance include estimates and forward-looking statements.

Our estimates and forward-looking statements are mainly based on our current expectations and estimates on projections of future events and trends, which affect or may affect our businesses and results of operations. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to several risks and uncertainties and are made in light of information currently available to us. Our estimates and forward-looking statements may be influenced by the following factors, among others:

 

   

general economic, political, demographic and business conditions in Brazil and in the world and the cyclicality affecting our selling prices;

 

   

the effects of global financial and economic crises in Brazil;

 

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our ability to implement our expansion strategy in other regions of Brazil and international markets through organic growth, acquisitions or Joint Ventures;

 

   

our ability to successfully compete in all segments and geographical markets where we currently conduct business or may conduct businesses in the future;

 

   

competitive developments in the segments in which we operate;

 

   

our ability to implement our capital expenditure plan, including our ability to arrange financing when required and on reasonable terms;

 

   

government intervention resulting in changes in the economy, taxes and tariffs affecting the markets in which we operate;

 

   

price of natural gas, ethanol and other fuels, as well as sugar;

 

   

equipment failure and service interruptions;

 

   

our ability to compete and conduct our businesses in the future;

 

   

adverse weather conditions;

 

   

changes in customer demand;

 

   

changes in our businesses;

 

   

our ability to work together successfully with our partners to operate our partnerships (such as the Joint Venture);

 

   

technological advances in the natural gas sector, including developments of natural gas for use in other applications, and advances in the development of alternatives to natural gas;

 

   

technological advances in the ethanol sector and advances in the development of alternatives to ethanol;

 

   

changes in global energy usage;

 

   

government intervention and trade barriers, resulting in changes in the economy, taxes, rates, prices or regulatory environment including in relation to our regulated businesses such as Comgás and Rumo;

 

   

inflation, depreciation, appreciation and depreciation of the real;

 

   

other factors that may affect our financial condition, liquidity and results of our operations; and

 

   

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

The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar words are intended to identify estimates and forward-looking statements. Estimates and forward-looking statements speak only as of the date they were made, and we undertake no obligation to update or to review any estimate and/or forward-looking statement because of new information, future events or other factors. Estimates and forward-looking statements involve risks and uncertainties and are not guarantees of future performance. Our future results may differ materially from those expressed in these estimates and forward-looking statements. In light of the risks and uncertainties described above, the estimates and forward-looking statements discussed in this annual report might not occur and our future results and our performance may differ materially from those expressed in these forward-looking statements due to but not limited to, the factors mentioned above. Because of these uncertainties, you should not make any investment decision based on these estimates and forward-looking statements.

 

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Market Data

We obtained market and competitive position data, including market forecasts, used throughout this annual report from market research, publicly available information and industry publications, as well as internal surveys. We include data from reports prepared by LMC International Ltd., the Central Bank of Brazil (Banco Central do Brasil), or the “Brazilian Central Bank,” the Sugarcane Agroindustry Association of the state of São Paulo (União da Agroindústria Canavieira de São Paulo), or “UNICA,” the Brazilian Ministry of Agriculture, Livestock, and Supply (Ministério da Agricultura, Pecuária e Abastecimento), or “MAPA,” the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or “IBGE,” the Brazilian Ministry of Development, Industry and Foreign Trade (Ministério do Desenvolvimento e do Comércio Exterior), or “MDIC,” the Food and Agriculture Organization of the United Nations, or “FAO,” the National Traffic Agency (Departamento Nacional de Trânsito—DENATRAN), the Brazilian Association of Vehicle Manufactures (Associação Nacional dos Fabricantes de Veículos Automotores—ANFAVEA), Datagro Publicações Ltda., F.O. Licht, Czarnikow, Apoio e Vendas Procana Comunicações Ltda., the São Paulo Stock, Commodities and Futures Exchange (B3 S.A. – Brasil, Bolsa, Balcão), or “B3,” the International Sugar Organization, the Brazilian National Economic and Social Development Bank (Banco Nacional de Desenvolvimento Econômico e Social), or “BNDES,” the New York Board of Trade, or “NYBOT,” the New York Stock Exchange, or “NYSE,” the Brazilian Agricultural Research Corporation (Empresa Brasileira de Pesquisa Agropecuária), or “Embrapa,” the Brazilian Secretariat for Foreign Trade (Secretaria de Comércio Exterior), or “Secex,” the National Supply Company (Companhia Nacional de Abastecimento), or “Conab,” the London Stock Exchange, the National Agency of Petroleum, Natural Gas and Biofuels (ANP—Agência Nacional do Petróleo, Gás Natural e Biocombustíveis), or “ANP,” the Brazilian antitrust authority (Superintendência-Geral do Conselho Administrativo de Defesa Econômica), or “CADE,” the National Union of Distributors of Fuels and Lubricants (Associação Nacional das Distribuidoras de Combustíveis, Lubrificantes, Logística e Conveniência), or “Plural,” the Sanitation and Energy Regulatory Agency for the state of São Paulo (Agência Reguladora de Energia de São Paulo), or “ARSESP,” the Brazilian Gas Distributors Association (Associação Brasileira das Empresas Distribuidoras de Gás), or “ABEGÁS,” the Agriculture School of the University of São Paulo (Escola Superior de Agricultura Luiz de Queiroz), or “ESALQ,” the National Waterway Transportation Agency (Agência Nacional de Transportes Aquaviários), or “ANTAQ,” and the National Electric Energy Agency (Agência Nacional de Energia Elétrica), or “ANEEL.” We believe that all market data in this annual report is reliable, accurate and complete.

Terms Used in This Annual Report

In this annual report, we present information in gallons, liters and cubic meters (m³). In addition, we also present information in tons. In this annual report, references to “ton” or “tonne” refer to the metric tonne, which is equal to 1,000 kilograms.

All references in this annual report to “TSR” are to total sugar recovered, which represents the total amount of sugar content in a given quantity of sugarcane.

All references in this annual report to “RTK” mean revenue ton kilometer.

All references in this annual report to “U.S. dollars,” “dollars” or “U.S.$” are to U.S. dollars. All references to the “real,” “reais” or “R$” are to the Brazilian real, the official currency of Brazil.

Rounding

We have rounding adjustments to reach some of the figures included in this annual report. Accordingly, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.

 

 

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PART I

 

Item 1.

Identity of Directors, Senior Management and Advisers

Not applicable.

 

Item 2.

Offer Statistics and Expected Timetable

Not applicable.

 

Item 3.

Key Information

 

A.

Selected Financial Data

The following tables present selected historical financial and operating data for the Company derived from our audited consolidated financial statements. You should read the following information in conjunction with our audited consolidated financial statements and related notes, and the information under “Item 5. Operating and Financial Review and Prospects” in this annual report.

The financial data at and for the fiscal years ended December 31, 2018, 2017, 2016, 2015 and 2014 have been derived from our audited consolidated financial statements prepared in accordance with IFRS as issued by the IASB, unless otherwise stated.

Business Segments and Presentation of Segment Financial Data

We present the following reportable segments:

(1) Raízen Energia: production and marketing of a variety of products derived from sugar cane, including raw sugar (Very High Polarization, or “VHP”), anhydrous and hydrated ethanol, and activities related to energy cogeneration from sugarcane bagasse. In addition, this segment holds interests in companies engaged in research and development on new technology;

(2) Raízen Combustíveis: distribution and marketing of fuels, mainly through a franchised network of service stations under the “Shell” brand throughout Brazil, petroleum refining, the operation of fuel resellers, the manufacture and sale of automotive and industrial lubricants, and the production and sale of liquefied petroleum gas throughout Argentina;

(3) Comgás: distribution of piped natural gas in part of the state of São Paulo to customers in the industrial, residential, commercial, automotive and cogeneration sectors;

(4) Cosan Logística: logistics services for rail transportation, storage and port loading of commodities, mainly for grains and sugar, leasing of locomotives, wagons and another railway equipment;

(5) Moove, consisting of Cosan Lubrificantes e Especialidades S.A., or “CLE,” Stanbridge Group Limited, or “Stanbridge,” Moove Lubricants Limited, or “Moove Lubricants,” (previously known as Comma Oil Chemicals Limited), TTA—SAS Techniques et Technologie Appliquées, or “TTA,” LubrigrupoII, S.A., or “LubrigrupoII,” Cosan Lubrificantes S.R.L, or “Cosan S.R.L” and Commercial Lubricants, LLC (d/b/a Metrolube), or “Metrolube”: production and distribution of lubricants under the Mobil brand in Brazil, Argentina, Bolivia, Uruguay, Paraguay, the United States of America and Europe, as well as in the European and Asian markets under the Comma trademark; and

 

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Reconciliation

(6) Cosan Corporate: an online payment services platform and other investments, in addition to the corporate activities of the Company. The Cosan corporate segment includes the financing subsidiaries for the Cosan group.

Following the adoption of IFRS 11, as of April 1, 2013 Cosan S.A. no longer proportionally consolidates Raízen Energia and Raízen Combustíveis in its consolidated statement of financial position, consolidated statement of profit or loss and comprehensive income and consolidated cash flows, and the results from these businesses are accounted for under the line item “Interest in earnings of joint ventures” in our consolidated statement of profit or loss and other comprehensive income.

 

     As of and for the fiscal year ended December 31,  
     2018     2017     2016     2015     2014  
     (in millions of reais, except where otherwise indicated)  

Consolidated Profit or Loss Data:

          

Net sales

     16,843.9       13,582.5       12,518.1       12,355.5       8,904.7  

Cost of sales

     (12,119.9     (9,232.2     (8,317.5     (8,645.7     (6,353.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     4,724.0       4,350.3       4,200.6       3,709.8       2,551.6  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selling expenses

     (1,023.5     (1,068.7     (1,037.5     (900.7     (881.5

General and administrative expenses

     (981.8     (935.3     (1,000.7     (911.7     (632.1

Other income (expense), net

     738.1       877.6       (116.3     252.3       (152.8

Total operations expenses

     (1,267.1     (1,126.4     (2,154.5     (1,560.1     (1,666.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before equity in earnings of investees and finance results

     3,456.9       3,223.9       2,046.1       2,149.7       885.1  

Interest in earnings of investees

     997.8       1,002.3       1,565.7       703.1       580.0  

Finance results

     (1,610.9     (2,751.5     (3,055.8     (2,184.5     (996.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit before taxes

     2,843.8       1,474.7       556.0       668.3       468.3  

Income tax (expense) benefit:

          

Current

     (464.9     (134.5     (228.6     (167.7     (143.3

Deferred

     (295.6     (293.9     166.9       198.1       119.7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (760.5     (428.4     (61.7     30.4       (23.6

Profit from continuing operations

     2,083.3       1,046.3       494.2       698.7       444.7  

(Loss) profit from discontinued operation, net of tax

                 (35.3     100.9       180.6  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit for the period

     2,083.3       1,046.3       458.9       799.6       625.3  

Net income for the period attributable to non-controlling interests

     (1,107.7     (495.3     (181.2     (394.0     (465.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income for the period attributable to owners of the parent (including discontinued operations)

     975.5       551.0       277.8       405.6       160.2  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Statement of Financial Position Data:

          

Cash and cash equivalents

     3,621.8       4,555.2       4,499.6       3,505.8       1,649.3  

Marketable securities

     4,202.8       3,853.3       1,291.6       605.5       149.7  

Inventories

     716.3       663.1       630.8       656.9       353.7  

Property, plant and equipment

     12,417.8       11,681.6       10,726.4       9,805.9       1,435.9  

Intangible assets and goodwill

     17,190.4       16,973.6       17,109.4       17,309.7       10,286.4  

Total assets

     56,360.7       55,624.5       50,469.9       52,249.2       29,696.3  

Current liabilities

     6,240.8       9,022.3       6,629.1       6,922.6       2,970.9  

Non-current liabilities

          

Loans, borrowings and debentures

     22,574.3       21,688.9       18,338.5       18,829.2       8,502.6  

Preferred shareholders payable in subsidiaries

     1,097.5       1,442.7       1,769.6       2,042.9       1,926.9  

Provision for legal proceedings

     1,363.2       1,348.2       1,268.6       1,193.9       657.8  

Equity attributable to owners of the parent

     6,614.4       6,038.8       6,272.5       5,913.7       5,795.4  

Equity attributable to non-controlling interests

     11,355.0       11,020.7       9,737.3       10,275.5       7,615.0  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     17,969.4       17,059.5       16,009.8       16,189.2       13,410.4  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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     As of and for the fiscal year ended December 31,  
     2018     2017     2016     2015     2014  
     (in millions of reais, except where otherwise indicated)  

Consolidated Other Financial Data:

          

Depreciation and amortization

     2,061.3       1,938.4       1,735.3       1,178.1       678.1  

Net debt(1)

     13,324.1       13,675.9       13,861.8       15,073.0       8,073.3  

Working capital(2)

     5,718.8       4,011.6       2,139.9       (87.4     594.2  

Cash flow provided by (used in):

          

Operating activities

     5,377.9       4,088.1       3,635.4       3,350.6       1,117.2  

Investing activities

     (1,498.8     (3,577.4     (727.0     (1,003.1     (308.5

Financing activities

     (5,106.4     (565.7     (1,819.3     (542.6     (658.6

Basic earnings per share from continuing operations

     R$4.00       R$2.10       R$1.23       R$ 1.44       R$ 0.46  

Diluted earnings per share from continuing operations

     R$3.83       R$2.05       R$1.16       R$ 1.38       R$ 0.40  

Basic earnings/(loss) per share from discontinued operations

                 (R$0.18     R$ 0.09       R$ 0.15  

Diluted earnings/(loss) per share from discontinued operations

                 (R$0.18     R$ 0.09       R$ 0.15  

Number of shares outstanding

     270,687,385       270,687,385       270,687,385       270,687,385       270,687,385  

Declared dividends (millions of reais)

     425.5       792.1       975.4       531.5       445.5  

Declared dividends (millions of U.S. dollars)

     U.S.$ 109.8       U.S.$ 239.5       U.S.$ 299.3       U.S.$ 136.1       U.S.$ 167.7  

Declared dividends per share (reais)

     R$1.7390       R$3.2572       R$3.6851       R$2.0080       R$1.6832  

Declared dividends per share (U.S. dollars)

     U.S.$ 0.4488       U.S.$0.9846       U.S.$1.1307       U.S.$ 0.5142       U.S.$0.6337  

Other Operating Data:

          

Crushed sugarcane (in million tons)

     60.1       60.7       62.2       59.9       57.1  

Sugar production (in million tons)

     3.7       4.3       4.4       4.1       4.1  

Ethanol production (in billion liters)

     2.6       2.2       2.1       2.1       2.1  

Volume of fuel sold (in million liters)(3)

     27,521.2       25,560.2       24,831.5       25,076       25,027.8  

Volume loaded (Cosan Logística)
(in million tons)

     10.8       13.1       13.1       11.7       11.1  

Transported volume (Cosan Logística)
(in million RTK)

     56,351.5       49,690.5       40,270.4       44,908.8        

Natural gas (Comgás) (in million m³)

     4,543.3       4,292.9       4,323.0       5,210.9       5,458.7  

Volume of lubricants and base oil sold
(in million liters)

     345.9       347.8       328.9       316.9       319.8  

 

(1)

Net debt consists of current and non-current debt (including preferred shareholders payable in subsidiaries), net of cash and cash equivalents, marketable securities and derivatives on debt recorded in our consolidated financial statements as other non-current assets. Net debt is a non-GAAP measure.

(2)

Working capital consists of total current assets less total current liabilities.

(3)

Starting from 2015 the reported volumes are based on a methodology developed by Sindicom (Sindicato Nacional das Empresas Distribuidoras de Combustíveis e de Lubrificantes), an association of fuel distributors, which excludes volumes sold to other distributors.

 

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The information in the table below presents a reconciliation of Net debt, a non-GAAP financial measure, the most directly comparable IFRS financial measure. Our calculation of these Net debt may differ from the calculation of similarly titled measures used by other companies. Our management believes that disclosure of Net Debt is useful to potential investors as it helps to give them a clearer understanding of our financial liquidity. Net Debt is also used to calculate certain leverage ratios. However, Net Debt is not a measure under IFRS and should not be considered as a substitute for measures of indebtedness determined in accordance with IFRS.

 

     As of and for the fiscal year ended December 31,  
     2018     2017     2016     2015     2014  
     (in millions of reais, except where otherwise indicated)  

Current loans, borrowings and debentures

     2,115.3       3,903.4       2,404.0       2,775.5       1,056.4  

Non-current loans, borrowings and debentures

     20,459.0       17,785.5       15,934.7       16,053.7       7,446.2  

Preferred shareholders payable in subsidiaries

     1,097.5       1,442.7       1,769.6       2,042.9       1,926.9  

Total

     23,671.8       23,131.6       20,108.3       20,872.1       10,429.5  

Cash and cash equivalents

     (3,621.8     (4,555.2     (4,499.6     (3,505.8     (1,649.3

Marketable securities

     (4,202.8     (3,853.3     (1,291.6     (605.5     (149.7

Total

     (7,824.6     (8,408.5     (5,791.2     (4,111.3     (1,799.0

Derivatives on debt

     (2,523.1     (1,047.2     (455.3     (1,687.8     (557.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net debt(1)

     13,324.1       13,675.9       13,861.8       15,073.0       8,073.3  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

The Company’s covenants consider preferred shareholders payable in subsidiaries in the calculation of net debt.

Exchange Rates

The Brazilian foreign exchange system allows the purchase and sale of foreign currency and the international transfer of reais by any person or legal entity, regardless of the amount, subject to certain regulatory procedures.

Since 1999, the Brazilian Central Bank has allowed the real/U.S. dollar exchange rate to float freely, which resulted in increasing exchange rate volatility. Until early 2003, the real declined against the U.S. dollar. Between 2004 and 2008, the real strengthened against the U.S. dollar, except in the most severe periods of the global economic crisis. Given the recent turmoil in international markets and the current Brazilian macroeconomic outlook, the real depreciated against the U.S. dollar from mid-2011 to early 2016. Beginning in early 2016 through the end of 2016, the real appreciated against the U.S. dollar, primarily as a result of Brazil’s changing political conditions. In 2017 and 2018, the real depreciated 1.5% and 17.1% against the U.S. dollar, respectively. In 2019, to April 26, 2019, the real depreciated 1.96% against the U.S. dollar. In the past, the Brazilian Central Bank has intervened occasionally to control high volatility in the foreign exchange rates. We cannot predict whether the Brazilian Central Bank or the Brazilian government will continue to permit the real to float freely or will intervene in the exchange rate market through the return of a currency band system or otherwise. In the future, the real may fluctuate substantially against the U.S. dollar.

Furthermore, Brazilian law provides that, whenever there is a serious imbalance in Brazil’s balance of payments or there are compelling reasons to foresee a serious imbalance, temporary restrictions may be imposed on remittances of foreign capital abroad. Any such restrictions on remittances of foreign capital abroad may limit our ability to receive dividends from our subsidiaries Cosan S.A. and Cosan Logística S.A. We cannot assure you that such measures will not be taken by the Brazilian government in the future. Exchange rate fluctuation will affect the U.S. dollar value of any distributions we receive from our subsidiaries Cosan S.A. and Cosan Logística S.A., which will be made in reais. See “—D. Risk Factors—Risks Related to Brazil.”

The following tables set forth the selling rate, expressed in reais per U.S. dollar (R$/U.S.$), for the periods indicated:

 

Year

   Period-end      Average(1)      Low      High  

2014

     2.656        2.354        2.197        2.740  

2015

     3.905        3.330        2.575        4.195  

2016

     3.259        3.512        3.119        4.156  

2017

     3.308        3.193        3.051        3.381  

2018

     3.875        3.653        3.139        4.188  

 

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Month

   Period-end      Average(2)      Low      High  

October 2018

     3.718        3.756        3.637        4.027  

November 2018

     3.863        3.775        3.697        3.893  

December 2018

     3.875        3.884        3.829        3.933  

January 2019

     3.652        3.747        3.652        3.860  

February 2019

     3.739        3.720        3.669        3.776  

March 2019

     3.897        3.844        3.776        3.968  

April 2019 (through April 26, 2019)

     3.935        3.892        3.835        3.973  

 

Source: Brazilian Central Bank.

(1)

Represents the average of the exchange rates on the closing of each day during the year.

(2)

Represents the average of the exchange rates on the closing of each day during the month.

 

B.

Capitalization and Indebtedness

Not applicable.

 

C.

Reasons for the Offer and Use of Proceeds

Not applicable.

 

D.

Risk Factors

This section is intended to be a summary of more detailed discussion contained elsewhere in this annual report. Our business, financial condition or results of operations could be materially and adversely affected by any of the risks and uncertainties described below. As a result, the market price of our shares could decline, and you could lose all or part of your investment. Additional risks not presently known to us, or that we currently deem immaterial, may also impair our financial condition and business operations.

Risks Related to Our Businesses, the Operations of Our Joint Venture, and Industries in Which We Operate

We may not be successful in reducing operating costs and increasing operating efficiencies.

As part of our strategy, we continue to seek to reduce operating costs and increase operating efficiencies to improve our future financial performance. We may not be able to achieve the cost savings that we expect to achieve as a result of several factors, including increases in the price of our raw materials and other cost inputs. Given the highly competitive markets in which we operate, with prices often being defined based on global supply and demand, it is highly likely that we will not pass on material cost increases, which would materially and adversely affect our financial performance.

The expansion of our business through acquisitions and strategic alliances creates risks that may reduce the benefits we anticipate from these transactions.

We have grown substantially through acquisitions. We may continue to expand by acquiring or investing, directly or indirectly, from time to time, in businesses considered suitable by our management that are consistent with our values and that are expected to generate positive returns. We may also enter into strategic alliances to increase our competitiveness. However, our management is unable to predict whether or when any prospective acquisitions or strategic alliances will occur, or the likelihood of any particular transaction being completed on favorable terms and conditions. Our ability to continue to expand our business through acquisitions or alliances depends on many factors, including our ability to identify acquisitions or access capital markets on acceptable terms. Even if we are able to identify acquisition targets and obtain the necessary financing to make these acquisitions, we could financially overextend ourselves.

Acquisitions, especially involving sizeable enterprises, may present financial, managerial and operational challenges, including diversion of management attention from existing business and difficulties in integrating operations and personnel. Any failure by us to integrate new businesses or manage any new alliances successfully could adversely affect our business and financial performance. Some of our major competitors may be pursuing growth through acquisitions and alliances, which may reduce the likelihood that we will be successful in completing acquisitions and alliances. In addition, any major acquisition we consider may be subject to antitrust and other regulatory approvals. We may not be successful in obtaining required approvals on a timely basis or at all.

 

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Acquisitions also pose the risk that we may be exposed to successor liability relating to prior actions involving an acquired company, or contingent liabilities incurred before the acquisition. Due diligence conducted in connection with an acquisition, and any contractual guarantees or indemnities that we receive from sellers of acquired companies, may not be sufficient to protect us from, or compensate us for, actual liabilities. A material liability associated with an acquisition, such as labor or environmental liability, could adversely affect our reputation and financial performance and reduce the benefits of the acquisition.

We may engage in hedging transactions, which involve risks that can harm our financial performance.

We are exposed to market risks arising from the conduct of our business activities—in particular, market risks arising from changes in commodity prices, exchange rates or interest rates. In an attempt to minimize the effects of the volatility of sugar prices and exchange rates on our cash flows and results of operations, we engage in hedging transactions involving commodities and exchange rate futures, options, forwards and swaps. We also engage in interest rate-related hedging transactions from time to time. Hedging transactions expose us to the risk of financial loss in situations where the counterparty to the hedging contract defaults on its contract or there is a change in the expected differential between the underlying price in the hedging agreement and the actual price of commodities or exchange rate. We may incur significant hedging-related losses in the future. We hedge against market price fluctuations by fixing the prices of our sugar export volumes and exchange rates. Since we record derivatives at fair value, to the extent that the market prices of our products exceed the fixed price under our hedging policy, our results will be lower than they would have been if we had not engaged in such transactions as a result of the related non-cash derivative expenses. As a result, our financial performance would be adversely affected during periods in which commodities prices increase. Alternatively, we may choose not to engage in hedging transactions in the future, which could have a material adverse effect on our financial performance during periods in which commodities prices decrease.

The costs of complying with current and future legislation related to environmental protection, health and safety, and the contingencies arising from environmental damage and affected third parties may have a material adverse effect on our business, results of operations as well as on our financial condition.

The judicial and administrative penalties, including criminal sanctions, imposed on those who fail to comply with environmental laws are applied irrespective of whether there exists any obligation on such persons to repair any damage caused to the environment. Furthermore, the obligation to repair environmental damage caused may be imposed upon all parties deemed to be involved in such damage, whether directly or indirectly and regardless of such parties’ actual culpability. As a result, when we hire third parties to perform work for us, such as the disposal of waste or vegetation suppression, we are not exempt from liability for any environmental damage caused by these independent contractors. In addition, we can be held liable for any and all consequences arising from the exposure of people to harmful substances or other environmental damage. The costs of complying with current and future legislation related to environmental protection, health and safety, and the contingencies arising from environmental damage and from the imposition of fines and other penalties by environmental agencies and regulators as well as compensation sought by affected third parties may have a material adverse effect on our business, results of operations as well as on our financial condition.

We may be required to expend significant financial resources in order to remedy or contain environmental damage or failures to comply with certain environmental and social obligations. In addition, any such damage or non-compliance may result in interruptions to our operations pursuant to orders from governmental authorities or restrictions on obtaining financing from government-owned institutions. Any of these developments could have a significant financial impact on us. In addition, the enactment of new regulations may require us to expend significant resources in order to comply with our environmental obligations.

The extensive environmental regulation to which we are subject may also lead to delays in the implementation of new projects given the considerable administrative procedures, and time, that are required to obtain environmental licenses from governmental bodies.

Technological advances could affect demand for our products or require substantial capital expenditures for us to remain competitive.

The development and implementation of new technologies may result in a significant reduction in the costs of sugar and ethanol production. We cannot predict when new technologies may become available, the rate of acceptance of new technologies by our competitors or the costs associated with such new technologies. Advances in the development of alternatives to sugar and ethanol also could significantly reduce demand or eliminate the need for sugar and ethanol as a fuel oxygenate. Any advances in technology which require significant capital expenditures to remain competitive or which otherwise reduce demand for sugar and ethanol will have a material adverse effect on our business and financial performance.

 

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We may be unable to implement our growth strategy successfully.

Our future growth and financial performance will depend, in part, on the successful implementation of our business strategy, including: (1) our ability to attract new clients or increase volume from existing clients in specific markets and locations, (2) our capacity to finance investments (through indebtedness or otherwise), (3) our ability to increase our operational capacity and expand our current capacity to supply to new markets, (4) our ability to maintain and renew our existing concessions, (5) our ability to reduce our operating costs and increase operating efficiency, (6) our ability to lead with regards to new technologies and market demands and (7) our ability to integrate our businesses. We cannot assure you that we will be able to achieve these objectives and/or strategies successfully or at all. Our failure to achieve any of these objectives and/or strategies as a result of competitive difficulties, cost increases or restrictions on our ability to invest, among others, may limit our ability to implement our growth strategy successfully. We may need to incur additional indebtedness in order to finance new investments to implement our growth strategy. Unfavorable economic conditions in Brazil and in the global credit markets, such as high interest rates on new loans, reduced liquidity or reduced interest of financial institutions in granting loans, may limit our access to new credit. Furthermore, failure to achieve our expected growth may have a material adverse effect on our business, financial conditions, results of operations and our ability to repay our debt obligations.

We may face conflicts of interest in transactions with related parties.

We engage in business and financial transactions with our controlling shareholder and other shareholders that may create conflicts of interest between our Company and these shareholders. Commercial and financial transactions between our affiliates and us, even if entered into on an arm’s-length basis, create the potential for, or could result in, conflicts of interests.

Lack of service providers for our expansion projects could adversely affect our business.

We are engaged in a number of expansion projects within our concession area that will require a significant number of service providers, which may not be available. Consequently, if we are unable to contract the necessary services due to service industry shortages or a lack of providers with the technical ability to provide the services we require, this could have an adverse effect on our expansion projects or lead to delays in the execution of our expansion projects as new service providers go through an approval process and develop the technical qualification to commence operations. Any delay or failure to commence or continue our expansion projects within our projected timeframe or budget could have a material adverse effect on our business, financial condition and results of operations.

We depend on our information technology systems, and any failure of these systems could adversely affect our business.

We depend on information technology systems for significant elements of our operations, including the storage of data and retrieval of critical business information. Our information technology systems are vulnerable to damage from a variety of sources, including network failures, malicious human acts, and natural disasters. Moreover, despite network security and back-up measures, some of our servers are potentially vulnerable to physical or electronic break-ins, computer viruses, and similar disruptive problems. Failures or significant disruptions to our information technology systems or those used by our third-party service providers could prevent us from conducting our general business operations. Any disruption or loss of information technology systems on which critical aspects of our operations depend could have an adverse effect on our business, results of operations, and financial condition.

Further, we store highly confidential information on our information technology systems, including information related to our products. If our servers or the servers of the third party on which our data is stored are attacked by a physical or electronic break-in, computer virus or other malicious human action, our confidential information could be stolen or destroyed. Any security breach involving the misappropriation, loss or other unauthorized disclosure or use of confidential information of our suppliers, customers, or others, whether by us or a third party, could have an adverse impact on our business, financial condition and results of operations.

In addition, the ability of our payment services (e-wallet) subsidiary, Payly Soluções de Pagamentos S.A., or “Payly,” to process online payments and provide high quality customer experience depends on the effective uninterrupted operation of internal and third party information technology systems in an integrated manner. Payly also holds certain highly confidential personal and financial data relating to its customers in its information technology systems. Any failures in the information technology systems on which Payly depends or any breaches resulting in the unauthorized disclosure of the personal or financial data of Payly’s customers may adversely affect Payly’s business, financial condition, results of operation and reputation.

 

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We could be the target of attempted cyber threats in the future and they could adversely affect our business.

We may be subject to potential fraud and theft by cyber criminals, who are becoming increasingly sophisticated, seeking to obtain unauthorized access to or exploit weaknesses that may exist in our systems. We continuously monitor and develop our information technology networks and infrastructure. We also conduct yearly tests to prevent, detect, address and mitigate the risk of unauthorized access, misuse, computer viruses and other events that could have a security impact on us. Although these measures are taken to ensure that we are protected, to the extent possible, against cyber risks and security breaches, they may not be effective in protecting us against cyber-attacks and other related breaches of our information technology systems. The techniques used to obtain unauthorized, improper or illegal access to our systems, our data or our customers’ data, to disable or degrade service, or to sabotage systems are constantly evolving, may be difficult to detect quickly, and often are not recognized until used against a target. Unauthorized parties may attempt to gain access to our systems or facilities through various means, including, among others, hacking into our systems or those of our customers, partners or vendors, or attempting to fraudulently induce our employees, customers, partners, vendors or other users of our systems to disclose user names, passwords, financial information or other sensitive information, which may in turn be used to access our information technology systems. Certain third-party efforts to access our information technology systems may be supported by significant financial and technological resources, making them even more sophisticated and difficult to detect. Any disruption or loss of information technology systems, on which critical aspects of our operations depend, could have an adverse effect on our business, results of operations and financial condition.

Further, we store highly confidential information on our information technology systems, including information related to our products and customers’ personal data, including financial information. If our servers or the servers of the third parties on which our data is stored are the subject of a physical or electronic break-in, computer virus or other cyber risks, our confidential information could be stolen or destroyed. Any security breach involving the misappropriation, loss or other unauthorized disclosure or use of confidential information of our suppliers, customers, or others, whether by us or a third party, could (1) subject us to civil and criminal penalties, (2) have a negative impact on our reputation or (3) expose us to liability to our suppliers, customers, other third parties or government authorities.

We cannot assure you that our information technology systems will not suffer attacks in the future or that we will be able to safeguard the confidential information which we hold adequately. Any failure by us to adequately protect our information technology systems and the confidential data which we hold could have a material adverse effect on our business, financial condition and results of operations.

We are subject to the application of data protection laws. Compliance with such data protection laws could require changes to certain of our business practices, thereby increasing our costs, and noncompliance with the terms of such laws could adversely affect our business. In addition, we may be subject to penalties if we fail to comply with data protection rules.

We operate in a complex regulatory and legal environment that exposes us to compliance and litigation risks that could materially affect our business, financial condition and results of operations. These laws may change, sometimes significantly, as a result of political, economic or social events.

The European Union has adopted a comprehensive overhaul of its data protection regime from the current national legislative approach to a single European Economic Area Privacy Regulation, the General Data Protection Regulation, or the “GDPR,” which came into effect in 2018, and some aspects of our operations or business are subject to the GDPR’s privacy and personal data protection provisions. The EU data protection regime extends the scope of the EU data protection law to all foreign companies processing data of EU residents and imposes heightened requirements on controllers that engage in activities that are within scope of this regulation. It imposes a strict data protection compliance regime with severe penalties of up to the greater of 4% of worldwide turnover or €20 million and, in the case of a data breach, the organization may be required to notify potentially affected individuals.

In addition, on August 14, 2018, the President of Brazil approved Law No. 13,709/2018, a comprehensive data protection law establishing general principles and obligations that apply across multiple economic sectors and contractual relationships (Lei Geral de Proteção de Dados), or the “LGPD.” The LGPD establishes detailed rules for the collection, use, processing and storage of personal data and will affect all economic sectors, including the relationship between customers and suppliers of goods and services, employees and employers and other relationships in which personal data is collected, whether in a digital or physical environment. The obligations established by LGPD will become effective within 18 months from the date of publication of the LGPD, by which date all legal entities will be required to adapt their data processing activities to these new rules. The data protection regime imposes more stringent data protection standards on Brazilian residents. Any breaches of the LGPD may subject us to penalties of up to R$50 million and a requirement to notify parties whose data has been affected.

 

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We are currently evaluating the GDPR, the LGPD, their requirements and their potential effect on our business. Implementation of the GDPR and the LGPD could require changes to certain of our business practices, thereby increasing our costs, and noncompliance with their terms could adversely affect our business. Moreover, additional data protection laws may be enacted in Brazil or in other jurisdictions in which we operate. Any such additional laws may require us to make additional changes to our business practices and may expose us to additional penalties for non-compliance.

Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

Our performance depends on favorable labor relations with our employees and our compliance with labor laws. Any deterioration of those relations or increase in labor costs could adversely affect our business.

All of our employees are represented by labor unions. Our relationships with these organizations are governed by labor agreements or collective bargaining agreements which we negotiate with labor unions. Upon the expiry of such agreements, we are required to renegotiate new agreements with the applicable labor union. As part of these renegotiations, new terms and conditions may be established. In certain cases, these agreements may not be renewed, which could lead to strikes and/or stoppages in our activities and have an adverse impact on our business, financial condition and results of operations. Furthermore, since the enactment of Law No. 13,467/2017, labor agreements and collective bargaining agreements prevail over certain provisions of labor legislation, as stated in items I to XV, of Article 611-A, of the Consolidation of Brazilian Labor Laws (Consolidação das Leis do Trabalho), such as, working time arrangements and the manner in which these are recorded, work breaks, and certain employer-specific internal rules, among others. As a result, employers may expand or reduce certain labor rights, provided this is done pursuant to the terms of labor agreements negotiated with unions and/or individual agreements negotiated with the respective employees.

We operate in industries in which the supply, demand and the market price for our products are cyclical and are affected by general economic conditions in Brazil and globally.

The ethanol and sugar industries, globally and in Brazil, have historically been cyclical and sensitive to domestic and international changes in supply and demand. Our sugar production depends on the volume and sucrose content of the sugarcane that we cultivate or is provided to us by farmers located near our plants. Crop yields and sucrose content of the sugarcane mainly depend on weather conditions, such as rainfall and temperature, which may vary and may be influenced by global climate change.

Weather conditions have caused volatility in the ethanol and sugar sectors and, consequently, in our operational results by causing crop failures or reduced harvests. Floods, droughts and frosts, which can be influenced by global climate change, may affect the supply and prices of the agricultural commodities we sell and use in our business. Future climate conditions may reduce the quantity of sugar and sugarcane that we can obtain in a given crop or the sucrose content of the sugarcane. In addition, our production of sugar and ethanol is contingent on our ability to incur capital expenditures to renew sugarcane crops.

Historically, the international sugar market has experienced periods of limited supply, causing sugar prices and industry profit margins to increase, followed by an expansion in the industry that results in oversupply, causing declines in sugar prices and industry profit margins. In addition, fluctuations in prices for ethanol or sugar may occur, for various other reasons, including factors beyond our control, such as:

 

   

reduced demand for motor vehicles powered by internal combustion engines;

 

   

fluctuations in gasoline prices;

 

   

variances in the production capacities of our competitors; and

 

   

the availability of substitute goods for the ethanol and sugar products we produce.

The prices we are able to obtain for sugar depend, in large part, on prevailing market conditions. These market conditions, both in Brazil and internationally, are beyond our control. The wholesale price of sugar has a significant impact on our profits. Like other agricultural commodities, sugar is subject to price fluctuations resulting from weather, natural disasters, harvest levels, agricultural investments, government policies and programs for the agricultural sector, domestic and foreign trade policies, shifts in supply and demand, increasing purchasing power, global production of similar or competing products, and other factors beyond our control. In addition, a significant portion of the total worldwide sugar production is traded on exchanges and thus is subject to speculation, which could affect the price of sugar and our results of operations.

 

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The price of sugar, in particular, is also affected by producers’ compliance with sugar export requirements and the resulting effects on domestic supply. As a consequence, sugar prices have been subject to high historical volatility. Competition from alternative sweeteners, including saccharine and high fructose corn syrup, known as “HFCS,” changes in Brazilian or international agricultural or trade policies or developments relating to international trade, including those under the World Trade Organization, are factors that can directly or indirectly result in lower domestic or global sugar prices. Any prolonged or significant decrease in sugar prices could have a material adverse effect on our business and financial performance.

Ethanol is marketed as a fuel additive to reduce vehicle emissions from gasoline, as an enhancer to improve the octane rating of gasoline with which it is blended or as a substitute fuel for gasoline. As a result, ethanol prices are influenced by the supply of and demand for gasoline, and our business and financial performance may be materially adversely affected by fluctuations in the demand for and/or price of gasoline. The increase in the production and sale of flex fuel vehicles (hybrid vehicles, that run with ethanol or gasoline or both combined in any proportion) has resulted, in part, from lower taxation, since 2002, of such vehicles compared to gasoline only cars. This favorable tax treatment may be eliminated and the production of flex fuel vehicles may decrease, which could adversely affect demand for ethanol.

If we are unable to maintain sales at generally prevailing market prices for sugar and ethanol in Brazil and internationally, or if we are unable to export sufficient quantities of ethanol and sugar to assure an appropriate domestic market balance, our ethanol and sugar business as well as our cash flow may be adversely affected.

Ethanol prices are directly influenced by sugar and gasoline prices, so that a decline in those prices will adversely affect both our ethanol and sugar businesses.

The price of ethanol generally is closely associated with the price of sugar and is increasingly becoming correlated to gasoline prices in local market. A vast majority of ethanol in Brazil is produced at sugarcane mills that produce both ethanol and sugar. Because sugarcane millers are able to alter their product mix in response to the relative prices of ethanol and sugar, this results in the prices of both products being directly correlated, and the correlation between them may increase over time. In addition, sugar prices in Brazil are determined by prices in the world market, so that there is a correlation between Brazilian ethanol prices and world sugar prices.

Because flex fuel vehicles allow consumers to choose between gasoline and ethanol at the pump rather than at the showroom, ethanol prices are now becoming increasingly correlated to gasoline prices and, consequently, oil prices. We believe that the correlation among the three products will increase over time. Accordingly, a decline in sugar prices will have an adverse effect on the financial performance of our ethanol and sugar businesses, and a decline in oil prices may have an adverse effect on that of our ethanol business, including on its cash flows.

We may not successfully implement our plans to sell energy from our cogeneration projects, and the Brazilian government’s regulation of the energy sector may adversely affect our business and financial performance.

Our current total installed energy cogeneration capacity is used to generate energy for our own industrial operations and to sell surplus energy to the Brazilian energy grid. The Brazilian government regulates the energy sector extensively. We may not be able to satisfy all the requirements necessary to enter into new contracts or to otherwise comply with Brazilian energy regulation. Changes to the current energy regulation or federal authorization programs, and the creation for more stringent criteria for qualification in future public energy auctions, in addition to lower prices, may adversely affect our results of operations from our cogeneration business.

Any failure in the implementation of these plans may have a material adverse effect on our business, financial condition and results of operations.

 

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A reduction in market demand for ethanol or a change in governmental policies requiring ethanol be added to gasoline may have a material adverse effect on our business.

We produce and sell three different types of ethanol: hydrous ethanol, anhydrous ethanol for fuel and industrial ethanol. The primary type of ethanol consumed in Brazil is hydrous ethanol, which is used as an alternative to gasoline for flex fuel vehicles (as opposed to anhydrous ethanol which is used as an additive to gasoline).

Governmental authorities of several countries, including Brazil and the United States, currently require the use of anhydrous ethanol as an additive to gasoline. Since 1997, the Brazilian Sugar and Alcohol Inter-ministerial Council (Conselho Interministerial do Açúcar e Álcool), or “CIMA,” has set the percentage of anhydrous ethanol that must be used as an additive to gasoline. According to CIMA Resolution No. 1 dated March 4, 2015, the current anhydrous ethanol percentage for regular gasoline is 27% and for additive/premium gasoline is 25%. Approximately one-half of all fuel ethanol in Brazil is used to fuel automobiles that run on a blend of anhydrous ethanol and gasoline; the remainder is used in either flex fuel vehicles or vehicles powered by hydrous ethanol alone. Other countries have similar governmental policies requiring various blends of anhydrous ethanol and gasoline. In addition, flex fuel vehicles in Brazil are currently taxed at lower levels than gasoline-only vehicles, which has contributed to the increase in the production and sale of flex fuel vehicles. Any reduction in the percentage of ethanol required to be added to gasoline or increase in the levels at which flex fuel vehicles are taxed in Brazil, as well as growth in the demand for natural gas and other fuels as an alternative to ethanol, lower gasoline prices or an increase in gasoline consumption (versus ethanol), may cause demand for ethanol to decline and affect our business. In addition, ethanol prices are influenced by the supply and demand for gasoline; therefore, a reduction in oil prices resulting in a decrease in gasoline prices and an increase in gasoline consumption (versus ethanol), may have a material adverse effect on our business, results of operations and financial condition.

Government policies and regulations could have a material adverse effect on our operations and profitability.

Government policies in Brazil and elsewhere, in each case whether at the federal, state or local level, may adversely affect the supply, and demand for, and prices of, our products or restrict our ability to do business in our existing and target markets, which could adversely affect our financial performance.

Agricultural production and trade flows are significantly affected by Brazilian federal, state and municipal, as well as foreign, government policies and regulations. Governmental policies affecting the agricultural industry, such as taxes, tariffs, duties, subsidies and import and export restrictions on agricultural commodities and commodity products, may influence industry profitability, the planting of certain crops versus others, the uses of agricultural resources, the location and size of crop production, the trading levels for unprocessed versus processed commodities, and the volume and types of imports and exports.

Our gas distribution operations are currently concentrated in the state of São Paulo. Any changes affecting governmental policies and regulations regarding natural gas in the state of São Paulo (at the federal, state or municipal level) may have a material adverse effect on our business and financial performance.

In addition, petroleum and petroleum products have historically been subject to price controls in Brazil. Currently there is no legislation or regulation in force giving the Brazilian government the power to set prices for petroleum, petroleum products, ethanol or vehicular natural gas. However, given that Petrobras, the only supplier of oil-based fuels in Brazil, is a government-controlled company, prices of petroleum and petroleum products are subject to government influence, resulting in potential inconsistencies between international prices and internal oil derivative prices that affect our business and our financial results.

As a payment institution (instituição de pagamento) and payment scheme settlor (instituidor de arranjo de pagamento) in Brazil, Payly is subject to Brazilian laws and regulations relating to electronic payments in Brazil, comprised of Brazilian Federal Law No. 12,865/13 and related rules and regulations. Any failure by Payly to comply with such legislation could result in disciplinary or punitive action by the relevant regulators. Furthermore, we cannot assure you that Payly will be able to obtain and maintain all required operating licenses. Any of these developments could have a material adverse effect on Payly’s business, financial condition and results of operations.

 

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Raízen Energia, Raízen Combustíveis and Moove are subject to the application of regulatory penalties in the event of non-compliance with the terms and conditions of their respective authorizations, including the possible revocation of such authorizations.

Raízen Energia performs generation activities in accordance with the regulation applicable to the energy sector and with the terms and conditions of authorizations granted by the Brazilian government through ANEEL. The duration of such authorizations varies from 20 to 35 years.

ANEEL may apply regulatory penalties to Raízen Energia in the event of non-compliance with the authorizations or with the regulations applicable to the energy sector. Such penalties may include, depending on the seriousness of the infraction, warnings, fines (in some cases up to 2% of our revenues for the last 12 months), restrictions on Raízen Energia’s operations, temporary suspension from participating in public bidding procedures to obtain new permissions, authorizations and concessions, prohibition from contracting with ANEEL, and revocation of its authorizations.

In addition, Raízen Combustíveis conducts its fuel distribution activities and Moove manufactures and distributes lubricants and base oil in accordance with the rules and regulations applicable to the oil and gas sector in Brazil as well as with the terms of the licenses and permits granted to them by the Brazilian government acting through the ANP. Failure to comply with the applicable rules and regulations or with the terms of the relevant licenses and permits may result in fines and other penalties (including confiscation or destruction of products, cancellation of product registrations, bans on certain facilities, and revocation of existing licenses and permits, among others). The applicable fines vary between R$5 thousand and R$5 million, depending on the gravity of the infraction.

Furthermore, the electricity trading operations of WX Energy Comercializadora de Energia Ltda., or “WX Energy,” which Bioenergia Barra Ltda., a wholly-owned subsidiary of Raízen Energia, acquired on July 5, 2018, are highly regulated and supervised by the Brazilian government, including through ANEEL as well as other regulatory authorities. Such regulatory authorities have discretionary authority to implement and change policies, interpretation and rules applicable to different aspects of WX Energy’s business, especially its operations, maintenance, safety, compensation and inspection. Any significant regulatory measure implemented by the competent authorities may impose a significant burden on WX Energy’s activities.

Raízen Energia, Raízen Combustíveis, Moove and WX Energy cannot assure that they will not be penalized by ANEEL, ANP or other regulatory authorities, as applicable, nor can they assure you that they will comply with all terms and conditions of their authorizations and with the regulation applicable to their respective businesses, which may have a material adverse effect on our business, results of operations and financial condition.

We face significant competition, which may have a material adverse effect on our market share and profitability.

The ethanol and sugar industries are highly competitive. Internationally, we compete with global ethanol and sugar producers in the United States, India, Thailand, Australia, among other countries and producers such as Poet, Inc., Archer-Daniels-Midland Company, Cargill, Inc. and A.E. Staley Manufacturing Company (a subsidiary of Tate & Lyle, PLC). Some of our competitors are divisions of larger enterprises and have greater financial resources than us. In Brazil, we compete with numerous small to medium-size producers. Despite increased consolidation, the Brazilian ethanol and sugar industries remain highly fragmented. Our major competitors in Brazil are Biosev (the second largest ethanol and sugar producer in Brazil), Tereos—Guarani (the third-largest ethanol and sugar producer in Brazil), Bunge, Santa Terezinha, São Martinho, Carlos Lyra, Tercio Wanderley, Zilor, Oscar Figueiredo, Da Pedra, and Irmãos Biagi and other ethanol and sugar producers in Brazil that market their ethanol and sugar products through the Cooperative of Sugarcane, Sugar and Ethanol Producers of the state of São Paulo (Cooperativa de Produtores de Cana-de-açúcar, Açúcar e Álcool do Estado de São Paulo), or “Copersucar.” Copersucar consists of producers in the states of São Paulo, Minas Gerais and Paraná. We are not a member of Copersucar.

 

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We also face strong competition from international producers, particularly in highly regulated and protected markets, such as the United States and the European Union. With regards to sugar exports, we face intense competition from producers all around the world, including India, Thailand, and the European Union, among others. There are global producers of sugar whose costs are lower than those of Brazilian producers, including us, and whose production capacity and prices could lead to a decrease in prices on the global sugar market. Furthermore, we face very strong competition internationally with regards to ethanol, especially from the United States. Ethanol production in the United States is based on corn-derived ethanol and is undertaken on a greater scale than Brazilian ethanol production. Accordingly, a reduction in corn prices may lead to material reductions in the price of ethanol produced in the United States and result in increased competition in the Brazilian market.

Historically, imports of sugar have not provided substantial competition for us in Brazil due to, among other factors, the production and logistical cost-competitiveness of sugar produced in Brazil. If the Brazilian government were to create incentives for sugar imports, we could face increased competition in the Brazilian market by foreign producers. Many factors influence our competitive position, including the availability, quality and cost of fertilizer, energy, water, chemical products and labor. Some of our international competitors might have greater financial and marketing resources, larger customer bases and broader product ranges than we do. If we are unable to remain competitive with these producers in the future, our market share may be adversely affected.

The fuel distribution and lubricant market in Brazil is highly competitive. For example, we compete with domestic fuel distributors who purchase substantially all of their fuel from Petrobras and from suppliers based outside of Brazil. There are very few domestic competitors, such as us, who import lubricants into Brazil. In addition, we compete with producers and marketers in other industries that supply alternative forms of energy and fuel to satisfy the requirements of our industrial, commercial and retail consumers. Certain of our competitors, such as Petrobras, have larger fuel distribution networks and vertically integrated oil refineries, and may be able to realize lower per-barrel costs or higher margins per barrel of throughput. Our principal competitors in the fuel distribution and the lubricant market are larger and have substantially greater resources than we do. Because of their integrated operations and larger capitalization, these companies may be more flexible in responding to volatile industry or market conditions, such as shortages of crude oil and other feedstock or intense price fluctuations. The actions of our competitors could lead to lower prices or reduced margins for the products we sell, which could have a material and adverse effect on our business, results of operations and our financial performance.

Certain measures currently being taken by participants in the fuel distribution market, including the expansion of their distribution networks, as well as the arrival of new participants, may result in an increase in fuel supply and a consequent decrease in fuel prices, which may have an adverse effect on our business, financial condition and results of operations.

In addition, the market for payment processing services, in which Payly operates, is highly competitive. Other providers of payment processing services in the acquirer market have also established a sizable market share in the small and mid-sized merchant processing and servicing sector.

The intense competition in the Brazilian market and the actions of our competitors could lead to lower prices or reduced margins for the products we sell, as well as reductions in our sales volumes, which could have a material and adverse effect on our business, results of operations and our financial performance.

Government laws and regulations governing the burning of sugarcane, including requirements in respect of the Legal Reserve, could have a material adverse impact on our business or financial performance.

The state of São Paulo and some local governments have established laws and regulations that limit our ability to burn sugarcane or that reduce and/or entirely prohibit the burning of sugarcane. The costs to comply with existing or new laws or regulations are likely to increase the cost of production, and, as a result, our ability to operate our own mills and harvest our sugarcane crops may be materially adversely affected.

In addition to restrictions that limit sugarcane burning and other environmental restrictions, we are required to preserve a percentage of our rural properties (sugarcane fields and other facilities), in order to contribute to a biodiversity preservation and ecologic rehabilitation fund known as the “Legal Reserve.” For rural areas located in the state of São Paulo, 20% of the property must be preserved to comply with the Brazilian Forest Code obligations.

 

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Any failure to comply with these laws and regulations may subject us to legal and administrative actions. These actions can result in administrative or criminal penalties, including, but not limited to, suspension, shutdowns, a requirement to pay fines, which may range from R$50 to R$50 million and can be doubled or tripled in case of recidivism, an obligation to make capital and other expenditures or an obligation to materially change or cease some operations. In addition, we may be subject to civil liabilities, which include the obligation to redress any damages caused to the environment and/or public health. The demonstration of the cause-effect relationship between the damage caused and action or omission is sufficient to trigger the obligation to redress environmental damage.

Adverse weather conditions may reduce the volume and sucrose content of sugarcane that we can cultivate and purchase in a given harvest as well as demands for natural gas.

Our sugar production depends on the volume and sucrose content of the sugarcane that we cultivate or that is supplied to us by growers located in the vicinity of our mills. Crop yields and sucrose content depend primarily on weather conditions such as rainfall and temperature, which vary and may be influenced by global climate change. Weather conditions have historically caused volatility in the ethanol and sugar industries and, consequently, in our results of operations, by causing crop failures or reduced harvests. Flood, drought or frost, which may be influenced by global climate change, may have a material adverse effect on the supply and pricing of the agricultural commodities that we sell and use in our business. Future weather patterns may reduce the amount of sugar or sugarcane that we can recover in a given harvest or its sucrose content.

During the third and fourth quarter of 2014, a severe drought affected southeast Brazil, Comgás’ concession area, during which time residents were encouraged to save water. As a relevant portion of Comgás’ revenues is derived from the residential segment, and a significant portion of natural gas used by residential consumers is used for heating water, Comgás experienced a decrease in its net revenues derived from the residential segment. Therefore, our and Comgás’ business may be materially affected by unusual climate patterns.

Our business is subject to seasonal trends.

Raízen Energia’s business is subject to seasonality according to the sugarcane growth cycle in the Central-South region of Brazil. The annual sugarcane harvesting period in the Central-South region of Brazil begins in April or May and ends in November or December. This creates fluctuations in Raízen Energia’s inventory and in its ability to generate energy, both of which usually peak in December, to cover sales between crop harvests (primarily from January to March), and a degree of seasonality in our gross profit, with ethanol and sugar sales significantly lower in the quarter ended on December 31. Rural producers of sugar and ethanol with whom Raízen Energia maintains a commercial relationship may experience a similar degree of seasonality, which may impact the supply of ethanol and/or other products necessary for Raízen Energia’s activities. Seasonality and any reduction in the volumes of sugar recovered could have a material adverse effect our business, results of operations and financial condition.

Raízen Energia and WX Energy are also subject to seasonality with respect to demand for the energy which they generate and sell, respectively. Specifically, demand for energy is subject to various factors which vary from season to season according to the type of customer, geographical location, consumption type (e.g., residential, commercial or industrial), among other factors, and demand for energy and trading activities may be affected by variations in such factors.

Furthermore, Rumo is subject to the seasonality that influences the sugarcane and grain harvest. During the peak months of the harvests, there is higher demand for transport and logistics operations. Rumo is also subject to the risk that sugarcane mills may change their production mix in favor of ethanol if the relative prices of the two products swing that way. This could reduce the demand for sugar logistics and transport.

Seasonality could have a material adverse effect on our business, results of operations and financial condition.

 

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We may be adversely affected by a shortage of sugarcane or by high sugarcane costs.

Sugarcane is the principal raw material used by Raízen Energia (a company which we jointly control with Shell) for the production of ethanol and sugar. As of December 31, 2018, sugarcane purchased from suppliers accounted for 52% of our total crushed sugarcane. Historically, approximately 91% of the sugarcane purchased by us has been under medium- and long-term contracts with sugarcane growers, 5% on a spot basis and the remaining 4% from sugarcane growers with whom we have long-term relationships but no contractual arrangements. We generally enter into medium- and long-term supply contracts for periods varying from three and one-half to seven years. As of December 31, 2018, we also leased approximately 611,000 hectares to produce our own sugarcane in contracts with an average term of 11 years.

Our supply of sugarcane in Brazil may be significantly reduced as a result of the termination of supply contracts or lease agreements, which may result in a shortage of sugarcane supply and an increase in the price of sugarcane. If there is a shortage of sugarcane or any supply contracts or lease agreements are terminated, Raízen Energia may experience a material reduction in the sugarcane available for processing or an increase in sugarcane prices, which may have a material adverse effect on our business, results of operation and financial condition.

In Brazil, the price of sugarcane may increase as a result of changes in the criteria established by Association of Producers of Sugarcane, Sugar and Ethanol of the State of São Paulo (Conselho dos Produtores de Cana-de-açúcar, Açúcar e Álcool do Estado de São Paulo), or “Consecana,” which is composed of sugarcane producers and sugar mill operators. The price of sugarcane is set in supply agreements, lease agreements and partnership agreements and is partially fixed and partially variable, as provided for in the criteria set forth by Consecana. As a result, any changes to the criteria established by Consecana may lead to an increase in the cost of sugarcane, which may have a material adverse effect on our business, financial condition and results of operations.

In addition, in certain cases, as a result of the price-setting formulas in the contracts which we have entered into with our customers, we may not be able to pass on the full amount of these cost increases to our customers. This may have a material adverse effect on our business, financial condition and results of operations.

We are subject to developments affecting the Brazilian agribusiness sector as a whole.

We cannot assure you that in the future, the Brazilian agribusiness sector (i) will maintain the rate of growth and development which it has experienced in recent years and (ii) will not suffer losses due to unfavorable climatic conditions, reduction of the prices of the agricultural commodities in the national and international markets, changes in credit policies for domestic producers, both by government agencies and private entities, that may affect our income, as well as other economic and political crises that may affect the agricultural industry in general. Any deterioration in the overall condition of the Brazilian agribusiness sector may have a material adverse effect on us.

Raízen may be subject to expropriation of real estate intended for rural production.

The real estate used by Raízen, or by third parties with whom Raízen maintains a partnership or lease relationship, for the cultivation of sugarcane may be unilaterally expropriated by the Brazilian government for purposes of public and social interest, and we cannot assure you that the payment of the indemnification that they may have to pay to Raízen will be fair. Pursuant to Brazilian law, the Brazilian government may expropriate the real estate of rural producers where the sugarcane is planted by necessity or public utility or social interest, partially or totally. In the event of expropriation, we cannot assure you that the price paid by the Brazilian government will be fair, equivalent to the market value, or that it will effectively and adequately compensate Raízen for the amounts invested. Accordingly, the eventual expropriation of any real estate used by Raízen, or by third parties with whom Raízen maintains partnership or lease relationships, may adversely and significantly affect Raízen’s financial situation and results, and may also impact Raízen’s activities.

Social movements may affect the use of Raízen’s agricultural properties or cause damage to them.

Social movements are active in Brazil and advocate land reform and property redistribution by the Brazilian government. Invasion and occupation of agricultural land by large numbers of people is a common practice among the members of such movements, and in certain regions, including those in which Raízen owns or leases property, remedies such as police protection or eviction procedures might be inadequate or non-existent. As a result, we cannot assure you that our agricultural properties will not be subject to invasion or occupation by any of such social movements. Any invasion or occupation may materially impair the use of our lands and have a material adverse effect on Raízen’s business, financial condition, and results of operations.

 

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The use of alternatives to sugar and ethanol and technological advances may reduce demand for our sugar products in Brazil and other countries or require us to make substantial investments in order to remain competitive.

The development of alternative products to sugarcane and ethanol may reduce the demand for our products or materially reduce the demand for ethanol to be used as fuel. The use of alternative sweeteners has adversely affected the overall demand for sugar in Brazil and abroad. A substantial reduction in the demand for sugar and ethanol or increased consumption of alternative sweeteners may reduce the demand for sugar and ethanol we produce in Brazil and could have a material adverse effect on our business, results of operations and financial condition.

Any other alternative products or technological advances which reduce demand for our products may have a material adverse effect on our results of operations and financial condition.

Raízen Energia’s sugar and ethanol products are sold to a small number of customers who may be able to exercise significant bargaining power concerning pricing and other sale terms.

A substantial portion of Raízen Energia’s sugar and ethanol is sold to a small number of customers that acquire large portions of our production and thus may be able to exercise significant bargaining power concerning pricing and other sale terms. In addition, intense competition in the ethanol and sugar industries further increases the bargaining power of customers, which may have a material adverse effect on Raízen Energia’s sales volumes.

Raízen Energia’s export sales are subject to a broad range of risks associated with international operations.

In the fiscal year ended December 31, 2018, Raízen Energia’s net sales from exports represented 25% of Raízen Energia’s total net sales, while in the year ended December 31, 2017, the net sales from exports represented 47% of Raízen Energia’s total net sales. Furthermore, in the fiscal year ended December 31, 2018, Raízen Energia’s net sales from sugar exports were R$2,452 million, representing 12% of its total net sales for the period. In the year ended December 31, 2017, Raízen Energia’s net sales from sugar exports were R$4,082 million, representing 31% of Raízen Energia’s total net sales for the period. Further, in the fiscal year ended December 31, 2018, Raízen Energia’s net sales from exports of ethanol were R$2,315 million, representing 12% of Raízen Energia’s total net sales for that period and in the year ended December 31, 2017, Raízen Energia’s net sales from ethanol exports were R$2,076 million, representing 16% of Raízen Energia’s total net sales for that period.

Our exports of ethanol are subject to factors beyond our control which may affect the competitiveness of Brazilian ethanol in other markets, such as import regulations, tax legislation, incentives for local production and the establishment of distribution systems for hydrous ethanol in countries outside of Brazil. Our future financial performance will depend, to a significant extent, on economic, political and social conditions in our main export markets.

Most ethanol and/or sugar producing countries, including the United States and member countries of the European Union, protect local producers from foreign competition by establishing government policies and regulations that affect ethanol and sugar production, including quotas, import and export restrictions, subsidies, tariffs and duties. As a result of these policies, domestic ethanol and sugar prices vary greatly in individual countries. We have limited or no access to these large markets as a result of trade barriers. If these protectionist policies continue, we may not be able to expand our export activities at the rate we currently expect, or at all, which could have a material adverse effect on our business, results of operations and financial condition. Also, if new trade barriers are established in our key export markets, we may face difficulties in reallocating our products to other markets on favorable terms, and our business and financial performance may be adversely affected.

Failure to comply with, obtain or renew the licenses and permits required for our business may have a material adverse effect on us.

We are required to obtain specific licenses with respect to our terminals from the applicable environmental authorities, which are applied in particular to the emission, ejection and emanation of products and by-products resulting from distribution activities. We are also required to obtain specific licenses and permits from governmental authorities for rural producers in order to carry out certain of our operations. The laws and regulations which govern these licenses may occasionally require us to purchase and install costly pollution-control equipment or to make operational changes to limit our impact on the environment and/or the health of our employees. Any failure to comply with the terms of such laws, regulations and licenses and permits may result in significant financial penalties, criminal sanctions, revocation of operating licenses and permits and/or the prohibition of certain of our activities.

In addition, we are currently in the process of obtaining or renewing, as the case may be, certain licenses and permits (including real estate and environmental permits) required for the continuity of our activities. Our business, financial condition and results of operations may be materially and adversely affected if we are unable to obtain or renew all licenses and permits required for our business and operations.

 

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Raízen Energia may be adversely affected if the outsourcing the mechanized sugarcane cutting becomes prohibited.

Raízen Energia is a defendant in a public civil action in which the Labor Public Prosecutor’s Office (Ministério Público de Trabalho) is seeking the prohibition of the outsourcing of planting, loading and transportation of sugarcane. Raízen Energia has appealed to the Superior Labor Court (Tribunal Superior do Trabalho) in order to overturn an unfavorable first instance decision. This appeal is currently awaiting judgment. If the Superior Labor Court rejects the appeal, Raízen Energia may be required to undertake these activities itself on a permanent basis (including hiring employees and acquiring appropriate machinery), which may have a material adverse effect on Raízen Energia.

The Brazilian Supreme Court has recently ruled that outsourcing is generally permitted. While we expect this ruling to have a positive effect on Raízen Energia’s ongoing proceedings, we cannot guarantee that Raízen Energia will be successful.

Any mismatches between the cash outflows for the payment of litigation costs of Raízen and the time of receipt of the related reimbursement by the Joint Venture’s shareholders may lead to pressures on Raízen Energia and Raízen Combustíveis’ cash flows.

Pursuant to the framework agreement which was entered into during the formation of the Joint Venture, Raízen Energia has agreed that it will reimburse Cosan S.A. and Shell or will be reimbursed by them, as applicable, for any amounts received or paid in connection with legal proceedings, provided that the triggering events for such payments or receipts occurred before the formation of the Joint Venture on June 1, 2011 and provided that any such sums have actually been paid or received.

The framework agreement also provides that Cosan S.A. is required to indemnify Raízen for any expense related to litigation (tax, labor, civil and other) that has been caused by events prior to the formation of the Joint Venture.

Any mismatches between the cash outflows from Raízen for the payment of litigation costs and the time of receipt of the related reimbursement by Cosan S.A. or Shell, as applicable, or any failure by Cosan S.A. or Shell to reimburse Raízen, may lead to pressures on Raízen’s cash flows.

Brazilian courts, in some circumstances, have understood that a controlling shareholder, a successor entity of another corporation, an assignee company of another company’s assets and other companies subject to common control to the assignor or predecessor company shall all be liable, jointly and severally, for, among other obligations, labor, social security, civil, tax or environmental obligations of the assignor, assignee or predecessor. Therefore, we may be liable for obligations of their controlling shareholders for which we have not constituted and do not intend to constitute any provisions, which may adversely affect our business, results of operations and financial condition.

Raízen is subject to risks arising from legal proceedings based on claims related to alleged breaches of the intellectual property rights of third parties.

Raízen is subject to risks arising from legal proceedings based on claims related to alleged breaches of the intellectual property rights of third parties. Raízen may alter the way in which it produces, in whole or in part, products which third parties allege infringe their intellectual property rights and/or pay significant indemnification amounts, royalties or licensing fees in connection with the use of third parties’ patents or copyrighted materials. The filing of a lawsuit or the review of a product that is in violation of third parties’ intellectual property rights may adversely affect Raízen’s reputation and the demand for our products. In addition, new lawsuits require the attention of Raízen’s management, as well as additional costs for our defense and, in certain cases, the establishment of provisions that could affect our results.

Contamination of our products and other related risks could adversely affect our reputation, leading to judicial and administrative proceedings and/or resulting in the closure of our production facilities.

Certain of our products may have adverse effects on our consumers (including certain components, raw materials and supplies used to produce our products), including as a result of product contamination or following errors in the production or distribution chain.

Contamination of any of our products may result in a need for recalls or the beginning of legal and administrative proceedings against us, which may adversely affect our reputation, our business, the operation of our production facilities, our financial condition and our operating results. Any damage to our reputation could have a material adverse effect on us.

 

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The modification, suspension, cancellation or non-renewal of certain tax benefits which we have been granted could have a material adverse effect on us.

We benefit from certain tax incentives, benefit programs and special regimes, such as:

 

   

State of Goiás: (a) Tax benefit “Protege” that accrues at the tax rate of 2% levied on transactions with gas. This benefit permits an increase in the income of the Social Fund of the state of Goiás. The taxpayer is able to credit the respective amount through its accounting to permit the offset with further debts of ICMS (Imposto sobre Operações relativas à Circulação de Mercadorias e Prestação de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação, a tax on sales and services which applies to goods, and transportation and communication) considering the rate as a reduction in the taxable basis of the gas acquired in the state of Goiás; (b) tax benefit “Protege II,” which permits a reduction in the taxable basis of 5% on all the basic transactions linked to ICMS in the state of Goiás (unlike the 2% reduction which is only applied to gas, the 5% rate applies to all other supplies) and (c) tax incentive “Produzir” that grants a reduction of ICMS payable of 63%.

 

   

State of Mato Grosso do Sul: (a) ICMS – Presumed Tax Credit: The state of Mato Grosso do Sul implemented a reduction of 15.93% of the taxable basis of ICMS on ethanol transactions within the state; (b) Tax incentive that grants 67% of the outstanding balance of ICMS on sugar transactions to be deducted from the outstanding balance of the tax; and (c) other ICMS presumed tax credits granted on sugar and ethanol transactions.

 

   

The states of Maranhão and Minas Gerais granted a reduction of calculation basis of ICMS on sales.

 

   

State of São Paulo: (a) Suspension of ICMS levied on the importation of fixed assets and deferral on the acquisition of fixed assets; and (b) suspension of ICMS on gas transport.

 

   

Federal tax incentive: Suspension of PIS and COFINS (respectively, the profit participation contribution and the social security financing contribution, both of which are social contributions due on certain revenues net of some expenses) levied on the importation of goods and of IPI on the sales and importation of inputs and raw materials.

We cannot assure you that these tax benefits will be maintained or renewed or that we will be able to obtain new tax benefits. If we lose our existing tax benefits due to our noncompliance with future requirements or if the current tax programs and agreements from which we benefit are modified, suspended, cancelled or not renewed, we could be materially and adversely affected. Moreover, the state tax benefits relating to ICMS from which we benefit may be declared unconstitutional by the Brazilian Supreme Court if they have been granted without the approval of all the States and the Federal District through the Brazilian National Council of Fiscal Policy (Conselho Nacional de Política Fazendária — CONFAZ). The Brazilian Supreme Court may grant retroactive or prospective effect to the declaration of unconstitutionality. The foregoing could result in a material adverse effect on us.

The shareholders’ and certain other definitive agreements with respect to the Joint Venture and certain other of our subsidiaries are subject to various put and call options and termination provisions.

Shell and Cosan S.A. have entered into certain definitive agreements with respect to the Joint Venture. Specifically, these agreements set forth the rights and obligations of each shareholder in respect of Cosan S.A.’s and Shell’s interest in the Joint Venture and establish certain options whereby Cosan S.A. or Shell may acquire the other shareholder’s interest in the Joint Venture, certain lock-up provisions, rules governing the intra-group transfers regarding to the economic group of Cosan S.A. and Shell, and remedies for fundamental breaches of the documentation governing the incorporation and operation of the Joint Venture. If triggered, these provisions may cause the Joint Venture, or our participation in it, to terminate prior to the scheduled expiration date of the agreements in June 2031.

In November 2016, Cosan S.A. and Shell executed amendments to certain agreements between them to remove the fixed-date call options over Raízen Energia and Raízen Combustíveis shares exercisable in 2021 and 2026 and replace them with certain call and put options exercisable by Shell or Cosan S.A. in certain circumstances, including, among others: (i) fundamental breaches of the obligations provided for in the agreements governing the Joint Venture; (ii) breach of anticorruption laws, (iii) insolvency or bankruptcy of a party, (iv) change of control, and (v) in the event of the death or disability of Cosan S.A.’s current Chairman, Mr. Rubens Ometto Silveira Mello. Moreover, Shell and Cosan S.A. agreed to renew the existing lock-up period for five years from the date of the execution of the amendment, following which the parties may sell their shares in each of Raízen Energia and Raízen Combustíveis subject to compliance with certain preemption rights in each other’s favor.

 

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On February 23, 2017, TPG VI Fundo de Investimento em Participações, or “TPG VI,” a shareholder of Rumo exercised its right to exchange 11,479,987 shares issued by Rumo for shares issued by Cosan S.A. pursuant to the shareholders’ agreement entered into in 2010 between Cosan Logística, TPG VI, GIF, Cosan S.A. and the Company. Cosan S.A. and GIF agreed to settle financially the stock replacement obligation through of payment of R$275.8 million and the shares received were valued at fair value in the amount of R$97.9 million and recorded as capital reserve.

Cosan S.A. and Shell were parties to a Comgás shareholders’ agreement dated December 19, 2012. The shareholders agreement established the terms and conditions that regulated the relationship between the parties as shareholders of Comgás. On December 12, 2017, Shell exercised a put option with us relating to shares in Comgás and, as a result, we bought a total of 21,805,645 shares in Comgás, which represents 16.77% of Comgás’s share capital, for R$1,042 million. As a result, Shell ceased to be a shareholder of Comgás and the Comgás shareholders’ agreement was terminated.

If any of these or other similar provisions are triggered under the shareholders’ agreements or any of the other related agreements, our partnerships, or certain rights we hold in connection therewith, could terminate prior to the scheduled expiration, which could adversely affect our results of operations.

Raw material and supply service costs are subject to wide fluctuations that could have a material adverse effect on our results of operations.

Raw materials used in our business and the cost of services we contract for the distribution of natural gas are subject to wide fluctuations depending on market conditions. These prices are influenced by several factors over which we have little or no control, including, but not limited to international and national economic conditions, regulations, government policies, tariff adjustments and global effects of supply and demand. We cannot ensure that our tariff adjustment will be conducted in a timely manner or be sufficient to reflect and/or offset increases in inflation, operation costs and expenses, amortization of investments and taxes. As a result, we might not be able to pass on the increase in our cost structure to our customers, which could decrease our profit margin and result in a material adverse effect on our business, financial condition and results of operations.

We may not successfully acquire or develop additional production capacity through greenfield projects or expansion of existing facilities.

We may explore growth opportunities in the future through the acquisition or development of greenfield projects or through the expansion of our existing facilities. We may be unable to complete these projects on a timely basis or at all, and may not realize the related benefits we anticipate. The factors which may prevent us from doing so include, among other things: (1) our failure to obtain environmental and other licenses; (2) our inability to obtain supplies of appropriate equipment or raw materials; (3) increases in costs and/or decreases in revenue; (4) lack of qualified workforce; (5) lack of service providers; and (6) our inability to obtain any required financing on satisfactory terms, or at all.

Our greenfield projects and/or expansion of existing facilities require a significant number of service providers. Any inability on our part to enter into contracts with duly qualified service providers who are able to provide the technical services that we require may prevent us from completing our greenfield projects and/or expansions of existing facilities on a timely basis or at all. In addition, the integration of greenfield projects or expansion of our existing facilities may result in unforeseen operating difficulties and may require significant financial and managerial resources that would otherwise be used for our current operations. Planned or future greenfield projects or expansions of existing facilities may not enhance our financial performance. Any failure in the implementation of growth projects and/or expansion of existing facilities may have a material adverse effect on our business, financial condition and results of operations.

Fire and other disasters could affect our agricultural and manufacturing properties and our facilities and distribution networks, which would have a material adverse effect on our production and distribution volumes and, consequently, results of operations.

Our operations are subject to risks affecting our agricultural properties and facilities and distribution networks, including fire potentially destroying some or all of our crop and facilities. In addition, our operations are subject to hazards associated with the manufacture of flammable products and transportation of raw materials and flammable products. Our insurance coverage may not be sufficient to provide full protection against these types of casualties.

 

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Crop disease and pestilence may strike our crops which may result in destruction of a significant portion of our harvest.

Crop disease and pestilence can occur from time to time and have a devastating effect on our crops, potentially rendering useless or unusable all or a substantial portion of affected harvests. Even when only a portion of the crop is damaged, our business, results of operations and financial condition could be adversely affected because we may have incurred a substantial portion of the production cost for the related harvest. The cost of treatment of crop disease tends to be high. Any serious incidents of crop disease or pestilence, and related costs, may adversely affect our production levels and, as a result, our net sales and overall financial performance.

Anticompetitive practices in the fuel distribution market may distort market prices.

In the last few years, anticompetitive practices have been one of the main problems affecting fuel distributors in Brazil. Generally these practices have involved a combination of tax evasion and fuel adulteration, such as the dilution of gasoline by mixing solvents or adding anhydrous ethanol in an amount greater than that permitted by applicable law (the overall taxation of anhydrous ethanol is lower than hydrated ethanol and gasoline).

Taxes constitute a significant portion of the cost of fuels sold in Brazil. For this reason, tax evasion by some fuel distributors has been prevalent, which allows them to lower the prices they charge. These practices have enabled certain distributors to supply large quantities of fuel products at prices lower than those offered by the major distributors, including us, which has resulted in a considerable increase in the sales volumes of the distributors who have adopted these practices. The final prices for fuels are calculated based on the taxes levied on their purchase and sale, among other factors. If such practices become more prevalent, it could lead to lower prices or reduced margins for the products we sell, which could have a material adverse effect on our business, results of operations or financial condition.

In Brazil, Petrobras is the main supplier of base oils, the primary distributor of fuel and the dominant company in the natural gas sector. In the event of an interruption of supply of fuels from Petrobras, significant disruption to Raízen Combustíveis, Comgás and Moove operations sales may occur.

Petrobras is the principal supplier of fuel in Brazil and the distribution policies it sets forth directly affect the Brazilian energy matrix. With the recent discoveries in the pre-salt oil fields, and the beginning of production in the Santos basin, which is located close to our concession area, we face uncertainties regarding the production of alternative fuel. Petrobras is also the subject of “Lava Jato” investigations by the Brazilian Federal Police, the Brazilian Federal Prosecutor’s Office, the CVM and the SEC in connection with corruption allegations, which could cause disruption in Petrobras’ activities. Significant disruption to our fuels, lubricant and natural gas sales may occur in the event of an interruption of supply from Petrobras. Any interruption would immediately affect our ability to provide fuel, lubricant and natural gas products to our customers. If we are not able to obtain an adequate supply of fuel, base oil and natural gas products from Petrobras under acceptable terms, we may seek to meet our demands through purchases on the international market. The cost of fuel and base oil products on the international market may be more expensive than the price we obtain through Petrobras.

In addition, we may be adversely affected if Petrobras significantly modifies its business plan or reduces its activities related to the distribution of fuel in Brazil. In particular, the most recently published divestment plan of Petrobras suggests that Petrobras is scaling back its positions in logistics, which may result in disruption of logistics services and result in changes to distribution policies which may adversely affect the competitiveness of fuel distributors.

Disruption of Raízen Energia’s transportation and logistics services or insufficient investment in public infrastructure could adversely affect our operating results.

One of the principal disadvantages of the Brazilian agriculture sector is that key growing regions lie far from major ports. As a result, efficient access to transportation infrastructure and ports is critical to the growth of Brazilian agriculture as a whole and of our operations in particular. As part of its business strategy, Raízen Energia is investing in areas where existing transportation infrastructure is underdeveloped.

A substantial portion of Brazilian agricultural production is currently transported by truck, a means of transportation significantly more expensive than the rail transportation available to U.S. and other international producers. Raízen Energia’s dependence on truck transport may affect our position as a low-cost producer, such that its ability to compete in world markets may be impaired. Furthermore, Raízen Energia’s supply chain is dependent on road transport and may be adversely affected by weather conditions which require a decrease or stoppage in road transport. Any such impediments to road traffic along the routes typically used within Raízen Energia’s supply chain could require it and its suppliers to use alternative routes, which may result in delays and have a material adverse effect on Raízen Energia’s business, financial condition and results of operations.

 

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In addition, Brazilian ports are operating at close to full capacity. Given that a significant part of Raízen Energia’s sales are exported to countries other than Brazil (both with regards to sugar and ethanol), we may be adversely affected by the lack of port capacity or an increase in the costs of such port capacity as a result of limitations in supply.

Raízen Energia currently outsources the transportation and logistics services necessary to operate its business. Any disruption in these services, or any obligation to take over these services from existing service providers as a result of judicial orders banning the outsourcing of these services, could result in supply problems at Raízen Energia’s processing plants and impair its ability to deliver processed products to our customers in a timely manner. In addition, a natural disaster or other catastrophic event could result in disruption in regional transportation infrastructure systems affecting Raízen Energia’s third-party transportation providers.

Even though road and rail improvement projects have been considered for some areas of Brazil, and in some cases implemented, substantial investments are required for road and rail improvement projects, which may not be completed on a timely basis, if at all. Any delay or failure in developing infrastructure systems could hurt the demand for our products, impede our delivery of products or impose additional costs on Raízen Energia.

The production of lubricants and the storage and transportation of fuel products and lubricant products are inherently hazardous.

The complex manufacturing operations we perform at our lubricants oil blending plant involve a variety of safety and other operating risks, including the handling, production, storage and transportation of toxic materials. These risks could result in personal injury and death, severe damage to or destruction of property and equipment and environmental damage. A material accident at one of our plants, service stations or storage facilities could force us to suspend our operations and result in significant remediation costs and lost revenue. In addition, insurance proceeds, if available, may not be received on a timely basis and may be insufficient to cover all losses, including lost profit. Equipment breakdowns, natural disasters, and delays in obtaining supplies or required replacement parts or equipment could also have a material adverse effect on our manufacturing operations and consequently our results of operations. Disruption of transportation and logistics services or insufficient investment in public infrastructure could have a material adverse effect on our operating results.

We may be adversely affected by unfavorable outcomes in pending legal proceedings.

We are involved in a significant number of tax, civil (including regulatory and environmental) and labor proceedings. As of December 31, 2018, we had recorded a provision totaling R$1,363.2 million for proceedings in which we deem the risk of loss as probable (equivalent to R$878.8 million net of judicial deposits or restricted bank accounts). We cannot predict whether we will prevail in these or other proceedings, or whether we will have to pay significant amounts, including penalties and interest, as payment for our liabilities, which would materially and adversely impact our business and financial performance.

In addition, unfavorable decisions in criminal proceedings involving members of our management may have a material adverse effect on us. Certain members of our management have been named as defendants in criminal proceedings (1) in their capacity as officers of the predecessor entity of Raízen Energia for alleged artificial price fixing of fuel and the formation of a cartel with the purpose of establishing control over the regional market, (2) in their capacity as officers of Raízen Energia and Cosan S.A. for alleged tax evasion carried out by these entities, and (3) in their capacity as officers of the predecessor entities of Raízen for the crimes of disobedience and pollution in connection with the alleged burning of sugarcane contrary to a judicial decision. In the event of a final non-appealable conviction, one or more of these officers may be barred from holding executive positions within our Company, and depending on the development of the proceedings, our reputation in the opinion of our clients, suppliers and investors may be materially adversely affected.

Two of Rumo’s subsidiaries, Rumo Malha Oeste S.A., or “Malha Oeste,” and Rumo Malha Sul S.A., or “Malha Sul,” are party to preliminary proceedings being conducted by ANTT in relation to certain alleged failures by Malha Oeste and Malha Sul to comply with their contractual obligations pursuant to certain concession agreements. Specifically, the ANTT is alleging that Malha Oeste and Malha Sul have failed to comply with certain deadlines for the presentation of documents and financial information in relation to their respective concessions. If the preliminary proceedings are decided against Malha Oeste and Malha Sul, we expect that Malha Oeste and Malha Sul will be given the opportunity to remedy the alleged breaches and/or to pursue the proceedings in court before any of the concession agreements in question is terminated. We estimate that the risk of loss in these proceedings is possible.

 

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One of Rumo’s subsidiaries, Rumo Malha Paulista S.A., or “Malha Paulista,” is party to a labor class action (ação civil pública) stemming from allegations by the Labor Prosecutor’s Office that certain persons working for MS Teixeira were working in degrading conditions analogous to indentured servitude. MS Teixeira was a subcontractor to Malha Paulista’s contractor for certain services, Prumo Engenharia. Malha Paulista has been ordered by the courts to undertake (and/or refrain from undertaking) various actions with respect to the working environment and to pay an indemnity for collective moral damages, as well as fines of R$100 thousand per breach or per worker in the event of future labor breaches. As of the date of this annual report, neither we nor Rumo have made provisions with respect to these proceedings as the external counsel advising Rumo on these proceedings has assessed the risk of loss as possible. An adverse outcome in this lawsuit could result in losses of approximately R$28.8 million to Rumo, and adversely affect Rumo’s reputation. However eventual future loss on this lawsuit cannot lead the inclusion of Malha Paulista on the list of Brazilian Ministry of Labor, containing the employers that practices supposed labor irregularities. If Malha Paulista’s appeal is rejected by the superior courts or if the Labor Prosecutor’s Office’s allegation of degrading working conditions analogous to indentured servitude is confirmed, the final outcome of the action may have a material adverse effect on Rumo’s business, financial condition and results of operations—including as a result of the acceleration of certain financial agreements to which Rumo is a party—and Rumo may suffer damage to its reputation. Any such developments could have a material adverse effect on us.

The Brazilian Ministry of Labor has imposed a fine and served an infraction notice on Malha Paulista in connection with the abovementioned allegations that certain employees of MS Teixeira were working in degrading conditions analogous to indentured servitude. Malha Paulista has challenged the infraction notice in an administrative proceeding with the Brazilian Ministry of Labor, pending a final decision. Prumo Engenharia has admitted responsibility for the degrading conditions in which certain employees were working, including acknowledging its status as their employer and paying all applicable employment termination fees. This process was recognized and duly recorded by Brazilian Ministry of Labor. In spite of this, Malha Paulista has been included in a list of employers that employ workers in a condition analogous to indenture servitude by the Brazilian Ministry of Labor. On April 13, 2018, as part of annulment action currently being heard, the 83rd Labor Court of São Paulo granted an injunction, requiring that Malha Paulista be removed from the list until a final and unappealable judicial verdict is issued. The Regional Labor Appeals Court of São Paulo upheld the injunction following an appeal. The annulment proceeding is currently in the discovery phase. The facts under discussion in the annulment proceeding are similar to those at issue in the abovementioned labor class action. However, in the labor class action, the Labor Prosecutor’s Office is seeking the payment of damages and compliance with certain labor obligations by Malha Paulista, while in the annulment proceeding Malha Paulista is seeking the annulment of the Brazilian Ministry of Labor’s infraction notice. We estimate that the risk of loss in these proceedings is possible. If the annulment proceeding is decided against Malha Paulista, this may have a material adverse effect on Rumo’s business, financial condition and results of operations and Rumo may suffer damage to its reputation. Any such developments could have a material adverse effect on us.

Moreover, Malha Paulista has contracted COS Emergencial Intermediação e Agendamento Ltda., or “COS Emergencial,” to perform property security services from 2006 until 2012. However, COS Emergencial’s managers were accused by the Federal Public Prosecutor’s Office of employing workers in degrading working conditions analogous to indentured servitude between the years of 2005 and 2010. According to testimony, the defendants had not complied with certain requirements to provide adequate working conditions, had left their employees for long periods without food, water, sanitation, communication and basic equipment, and had submitted them to long continuous periods of work. The lower court convicted the defendants and the Federal Public Prosecutor’s Office filed an appeal seeking to increase the defendants’ sentence. Even though there is no allegation that Malha Paulista committed any crime, one of the defendants stated in his defense that Malha Paulista was responsible for overseeing its contracted companies, and should therefore have identified the abovementioned working condition irregularities and sanctioned COS Emergencial or rescinded its agreement with COS Emergencial. We estimate that the risk of loss in these proceedings is possible.

We cannot predict whether we will prevail in these or other proceedings, or whether we will have to pay significant amounts, including penalties and interest, as payment for our liabilities, which would materially and adversely impact our business, results of operations and financial condition. If we are the subject of an unfavorable outcome in any of these legal proceedings, the amount of such unfavorable decisions will have a material adverse effect on our financial position and operating results.

Transporting gas involves numerous risks that may result in accidents and other operating risks and costs that could adversely affect our results of operations, cash flows and financial condition.

Our activities involve a variety of inherent hazards and operating risks, such as leaks, accidents and mechanical problems, which could cause substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution and impairment of our operations, which in turn could lead to substantial losses. In accordance with customary industry practice, we maintain insurance against some, but not all, of these risks and losses. The location of pipelines near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. The occurrence of any of these events if not fully covered by insurance could adversely affect our results of operations, cash flows and financial condition.

 

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The volatility and uncertainties in international oil and gas prices as well as a significant depreciation of the real relative to the U.S. dollar may affect the operating costs and competitive positions of our businesses, which could adversely affect our results of operations, cash flows and financial condition.

Natural gas and oil prices historically have been volatile and may continue to be volatile in the future. Prices for natural gas and oil are subject to a variety of factors that are beyond our control. These factors include, but are not limited to, the level of consumer demand for, and the supply of, natural gas, processing, gathering and transportation availability, statutory gas supply purchase obligations, price and availability of alternative fuel sources, weather conditions, natural disasters and political conditions or hostilities in natural gas producing regions.

In addition, the amounts we pay under our natural gas supply agreements are composed of two components: (1) one that is indexed to a basket of combustible oils in the international market that is adjusted quarterly and (2) one that is adjusted annually based on the inflation rate. We have no control over either of these components. Furthermore, natural gas supply agreements often take the form of a “take or pay” agreement, pursuant to which we might be required to pay the difference in amounts between actual consumption and the contract amount. Variations and uncertainties in the price and demand of oil and gas are beyond our control and may adversely affect our results of operations.

Renewal of our natural gas concession agreement is not guaranteed, the terms we will receive if such renewal is granted could adversely affect our results of operations, cash flows and financial condition and our growth strategy would be materially adversely affected if we cannot obtain new concessions on similar terms or if our existing concession is terminated.

We, through our affiliate Comgás, carry out our natural gas distribution activities pursuant to a concession agreement entered into with the government of the state of São Paulo and regulated by ARSESP for a 30-year term with a one-time possibility of renewal for an additional 20 years at the discretion of the government of the state of São Paulo, subject to certain conditions, including approval by ARSESP. The Brazilian Constitution (Article 175) requires that all concessions relating to public services be awarded through a public bidding process.

Due to the discretionary power of the government of the state of São Paulo in granting the renewal of our concession agreement, we cannot assure you that our concession agreement will be renewed, or that it will be renewed on the same terms. Moreover, pursuant to the terms of our concession agreement, the government of the state of São Paulo may terminate our concession agreement upon the occurrence of certain conditions. If our concession agreement is not renewed, or is renewed with less favorable terms, or is terminated, our business, financial condition and results of operations will be materially adversely affected.

Our business is subject to regulation, control and supervision of ARSESP, which could affect our financial performance. ARSESP establishes the maximum values of our rates and regulates and supervises our business. Pursuant to our concession agreement, every five years – or whenever ARSESP deems the economic and financial balance of the concession agreement to be adversely affected due to the variation of costs incurred by Comgás – our rates are reviewed by ARSESP, which directly affects our margins and our results, either positively or negatively. Such margins are adjusted annually by the IGP-M minus the efficiency factor determined for each tariff cycle by ARSESP. As a result, the implementation of our growth strategy and the normal course of our business may be adversely affected by government actions.

We cannot guarantee that changes arising from the tariff review process will be supportive of our strategy in our subsidiary Comgás.

The principal rights and obligations of the holders of concessions are included in the concession agreement, and in the regulations established by ARSESP. Among the items provided in the concession agreement is the tariff review, which should occur in five-year cycles and serves to reestablish the economic and financial balance of the concession, setting the average margin for the cycle and the rates that will apply for each segment. The tariff review process, which should have been concluded in May 2014, is still in process. We cannot assure you that in the future tariffs will be set at a level that would permit us to continue to operate profitably.

In addition, in its regulatory capacity, ARSESP may impose penalties on us if we fail to comply with any provision of the concession agreement. Depending on the severity of noncompliance, applicable penalties include, among others:

 

   

assessments;

 

   

fines;

 

   

bans on the construction of new facilities and equipment;

 

   

forfeiture of the concession; and

 

   

impediments from participating in public bidding processes and from being awarded new concessions.

 

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We cannot guarantee that we will not be penalized by ARSESP for breaching our natural gas concession agreement or that the concession will not be revoked in the future. The compensation to which we would be entitled in the event of possible revocation of the concessions may not be sufficient to recover the full value of certain assets. Therefore, the imposition of fines or penalties on us or the revocation of the concessions may have a material adverse effect on our financial condition and results of operations.

We depend on third parties to provide our customers and us with facilities and services that are integral to our business.

We have entered into agreements with third-party contractors to provide facilities and services required for our operations, including storage facilities and transportation services for our ethanol and sugar operations. The loss or expiration of our agreements with third-party contractors or our inability to renew these agreements or to negotiate new agreements with other suppliers at comparable rates could harm our business and financial performance. Our reliance on third parties to provide essential services on our behalf also gives us less control over the costs, efficiency, timeliness and quality of those services. Contractors’ negligence could compromise the safety of the transportation of ethanol from our production facilities to our export facilities and expose us to the risk of liability for environmental damage caused by such third parties. We expect to be dependent on such agreements for the foreseeable future, and if we enter any new market segments, we will need to have similar agreements in place.

Brazilian labor authorities previously prohibited the outsourcing of activities considered to be part of an entity’s core business. Noncompliance with this prohibition could result in fines and a requirement that the outsourcing be terminated. However, the Brazilian Supreme Court has recently ruled that outsourcing is generally permitted. Moreover, recently enacted labor legislation has explicitly allowed the outsourcing of activities considered to be part of an entity’s core business provided that certain conditions are complied with. While we expect that these legal developments will make it easier to outsource activities to third-party contractors, we still face the risk that (i) we may be held indirectly liable when third-party contractors fail to comply with their labor obligations, and (ii) we are held jointly and severally liable with our third-party contractors where they fail to comply with their labor obligations if it is proved that there was a direct relationship between us and the outsourced employees, or in cases of fraud. Any such developments could have a material adverse effect on us.

Our international operations expose us to political and economic risks in other countries.

We derive 2.2% of our revenues from exports. In particular, Moove derives approximately 3.2% of its revenues from exports, as it distributes and sells Mobil brand products manufactured in Brazil and sold in Bolivia, Paraguay and Uruguay, and, in July 2012, we acquired Comma, which produces and distributes lubricants throughout Europe and Asia. In 2017 we also acquired Stanbridge group, which distributes lubricant and fuels in the United Kingdom. In addition, Moove has started a new distribution operation under the Mobil brand, in Spain, France, Portugal, the United States and Argentina, aligned with its strategy to leverage the ExxonMobil partnership and expand abroad.

Our international activities expose us to risks not faced by companies that operate solely in Brazil. Risks associated with our international operations include: (1) foreign exchange controls; (2) changes in the political or economic conditions in a specific country or region, especially in emerging markets; (3) potentially negative consequences resulting from changes to regulatory requirements; (4) difficulties and costs associated with our observance of different laws, treaties and complex international regulations; (5) tax rates that may exceed those applicable in Brazil and other countries or gains that may be subject to withholding regimes and an increase in repatriation taxes; (6) imposition of trade barriers; and (7) limitations on the repatriation of undistributed profits. The realization of any of these risks may have a material adverse effect on our business, results of operations or financial condition.

We may not be able to maintain or renew certain agreements with third parties which are important to our business.

Our business, financial condition and results of operations may be materially and adversely affected if we are unable to maintain or renew certain agreements (including, without limitation, supply agreements, service contracts, licensing agreements, distribution agreements, joint ventures, partnerships and others) with third parties which are important to our business and operations.

 

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On November 1, 2017, we acquired Stanbridge, which distributes lubricants and fuels in some regions of the United Kingdom. The company has an exclusive supply service contract with the company operating Heathrow Airport to supply fuel, fuel management services and certain other products and services to Heathrow Airport. This contract is expected to terminate in 2019. While negotiations have begun to renew this agreement, we cannot assure you that such negotiations will be successful. Failure to renew such agreement could materially and adversely affect our results of operations.

We, through our subsidiary Moove, are the manufacturer and exclusive distributor of lubricants in Brazil based on formulas that have been provided under the terms of the Principal Lubricants Agreement that we have entered into with ExxonMobil. On March 19, 2018, we entered into an agreement with ExxonMobil Lubricants Trading Company which grants our subsidiary Moove the exclusive production, import, distribution and marketing rights in Brazil, Bolivia, Paraguay and Uruguay of lubricants and certain other related products under the Mobil brand until November 30, 2038. This agreement came into force on December 1, 2018. The termination or failure to renew these agreements, or the failure by ExxonMobil to adequately maintain and protect its intellectual property rights, could materially and adversely affect our results of operations or could require significant unplanned investments by us if we are forced to develop or acquire alternative technology. In the future, it may be necessary or desirable to obtain other third-party technology licenses relating to one or more of our products or relating to current or future technologies to enhance our product offerings. However, we may not be able to obtain licensing rights to the needed technology or components on commercially reasonable terms or at all.

We incur substantial costs to comply with environmental regulations and may be exposed to liabilities in the event we fail to comply with these regulations or as a result of our handling of hazardous materials.

We are subject to various Brazilian federal, state and municipal environmental protection and health and safety laws and regulations governing, among other matters:

 

   

the issuance and renewal of valid environmental licenses and authorizations;

 

   

the use of water;

 

   

the generation, storage, handling, use and transportation of hazardous materials;

 

   

sugarcane burning;

 

   

wildlife preservation;

 

   

the protection of cultural and historic sites;

 

   

the emission and discharge of hazardous materials into the ground, air or water; and

 

   

the health and safety of our employees.

We are also required to obtain environmental and health permits and/or authorizations (such as installation and operation permits as well as permits for the removal of vegetation) from governmental authorities for certain aspects of our operations. Failure to obtain environmental and/or health permits or comply with the conditions under which such permits are issued could subject us to criminal, administrative and/or civil liabilities. These laws, regulations and permits often require us to purchase and install expensive pollution control equipment or to make operational changes to limit actual or potential impacts on the environment and/or health of our employees. In addition, Brazilian environmental laws establish restrictions to obtain financing from public entities in case of breach of certain environmental protection obligations. Any violations of these laws and regulations or permit conditions can result in substantial fines, criminal sanctions, revocations of operating permits and/or shutdowns of our facilities.

Due to the possibility of changes to environmental and/or health regulations and other unanticipated developments, the amount and timing of future environmental and health expenditures may vary substantially from those currently anticipated. Under Brazilian environmental laws, we could be held strictly liable for all of the costs relating to any contamination at our or our predecessors’ current and former facilities and at third-party waste disposal sites used by us or any of our predecessors. We could also be held responsible for any and all consequences arising out of human exposure to hazardous substances, such as pesticides, herbicides, soil or groundwater contamination or other kinds of environmental damage.

We are party to a number of administrative and judicial proceedings for alleged failures to comply with environmental and health laws, which may result in fines, shutdowns or other adverse effects on our operations. Actions that give rise to administrative proceedings may also lead to civil or criminal claims against us. We have not recorded any relevant provisions or reserves for these proceedings as we do not currently believe that they will result in liabilities material to our business or financial performance. Our costs of complying with current and future environmental and health and safety laws, and our liabilities arising from past or future releases of, or exposure to, hazardous substances could adversely affect our business or financial performance.

 

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Our business would be materially adversely affected if operations at our transportation and distribution facilities experienced significant interruptions. Our business would also be materially adversely affected if the operations of our customers and suppliers experienced significant interruptions.

The distribution of natural gas is by its nature subject to inherent risks, including interruptions or disturbances in the natural gas distribution system which may be caused by accidents or force majeure events. Our operations are dependent upon the uninterrupted operation of our terminal and storage facilities and various means of transportation and distribution facilities. We are also dependent upon the uninterrupted operation of certain facilities owned or operated by our suppliers and customers. Operations at our facilities and at the facilities owned or operated by our suppliers and customers could be partially or completely shut down, temporarily or permanently, as the result of any number of circumstances that are not within our control, such as:

 

   

catastrophic events, including hurricanes and floods;

 

   

environmental matters (including environmental licensing processes or environmental incidents, contamination, wildlife preservation obligations and others);

 

   

labor difficulties (including work stoppages, strikes and other events); and

 

   

disruptions in the supply of our products to our facilities or means of transportation.

Any significant interruption at these facilities or inability to transport products to or from these facilities or to or from our customers for any reason could subject us to liability in judicial, administrative or other proceedings, even for disruptions caused by events outside of our control. If we are held liable for such events, results of operations and cash flow would be materially adversely affected.

For example, between May 21 and May 31, 2018, Brazil suffered an extensive nationwide trucking strike. With trucks stopped and blocking highways, supplies of fuel, food and medical supplies ceased being delivered to distribution points. The stoppage began to subside on May 27, 2018, after representatives of the trucking industry and the Brazilian government reached an agreement. We estimate that the nationwide trucking strike impacted our results (principally those of Raízen Combustíveis) by approximately R$220 million during the fiscal year ended December 31, 2018.

Rumo depends on a few major customers for a significant portion of its revenue.

The majority of the cargo Rumo transports is for the agricultural commodities industry. Rumo’s major clients are export companies participating in this market, such as Amaggi, ADM, Bunge, Cargill, Louis Dreyfus and Raízen. In the fiscal year ended December 31, 2018, Bunge accounted for 13.9% of Rumo’s total net revenue from services, while Rumo’s six major clients accounted for 48% of Rumo’s total net revenue from services. In the fiscal year ended December 31, 2017, Bunge accounted for 15% of Rumo’s total net revenue from services, while Rumo’s six major clients accounted for 52.5% of Rumo’s total net revenue from services in the same period. Bunge is the principal customer of Rumo’s Northern Operations (as defined below) and Southern Operations (as defined below) and is active in agricultural commodities, especially corn, soy and derivatives thereof, loading cargo in transshipment terminals destined for ports which Rumo operates.

Rumo’s major clients in the rail sector are export companies such as Amaggi, ADM, Bunge, Cargill, Louis Dreyfus and Raízen. In the fiscal year ended December 31, 2018, Bunge accounted for 15.6% of Rumo’s net revenue from services in the rail sector, while Rumo’s six major clients in the rail sector jointly accounted for 53.9% of Rumo’s net revenue from services in that sector. In 2017, Bunge accounted for 14.5% of Rumo’s net revenue from services in the rail sector, while Rumo’s six major clients in the rail sector accounted for 46.4% of Rumo’s net revenue from services in that sector.

Rumo’s largest clients in the port elevation sector include Engelhart, Czarnikow, Cofco, Wilmar, Raízen and Sucden. In the fiscal year ended December 31, 2018, Engelhart accounted for 17.8% of our net revenue from services in the port elevation sector, while Rumo’s six largest clients in the port elevation sector collectively accounted for 70% of Rumo’s net revenue from services in that sector. In the fiscal year ended December 31, 2017, Raízen accounted for 17.9% of Rumo’s net revenue from services in the port elevation sector, while Rumo’s six largest clients in the port elevation sector accounted collectively for 52.3% of Rumo’s net revenue from services in that sector.

We cannot guarantee that Rumo will obtain similar revenue from its major clients in the future. Any change by Rumo’s major clients in their demand for transportation services, including logistics services, may have a material adverse effect on Rumo’s business, financial condition and results of operations. Moreover, Rumo’s revenue predominantly derives from transportation agreements between Rumo and its clients. We cannot guarantee that these transportation agreements will be renewed once they have expired, which may adversely affect Rumo’s business, financial condition and results of operations.

 

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Rumo’s significant debt could adversely affect its financial health and prevent it from fulfilling its debt obligations, which would have a material adverse effect on us, our financial condition and our results of operations.

Rumo has a significant amount of debt. As of December 31, 2018, Rumo’s gross debt was R$10,594.4 million, of which R$924.9 million was short-term debt.

Rumo’s debt level and the composition of its debt could have important consequences to its business. For example, it could: (1) require Rumo to reserve a substantial part of its operational cash flows to pay principal and interest on Rumo’s debt, which will reduce the availability of its cash flow to fund working capital, capital expenditures, acquisitions and investments; (2) limit its flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; (3) limit its ability to borrow additional funds, obtain bank guarantees or collateral insurance and generally increase its borrowing costs; and (4) place Rumo at a competitive disadvantage compared to our competitors that have less debt.

Any of the aforementioned developments could have a material adverse effect on us, our financial condition and results of operations.

Significant deterioration in Rumo’s short-term liquidity could materially affect our business, result of operations and financial condition.

If Rumo fails to improve its short-term liquidity, we may face difficulties in fulfilling its obligations relating to financing agreements, and agreements with suppliers and/or subcontractors, among others. For example, as of December 31, 2018, Rumo’s material contractual financial obligations maturing in less than one year totaled R$2,927.1 million (amortization only), while such obligations with maturities between one to two years totaled R$2,118.6 million (based on contracted undiscounted cash flow). Rumo’s failure to comply with these obligations and/or other undertakings may have a material adverse effect on our business, results of operations and financial condition.

The sector in which Rumo operates has limited working capital, if not negative. If Rumo’s cash flow is impaired, Rumo may not be able to maintain its short-term liquidity and may face difficulties in meeting its obligations pursuant to its financing agreements, and contracts with suppliers and/or subcontractors, among others. Any failure by Rumo to comply with these and/or other obligations may, in turn, materially impact Rumo’s business, results and financial condition.

Rumo’s concessions to operate port terminals are subject to expiration, limitation on renewal and early termination by the granting authority.

Rumo leases 118,434.38 square meters of property located in the port of Santos (state of São Paulo), which has two docking cradles for loading sugar and solid agricultural bulk (corn and soy). This property is leased pursuant to lease agreement PRES-05/96, which matures on March 6, 2036. Pursuant to Article 19 of Decree No. 8,033/2013, recently amended by Decree No. 9,048/2017, lease agreements may be extended for up to the limit of 70 years. Pursuant to the lease agreement, Rumo has an obligation to make investments totaling an estimated R$308 million, of which we have already invested 85% as of April 29, 2019.

Rumo also holds equity interests in: (1) Terminal XXXIX and the adjacent areas for moving agricultural products and bulk as well as other goods capable of being transported in those port installations, through a port lease agreement due to expire in 2050; (2) facilities, equipment and track for rail transport of goods and import/export through the right bank of the port of Santos, by means of a lease agreement with Portofer Transporte Ferroviário Ltda. due to expire in 2025; (3) Terminal de Granéis do Guarujá (TGG) located on the left bank of the port of Santos, for the transport of solid and liquid bulk, through an area used by Rumo Malha Norte S.A., or “Malha Norte” via a leasing agreement due to expire in 2022; and (4) Terminal Marítimo do Guarujá (TERMAG), located on the left bank of the port of Santos, mainly for the transport of solid and liquid bulk, through an area used by Malha Norte via a lease agreement due to expire in 2022.

There are ongoing legal proceedings regarding whether the lease agreements (as amended) relating to Terminal XXXIX, Terminal de Granéis do Guarujá and Terminal Marítimo do Guarujá should be subject to the public procurement regime. These proceedings are currently under appeal in the Brazilian superior courts (Superior Tribunal de Justiça and Supremo Tribunal Federal). With regards to the Portofer lease agreement, there is a public civil action filed by the Brazilian Federal Prosecutors’ Office, to challenge the legal validity of the agreement.

 

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If Rumo fails to comply with the applicable regulatory rules or contractual obligations relating to Terminals 16 and 19 its lease may be terminated early pursuant to the Concessions Law (Law No. 8,987/1995), which applies to port leases. Below is a list of the termination events applicable to the port lease agreements:

 

   

expiration of the lease agreement (currently in 2036, which can be legally extended up to 2066 through new investments);

 

   

encampação, which is the possibility of expropriation of the port concessions by the granting authority during the contractual term. Such expropriation must be for public interest, performed pursuant to applicable authorizing law and accompanied by the payment of an indemnity for investments not yet depreciated, if applicable;

 

   

a statement of forfeiture, which occurs, at the granting authority’s sole discretion, in case of total or partial non-performance of the lease, without prejudice to the application of other contractual penalties. The forfeiture may be declared under the following circumstances: (1) the service is not being provided adequately (i.e., there has been a breach of the minimum transport requirements); (2) failure to undertake the investments stipulated in the agreement; (3) breach of contractual obligations; (4) transfer of the agreement without prior consent from the granting authority; (5) obstruction of audits carried out by the granting authority; (6) changes to the contractual objective; (7) failure to maintain or conserve the leased facilities; (8) default in financial obligations set out in the agreement; or (9) loss by us of the economic, technical and operating conditions required for the adequate provision of services set out in the agreement. The forfeiture must be preceded by the verification of the default in an administrative proceeding in connection with which we have a right of defense;

 

   

termination by the lessee in the event of breach of contractual provisions or rules established by the granting authority by means of judicial action for this specific purpose;

 

   

annulment; and

 

   

bankruptcy or extinction of the lessee.

The lease agreements and applicable legislation confer several rights of the granting authority pursuant to the specific rules and regulations for the industry. Accordingly, there are contractual provisions that allow, among other things, amendments to the agreement, assignment and/or transfer of the lease agreement (the latter subject to prior consent from the granting authority), provided, however, that all amendments to the agreement must abide by the rules and proceedings set out in the specific law or regulation.

Termination of Rumo’s port lease agreements may adversely impact Rumo’s transportation costs and the turnaround time for the export of Rumo’s products, as well as Rumo’s revenues from service agreements related to Rumo’s port facilities.

In addition, port assets deemed essential to the continuity of port operations will revert to the granting authority upon expiration of the concession. The reversion following expiration is subject to indemnification for investments in assets not yet amortized or depreciated which were undertaken to guarantee service continuity. Upon termination of the concession, it is possible that the investments made in those assets will have not been entirely amortized or depreciated. In this case, Rumo and the granting authority will negotiate the amount of any indemnification for such investments, to the extent such investments have been previously approved by the granting authority. As the final decision on this amount will be made solely by the granting authority, Rumo’s financial condition may be negatively impacted if indemnification eventually approved is not sufficient to compensate us for the investments made.

Any of the aforementioned developments could have a material adverse effect on us, our financial condition and results of operations.

We are unable to estimate the impact of new regulations applicable to port operations in Brazil.

Until December 6, 2012, port operations in Brazil were governed by Federal Law No. 8,630/1993, or the Ports Modernization Law, which provided the legal framework applicable to the development and operation of ports and port facilities in Brazil. To improve the applicable legislation, the Brazilian government enacted Law No. 12,815/2013, or the “New Ports Law,” which has been regulated by Decree No. 8,033/2013, amended by Decree No. 9,084/2017. Such law revoked the Ports Modernization Law and established a new legal framework for port operations in Brazil. As a result, public ports are governed by the New Ports Law and by specific complementary regulations enacted at the federal level, particularly by the Agência Nacional de Transportes Aquaviários and by the Secretaria Nacional de Portos, or “SNP.” (SNP has been integrated within the structure of the Federal Government’s Transportation, Ports and Civil Aviation Ministry by Federal Law No. 13,341/2016).

 

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Pursuant to the New Ports Law, there is no longer a distinction between third-party and own cargo handled at private port terminals, i.e., the activities carried out in private terminals will be identical to those performed at public terminals with respect to the rendering of services. As a result, public ports are expected to face higher competition from the potential increase in development of operations in private ports. Accordingly, new port lease grants may be carried out by the Brazilian federal government, which may affect inter-and intra-port competition. Finally, Rumo may not be able to meet the minimum cargo volumes provided for in Rumo’s port lease agreements, which may subject it to fines and, upon repeated violations, to the early termination of the relevant grants.

Although the New Ports Law does not retroactively adjust the terms of any concession agreement currently in effect, it is possible that the supplemental regulations provide for such retroactive adjustment (including by means of unilateral requirements from the granting authority). New regulations applicable to port operations in Brazil that modify the terms of Rumo’s grant documents may materially and adversely affect our results of operations.

The loss of Brazilian railway concessions may have a material adverse effect on our business.

Brazilian railway concessions are subject to early termination in certain circumstances, including the Brazilian authorities reassuming control of the service pursuant to applicable law or by the termination of the relevant concession for breach of any underlying contractual agreements, in particular the inadequate provision of rail transportation services provided for in the concession agreements. Pursuant to Federal Law No. 8,987/1995, concession agreements may be terminated as a consequence of: (1) expiration of the contractual term; (2) expropriation of the port concessions in the public interest (i.e., encampação); (3) forfeiture (caducidade); (4) termination; (5) annulment; (6) bankruptcy; or (7) expiration of the concession-holding entity.

Encampação is the seizure of the service by the granting authority during the concession term to the benefit of public interest, by means of a specific authorizing law and after payment of an indemnity. The granting authority may declare the forfeiture of the agreement in the cases in which the concessionaire recurrently defaults on its obligations, or annulment in the cases that the bidding documents for the concession or the concession agreement are tainted by unlawful provisions, or declare penalties, due to total or partial non-performance of the agreement. The granting authority may forfeit the concession when, among other events: (1) the service is being rendered in an inadequate or insufficient manner, according to the norms, criteria, indicators and parameters defining the quality of the service; (2) the concessionaire breaches contractual, regulatory or legal provisions concerning the concession; (3) the concessionaire interrupts the service other than for acts of god or force majeure events; (4) the concessionaire no longer possesses the economic, technical or operational conditions required to adequately render the services under the concession; and (5) the concessionaire does not comply with the penalties imposed for breaches within the established deadlines.

Upon termination of a concession, the leased or operated assets revert to the granting authority, and the amount of compensation received may not be sufficient to cover the losses incurred by us as a result of such early termination. In addition, certain creditors may have priority with regards to such compensation.

In addition, pursuant to the terms of Rumo’s concession agreements, the granting authority may intervene in the concession to ensure that the relevant services are being provided as well as to ensure compliance with the applicable contractual clauses and legal and regulatory norms.

An early termination of Rumo’s concession agreement, as well as the imposition upon Rumo of penalties associated with such termination and interventions in our management may have a material impact on Rumo’s operating results and affect our payment capacity and ability to meet our financial obligations.

 

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Rumo may not obtain early renewals of the Malha Paulista, Malha Sul and Malha Oeste concession agreements, currently under review by the Brazilian Transportation Authority (Agência Nacional de Transporte Terrestre), or “ANTT,” which may have a material adverse effect on Rumo’s investment plan and growth strategy.

The concession agreements for Malha Paulista, Malha Sul and Malha Oeste are currently due to expire in 2028, 2026 and 2027, respectively. In September 2015, Rumo filed formal requests with the ANTT for early renewals of such agreements. Malha Paulista’s formal extension request was approved by ANTT and is currently under audit by the Federal Court of Audit, under the terms of Law 13,488/2017.

Following the applications for extensions referred to above, Law No. 13,448/2017 was enacted following the conversion into law of Provisional Measure No. 752/2016 which defines the general rules governing extensions of concessions, including early renewals, as well as rebidding of partnership contracts of the federal public administration pursuant to the provisions of Law No. 13,334/2016 in the road, rail and airport sectors. Pursuant to the terms of the new law, the granting authority will perform rebidding if there is a breach of contract or if the concession holders are no longer capable of fulfilling the contractual and financial obligations originally undertaken. In the case of early renewals, rail concession holders must demonstrate provision of adequate services, including compliance with production and safety targets or of safety targets set forth in the applicable contracts, pursuant to the provisions of article 6, paragraph 2 of Law No. 13,448/2017. In addition, contract amendments must contain a timeline for required investments and include measures to discourage potential noncompliance or delay in complying with obligations (such as the annual rebalancing discount and the additional grant payment).

We cannot guarantee that Rumo’s requests for renewals will be successful or that they will occur within the timeframe which we anticipate. In addition, any early renewal may be subject to certain conditions precedent or the applicable concessions may be renewed on terms less favorable than those currently in place. Rumo may also face significant competition from third parties if the granting authority decides to subject our maturing concessions to a rebidding process.

Rumo may incur additional liabilities if it obtains an early renewal of the Malha Paulista concession agreement, currently under review by the ANTT.

Malha Paulista’s concession agreement is due to expire in 2028. In September 2015, Rumo filed a formal request with the ANTT for early renewal of such concession agreement. The extension request was duly approved by ANTT and is currently under audit by the Federal Court of Audit, under the terms of Law 13,488/2017 If, following the analysis by the Federal Court of Audit, the ANTT and Rumo execute an amendment to Malha Paulista’s concession agreement, it is estimated that, in addition to the investment commitments provided for in our business plan, Malha Paulista may incur additional liabilities currently estimated by the ANTT to be in an amount of approximately R$1 billion. Once the value of these liabilities has been confirmed, Rumo may, pursuant to (i) applicable legislation and (ii) clause 6.2 of the draft of the amendment to the Malha Paulista’s concession agreement (the public consultation procedure for which has already been completed by the ANTT), enter into an agreement with the ANTT whereby instead of indemnifying the ANTT for such liabilities, we would be required to invest a substantial amount in our rail networks (both within Malha Paulista and in other parts of our logistics business).

Rumo’s Brazilian rail tariffs are subject to a maximum rate established by the Brazilian government.

Under Rumo’s rail network concession agreements, tariffs for our rail freight services are subject to a maximum rate. Maximum tariff rates that Rumo is allowed to charge are adjusted for inflation according to variations in the IGP-DI index (or a substitute index) in accordance with applicable Brazilian law or concession agreements. Currently, tariff adjustments are performed on an annual basis, at different months of the year, depending on the terms of each concession agreement. Additionally, the tariffs Rumo charges for rail freight services on our rail network can be revised upwards or downwards if there is a justified, permanent market and/or costs change that may alter the rail network concession agreements’ economic and financial balance, or as determined by the Brazilian government every five years. The mechanisms for restoring the financial balance are defined in Brazilian law or in the agreements and must be requested by the non-breaching party along with adequate economic evidence. Rumo’s tariffs are currently below the maximum tariff levels allowable under Rumo’s concession agreements. In 2012, the ANTT implemented a review of reference rates that altered the original methodology for defining such rates. The use of revised rate charts could affect Rumo’s capacity to generate revenues, as such review revised most rates downwards and established a cap for Malha Norte, which originally was not subject to a cap. Before Cosan S.A., through its then subsidiary Rumo Logística, acquired 100% of the common shares of ALL on April 1, 2015, ALL obtained an injunction suspending the application of such revised rate charts by the ANTT and, therefore, is not subject to them. However, we cannot assure you that in the future tariffs will be set at a level that would permit Rumo to continue to operate profitably.

 

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Rumo may become subject to additional stringent environmental requirements.

In September 2016, the environmental agency of the state of São Paulo (Companhia de Tecnologia de Saneamento Ambiental or “CETESB”) enacted a regulation (Board Decision No. 210/2016/I/C) requiring private ports in the state of São Paulo to comply with more stringent requirements with respect to environmental permits. As a result, Rumo received notifications requiring it to present a regularization plan to CETESB, setting forth how Rumo proposes to comply with these more stringent requirements. This regularization plan was submitted to CETESB on June 12, 2017 and Rumo expects that it will form the basis of an agreement between it and CETESB. However, there can be no assurance that such an agreement will be reached.

Rumo is unable to estimate the amounts it may have to spend in order to fully implement the regularization plan to be presented to CETESB. If these amounts are significant, Rumo’s business, operating results and financial condition could be materially and adversely affected.

We are subject to extensive environmental regulation.

Our business activities in Brazil are subject to extensive laws and regulations concerning environmental protection, which impose on us various environmental obligations, such as environmental licensing requirements, standards for the release of effluents, management of solid waste, protection of certain areas (including Legal Reserve, indigenous areas, quilombolas community areas, conservation units, archeological sites and permanent preservation areas), and the need for special authorizations for the use of water, among others.

The failure to comply with such laws and regulations (including failure to obtain or maintain the relevant environmental permits) may subject the violator to administrative fines, mandatory interruption of activities and criminal sanctions, in addition to the obligation to cure and pay environmental and third-party damage compensation, without any caps. In addition, Brazilian environmental law adopts a joint and several and strict liability system for environmental damages, which makes the polluter liable regardless of fault or intentional misconduct and would make us jointly and severally liable for the obligations of our producers or off-takers. If we become subject to environmental liabilities, any costs we may incur to rectify possible environmental damage would lead to a reduction in the financial resources which would otherwise remain at our disposal for current or future strategic investment, thus causing an adverse impact on us.

As environmental laws and their enforcement become increasingly stringent, our expenses for complying with environmental requirements are likely to increase in the future. Furthermore, the possible implementation of new regulations, changes in existing regulations or the adoption of other measures could cause the amount and frequency of our expenditures on environmental preservation to vary significantly compared to present estimates or historical costs. Any unplanned future expenses could force us to reduce or forego strategic investments and as a result could materially and adversely affect us.

The occurrence of environmental damage may lead to the need to make significant financial resources available for both containment and repair of these damages. The occurrence of such events may also lead to a disruption in production due to intervention by government agencies. In either case, financial and/or image impacts may be significant. In addition, the creation of new regulations may lead to the need for greater expenses with environmental preservation. Furthermore, extensive environmental regulation can also lead to delays in the implementation of new projects as bureaucratic procedures for obtaining environmental licenses from various government agencies may take considerable time.

The realization of any of these risks may have a material adverse effect on our business, results of operations or financial condition.

We cannot predict the outcome of an investigation into the conduct of former employees of ALL prior to its acquisition by Rumo.

During the course of 2016, Rumo became aware of certain press reports alleging that improper payments to government officials were made by former employees of ALL (prior to being acquired by Rumo) in connection with an investment by Fundo de Investimento do Fundo de Garantia do Tempo de Serviço, or “FI-FGTS,” in Rumo’s indirect subsidiary Brado Logística and in ALL. As a result of these allegations, Rumo has engaged external legal counsel and consultants to conduct an internal investigation. The report of the investigation was submitted to the Federal Prosecutor’s Office (without being made available to the Company, in accordance with the terms of the engagement). At this time, we can neither predict the outcome of the internal investigation, the consequences of any findings or any measures that may be taken by local authorities, any of which may have a material adverse effect on Rumo.

 

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Rumo may not have access to new financing on favorable conditions to meet its capital needs and fulfill its financial obligations.

Rumo relies on obtaining financing and refinancing of existing loans, particularly from BNDES, in order to operate its business, implement its strategy and grow its business. Rumo needs bank guarantees to obtain credit facilities from both BNDES and banks, and typically needs insurance guarantees in order to participate in court proceedings to which it is a party. Recent disruptions in the global credit markets and their effect on the global and Brazilian economies could affect Rumo’s ability to raise capital and materially and adversely affect Rumo’s business.

Substantial volatility in the global capital markets, unavailability of financing in the global capital markets at reasonable rates and credit market disruptions have had a significant negative impact on financial markets, as well as on the global and domestic economies. In particular, the cost of financing in the global debt markets has increased substantially, greatly restricting the availability of funds in such markets. Further, volatility in the markets has led to increased costs for obtaining financing in the credit markets, as many creditors have raised interest rates, adopted more rigorous loan policies, reduced volume and, in some cases, ceased offering financing to borrowers on reasonable terms.

If Rumo is unable to obtain new financing or to refinance existing loans when necessary, or obtain or renew insurance guarantees on reasonable terms or at all, Rumo may not be able to comply with its financial obligations or explore business opportunities. This would have a material adverse effect on Rumo’s business, financial condition and results of operations.

Rumo may not be successful in reducing operating costs and increasing operating efficiencies.

Rumo may not be able to achieve expected cost savings, which rely on several factors such as rail track prices, railroad ties, fuel, iron, engineering and other resources required for our operations. Given the competitive markets in which Rumo operates, it is likely that it will not be able to pass increases in costs of materials onto the price of our services (including as a result of limits applying to our tariffs), which would materially and adversely affect its financial performance.

Rumo may not have sufficient funds to invest in technology, which may adversely affect Rumo’s ability to increase its rail transportation capacity and reduce accidents.

The development and implementation of new technologies may result in a significant reduction in the cost of logistics services and a reduction in accidents. We cannot predict when new technologies may become available, the rate of acceptance of new technologies by competitors or the costs associated with such new technologies. Rumo may not have enough funds to keep up with advances in technology, which could reduce demand for the logistics services Rumo provides and affect Rumo’s capacity to reduce accidents in its activities.

The exercise of an option granted under the shareholders’ agreement of one of Rumo’s subsidiaries, Brado Logística, may have a material adverse effect on Rumo’s financial condition or result in a dilution of Rumo’s shareholders’ equity interest.

Fundo de Investimento do Fundo de Garantia do Tempo de Serviço, or “FI-FGTS,” Logística Brasil — Fundo de Investimento em Participações, or “FIP – BRZ,” Deminvest Empreendimentos e Participações S.A, or “Deminvest,” Markinvest Gestão de Participações Ltda., or “Markinvest” and Brado Holding S.A., or “Brado Holding,” are parties to a shareholders’ agreement governing the investment in Brado Logística, Rumo’s subsidiary active in the intermodal container logistics sector, or the “Brado Shareholders’ Agreement.” Markinvest, FIP – BRZ and Deminvest are jointly referred to as the “Original Shareholders.” Brado Holding, FI-FGTS and the Original Shareholders are jointly referred to as the “Brado Shareholders.”

The Brado Shareholders’ Agreement provides that, to the extent the initial public offering of Brado LP has not occurred prior to March 31, 2014, the Brado Shareholders are entitled to swap the totality of their shares in Brado Logística for, at the discretion of the Brado Shareholders (1) shares as provided for in the Brado Shareholders’ Agreement, or (2) an amount corresponding to the market value of such shares. The exchange ratio would be based on fair market value. If the Brado Shareholders do not reach consensus on the appraisal thereof, the fair market value would be based on independent appraisals carried out as provided for in the Brado Shareholders’ Agreement.

The option described above became exercisable on April 1, 2014 and was exercised on each of April 20 and 23, 2015. There is an ongoing confidential arbitration proceeding against Rumo relating to the appraisal reports prepared by financial institutions appointed pursuant to the shareholders’ agreement of Brado Logística and the type of consideration (money or shares) due as a result of the exercise of the option.

 

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In addition, the exercise of the option by FI-FGTS may occur between the fifth and the seventh anniversary of the date of signing of the Brado Shareholders’ Agreement (which was August 5, 2013). FI-FGTS will lose the right to exercise its option if the aforementioned initial public offering is undertaken (even if such initial public offering is undertaken after the aforementioned dates).

The exercise of the option may result in: (1) disbursement of material amounts by Rumo, which may adversely affect Rumo’s results of operations and financial condition; or (2) the issuance of new shares by Rumo in a quantity which may dilute the equity interests held by Rumo’s shareholders.

Downturns in certain cyclical market sectors in which Rumo’s customers operate could have a material adverse effect on Rumo’s business.

The transportation and logistics industries are highly cyclical, generally tracking the cycles of the world economy. Accordingly, the transportation industry is affected by macroeconomic conditions and by various factors within each particular industry that may influence operating results. Some of Rumo’s customers do business in highly cyclical markets, including the oil and gas and agricultural sectors.

Soybean harvests generally occur between January and May, corn harvests (mainly for export) generally occur between April and July and sugar harvests generally occur between March and November. For this reason, Rumo typically transports larger volumes of goods in the second and third quarters of each year and lower volumes in the “off season” (i.e., the first and fourth quarters of each year).

Any downturn in these industries may have a material adverse effect on Rumo’s business, results of operations and financial condition. In addition, some of the products Rumo transports have shown a historical pattern of price cyclicality, which has typically been influenced by the general economic environment, industry capacity and demand. We cannot assure you that prices and demand for these products will not decline in the future, adversely affecting those industries and, in turn, Rumo’s business, results of operations and financial condition.

Rumo operates in a competitive industry, and if it is unable to adequately address factors that may adversely affect its revenue and costs, Rumo’s business could suffer.

An increase in competition may reduce our revenues and result in smaller profit margins or the loss of market share. Our business, financial condition and results of operations may be adversely affected if we are not able to adequately compete in the market.

Competition in the transportation services industry is intense and includes:

 

   

competition with other transportation modes, such as road freight;

 

   

competition with alternative export options for agricultural products through other ports (particularly in the northern region of Brazil) to the detriment of the ports of Santos (state of São Paulo), Paranaguá (state of Paraná) and São Francisco do Sul (state of Santa Catarina);

 

   

dependence on operating quality and port and terminal capacity;

 

   

the limitations established by the maximum tariffs established by the ANTT;

 

   

a reduction in road tariffs, particularly during times of declining growth rates in the economy or low demand from agricultural producers, which may limit Rumo’s ability to maintain or increase rates, operating margins or growth of its business; and

 

   

establishment of cooperative relationships by Rumo’s competitors to increase their ability to address shipper needs.

Rumo’s main competitors are companies in the truck transportation business, which has historically been the main cargo transportation mode in Brazil. According to the CNT, trucks transported 60% of Brazil’s production in 2018, while only 15% of that production was transported by rail. Although Rumo is expanding our intermodal services via truck transportation, any new measures by the Brazilian government that lower costs for road transportation, such as cheaper toll fares or permanent suspension of the toll-road concession program, may limit Rumo’s growth prospects.

New measures by the Brazilian government that benefit or reduce costs for road transportation, such as cheaper toll fares or permanent suspension of the toll-road concession program, may limit our growth prospects.

 

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Increased competition may lead to decreases in Rumo’s revenues, smaller profit margins or loss of market share. If Rumo is unable to address any of these adequately, it may adversely impact Rumo’s business, financial condition and results of operations.

Rumo operates in a regulated environment, and measures taken by public authorities may impact Rumo’s activities.

The rail services which Rumo provides are regulated and supervised by the Brazilian government and in particular by the Brazilian Ministry of Infrastructure as well as the ANTT. The ANTT regulates various aspects of the business of companies active in the Brazilian rail sector, including with regards to requirements for investments, expenses, determination of revenue and the setting of tariffs in order to guarantee regularity, continuity, efficiency, safety and affordability. These activities are intensely regulated through laws, decrees, provisional measures, ordinances, resolutions and other regulatory and legislative actions. Changes to legislation or regulation relating to the rail sector may adversely affect Rumo’s business, financial results and operating results.

In addition, Rumo’s railroad concession agreements have been originally entered into with the Brazilian Ministry of Transportation (currently known as the Brazilian Ministry of Infrastructure) (acting as granting authority when the grants took place), later substituted by the ANTT after the enactment of Federal Law No. 10,233/2001. Rumo’s operations take place in a highly regulated environment because concessions agreements are administrative contracts. Such contracts are therefore subject to public law, which gives the granting authority the right to: (1) amend the contracts unilaterally when in the public interest (while respecting the rights under the contract); (2) rescind the contracts unilaterally in the instances provided for in Law No. 8,666/1993; (3) supervise the execution of the contracts; and (4) impose sanctions in the case of partial or complete non-compliance with the adjustment (among other instances).

Therefore, notwithstanding the concessionaire’s right to maintain the financial balance of the concession agreement, actions taken by the public administration in general may affect the services rendered by Rumo. For example, if (1) new obligations are imposed; (2) additional investments not originally provided for in the concession agreements are required as a result of unilateral measures provided for in the statute or through the creation of new regulations by the ANTT; and (3) the scope of the concession agreements is reduced or certain actions taken by us are rejected or not given effect (such as anticipated concession renewals, extensions of grants in force or extensions under conditions not favorable to us), Rumo’s economic and financial condition and operating results may be adversely affected.

We cannot predict which actions the Brazilian government will take in the future and how such actions will affect Rumo’s operating results. If Rumo is required to conduct its business in a manner substantially different from that contemplated in Rumo’s business plan, Rumo’s financial and operating results may be adversely affected.

We are exposed to the possibility of losses related to natural disasters, catastrophes, accidents, fire and other events not in our control, which may have a material adverse effect on our financial performance.

Our operations are subject to certain risks that affect our properties, facilities, permanent passageways, rail banks and inventory, including, among others, fire, which may destroy machinery, equipment and facilities, as well as client cargo being transported. Fires, explosions, fuel leaks and other flammable products as well as other environmental events, cargo loss or damage, railroad, cargo loading and unloading terminal, accidents, business interruptions due to political events as well as labor claims, demonstrations by social and/or environmental groups or associations, strikes (of our own employees or of those linked to entities with which we have a relationship, such as port operators), adverse weather conditions and natural disasters, such as floods, may result in the loss of revenues, assumption of liabilities or cost increases. Moreover, our operations may be periodically affected by crop shortfalls, landslides and other natural disasters.

Our transportation and handling of cargo exposes us to risks of catastrophes, mechanical and electrical failures, collisions and loss of assets. A portion of our freight activities involves petroleum products and other flammable materials, and the presence of such products may aggravate the effects of any catastrophe.

Because our insurance does not cover all potential risks and losses we may incur, the occurrence of a natural disaster of large proportions, catastrophes, mechanical failures, loss of assets or any other of the events referred to above, and any resulting damage to our business, may have a material adverse effect on our business, operating results and financial condition, including as a result of civil, administrative and/or criminal sanctions relating to environmental liability (including civil, administrative and/or criminal sanctions of such nature imposed on our management).

 

 

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We are exposed to credit and other counterparty risks of our customers in the ordinary course of our business.

We have various credit terms with various types of customers, including fuel distributors, wholesalers, retailers, trading companies and consumers of the energy which we generate or trade. Our customers have varying degrees of creditworthiness and are subject to different rules and regulations. We are therefore exposed to the risk of nonpayment or other default under our contracts and other arrangements with them.

As part of our relationship with our customers, we set different credit conditions for each customer based on their perceived creditworthiness. Economic conditions may also affect our customers’ ability to meet their obligations to us. In addition, we are also exposed to other types of counterparty risk, including reputational risk, as well as risks relating to money laundering, embargos, breaches of labor regulations and other related matters.

In the event that a significant number of material customers default on their payment obligations to us, our financial condition, results of operations or cash flows, could be materially and adversely affected. Any of these risks could have an adverse effect on our business, financial condition and results of operations.

Our inability to post judicial collateral or provide guarantees in pending legal or administrative proceedings could have a material adverse effect on our business, financial condition and results of operations.

We may not have sufficient funds to post collateral or provide guarantees in judicial or administrative proceedings involving substantial amounts. Even if we do not post such collateral or provide guarantees, we will be liable for paying any amounts due pursuant to any unfavorable outcomes in legal proceedings. We cannot assure you that, if we cannot make such payments, our assets, including financial assets, will not be attached, or that we will be able to obtain tax good standing certificates, all of which may have a material adverse effect on our business, financial condition and results of operations.

We are subject to anti-corruption, anti-bribery, anti-money laundering and other international trade laws and regulations.

We are subject to anti-corruption, anti-bribery, anti-money laundering and other international trade laws and regulations. We are required to comply with the laws and regulations of Brazil and various jurisdictions where we conduct operations. In particular, we are subject to the Brazilian Anti-corruption Law nº 12.846, to the U.S. Foreign Corrupt Practices Act of 1977, or the “FCPA,” to the United Kingdom Bribery Act of 2010, as well as economic sanction programs, including those administered by the United Nations, the European Union and the United States, including the U.S. Treasury Department’s Office of Foreign Assets Control, or “OFAC.” The FCPA prohibits providing anything of value to foreign officials for the purposes of obtaining or retaining business or securing any improper business advantage. As part of our business, we may deal with entities and employees which are considered foreign officials for purposes of the FCPA. In addition, economic sanctions programs restrict our dealings with certain sanctioned countries, individuals and entities. Although we have internal policies and procedures designed to ensure compliance with applicable anti-fraud, anti-bribery and anti-corruption laws and sanctions regulations, potential violations of anti-corruption laws have been identified on occasion as part of our compliance and internal control processes. When such issues arise, we attempt to act promptly to learn relevant facts, conduct appropriate due diligence, and take any appropriate remedial action to address the risk. Given the size of our operations and the complexity of the production chain, there can be no assurance that our internal policies and procedures will be sufficient to prevent or detect all inappropriate practices, fraud or violations of law by our employees, directors, officers, partners, agents and service providers or that such persons will not take actions in violation of our policies and procedures (or otherwise in violation of the relevant anti-corruption laws and sanctions regulations) for which we or they may be ultimately held responsible. Violations of anti-bribery and anti-corruption laws and sanctions regulations could have a material adverse effect on our business, reputation, results of operations and financial condition. In addition, we may be subject to one or more enforcement actions, investigations and proceedings by authorities for alleged infringements of these laws. These proceedings may result in penalties, fines, sanctions or other forms of liability and could have a material adverse effect on our reputation, business, financial condition and results of operations.

Funding, especially on terms acceptable to us, may not be available to meet our financial obligations and future capital needs.

We rely on obtaining financing and refinancing of existing loans in order to operate our business, implement our strategy and grow our business. We need bank guarantees to obtain credit facilities and we typically need insurance guarantees in order to participate in court proceedings to which we are a party.

If we are unable to obtain new financing or to refinance existing loans when necessary, or obtain or renew insurance guarantees on reasonable terms or at all, we may not be able to comply with our financial obligations or explore business opportunities, and responding to competitive pressures may become challenging. This would have a material adverse effect on our business, financial condition and results of operations.

 

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We operate in industry sectors that require significant financial resources that will require access to the capital markets and bank financing in significant volumes to meet our investment objectives.

We obtain funds for our activities through loans from financial institutions, domestic and foreign lenders, and through access to the capital markets. Our ability to obtain funding to finance our growth or operate our business depends on several factors, including our level of indebtedness and market conditions. Global market and economic conditions have been, and continue to be, disruptive and volatile. The debt capital markets have been impacted by significant write-offs in the financial services sector and the re-pricing of credit risk, sovereign defaults, political and economic developments in and affecting Brazil such as the “Lava Jato” scandal, among other things. These events have negatively affected general economic conditions. During that period, the cost of raising money in the debt capital markets has increased substantially while the availability of funds from those markets for Brazilian companies has diminished significantly. Also, as a result of concerns about the stability of financial markets generally and the solvency of counterparties specifically, the cost of obtaining money from the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards and reduced and, in some cases, ceased to provide funding to borrowers on commercially reasonable terms or at all. Our failure to obtain the necessary resources on reasonable terms may adversely affect our investment strategy. If we decide to increase our debt levels, we may be subject to risks, including our inability to pay outstanding debt, which may adversely affect our financial condition.

In addition, in connection with any new indebtedness we incur, we may be required to meet certain covenants in our financing arrangements, such as maintaining financial ratios, and may be subject to restrictions on our ability to incur new debt or make new investments. A breach of these covenants may result in a mandatory prepayment or acceleration of the maturity of our outstanding debt. In the event of a prepayment or acceleration, our assets and cash flow might not be sufficient to pay the full amount due, which would have a material adverse effect on our financial condition.

Our debt level could adversely affect our financial health and prevent us from fulfilling our debt obligations, which would reduce our ability to raise capital to finance our investments and operations and would adversely impact our ability to recover from economic changes.

Our debt level and the composition of our debt could, among other things: (1) require us to reserve a substantial part of our operational cash flows to pay principal and interest on our debt, which will reduce the availability of our cash flow to fund working capital, capital expenditures, acquisitions and investments; (2) limit our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate; (3) limit our ability to borrow additional funds, obtain bank guarantees or collateral insurance and generally increase our borrowing costs; and (4) place us at a competitive disadvantage compared to our competitors that have less debt.

Any of the aforementioned developments could have a material adverse effect on us, our financial condition and our results of operations.

We may be unable to comply with restrictive covenants under our financing agreements.

We are subject to certain restrictive covenants based on certain financial and non-financial indicators which are set forth in the majority of the indebtedness and finance agreements to which we are a party. The majority of such covenants relate to requirements to comply with certain pre-determined levels of leverage.

Any failure by us to comply with the restrictive covenants in our credit agreements as a result of adverse conditions in our business environment may trigger the acceleration of part of our indebtedness, limit our access to new credit facilities as well as adversely affect our business and results of operations.

We may not effectively manage risks associated with the replacement of benchmark indices.

Interest rate, equity, foreign exchange rate and other types of indices which are deemed to be “benchmarks” are the subject of increased regulatory scrutiny. In 2017, the United Kingdom’s Financial Conduct Authority, or the FCA, announced that it will no longer persuade or compel banks to submit rates for the calculation of the London interbank offered rate (“LIBOR”) benchmark after 2021. This announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021, and it appears likely that LIBOR will be discontinued or modified by 2021. This and other reforms may cause benchmarks to reform differently than in the past, or to disappear entirely, or have other consequences which cannot be fully anticipated which introduces a number of risks for us including legal risks arising from potential changes required to documentation for new and existing transactions and financial risks arising from any changes in the valuation of financial instruments linked to benchmark rates, pricing risks arising from how changes to benchmark indices could impact pricing mechanisms on some instruments. Accordingly, it is not currently possible to determine whether, or to what extent, any such changes would affect us. However, the implementation of alternative benchmark rates may have a material adverse effect on our business, results of operations, financial condition and prospects.

 

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We may raise additional capital in the future for strategic partnerships or by issuing securities, which may result in a potential dilution of your equity interest.

We are constantly analyzing alternatives and considering the possibility of entering into strategic partnerships, disposing of assets, raising additional capital through a public or private issuance of shares and/or securities convertible into or exchangeable for shares. Any strategic partnership, issuance or placement of shares and/or securities convertible into or exchangeable for shares may affect the market price of our shares and could result in dilution of your equity interest.

Our insurance coverage may be inadequate to cover all losses and/or liabilities that may be incurred in our operations.

Our operations are subject to a number of hazards and risks. We maintain insurance at levels that are customary in our industry to protect against these liabilities; however, our insurance may not be adequate to cover all losses or liabilities that might be incurred in our operations.

For example, we do not maintain coverage for business interruptions of any nature for our Brazilian operations, including business interruptions caused by labor disruptions. If, for instance, our workers were to strike, the resulting work stoppages could have a material and adverse effect on us. Similarly, we do not insure most of our assets against war or sabotage. Therefore, an attack or an operational incident causing an interruption of our business could have a material and adverse effect on our financial condition or results of operations.

Moreover, we will be subject to the risk that we may not be able to maintain or obtain insurance of the type and amount desired at reasonable rates. If we were to incur a significant liability for which we were not fully insured, it could have a materially adverse effect on our business, financial condition and results of operations.

Any failure relating to our strategic partnerships may result in additional financial or performance obligations by us, which would reduce our profitability.

We may enter into strategic partnerships, joint ventures, combinations, alliances and collaborations, including, among other things, partnerships with our customers. The success of these and other partnerships depends, in part, on the satisfactory performance of our and our partners’ obligations.

If we or our partners do not satisfactorily perform such obligations, our strategic partnerships may fail to perform as expected or to deliver the agreed services. Should this occur, we may be required to make additional investments and provide additional services to guarantee the adequate performance and delivery of the agreed services, or terminate such partnerships prior to their stated maturity. The performance by us of additional obligations with respect to our strategic partnerships may result in the reduction of our profits and material losses to us.

Likewise, the failure of our strategic partners to fulfill their obligations under our partnership agreements may have a material adverse effect on such partnerships. In addition, the failure to reach an agreement as to certain matters may result in deadlock pursuant to certain of the shareholders’ and other agreements governing our strategic partnerships.

Strategic partnerships are essential to the continuity of our operations and our growth. If we fail to maintain our existing partnerships or identify new partnerships, our business, financial condition and results of operations may be materially and adversely affected.

We are highly dependent on our chairman and other members of our management to develop and implement our strategy and to oversee our operations.

We are dependent upon our chairman and controlling shareholder, other members of senior management and certain members of our board of directors, especially with respect to business planning, strategy and operations. If any of these key members of our management leaves our Company, our business and financial performance may be negatively affected. Our business is particularly dependent on our chairman, who is also our controlling shareholder. We currently do not carry any key man insurance.

 

 

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We are indirectly controlled by a single individual who has the power to control us.

Our controlling shareholder and chairman has the power to indirectly control us, including the power to:

 

   

elect a majority of our directors and appoint our executive officers, set our management policies and exercise overall control over our Company and subsidiaries;

 

   

agree to sell or otherwise transfer his controlling stake in our Company; and

 

   

determine the outcome of substantially all actions requiring shareholder approval, including transactions with related parties, corporate reorganizations, acquisitions and dispositions of assets, and dividends.

Currently, because of our share capital structure, our controlling shareholder is able to control substantially all matters submitted to our shareholders for a vote or approval even if the controlling shareholder comes to own less than 50% of our issued and outstanding share capital. The concentrated control will limit your ability to influence corporate matters and, consequently, we may take actions that our shareholders do not view as beneficial. Moreover, our controlling shareholder may make decisions that are contrary to the interests of our other shareholders, and diverge from those minority shareholders. These may include actions to conduct acquisitions, divest assets, engage in new business partnerships and engage in new financings or similar operations. As a result, the market price of our shares could be adversely affected.

We operate in industry sectors that require significant financial resources that will require access to the capital markets and bank financing in significant volumes to meet our investment objectives.

We obtain funds for our activities through loans from financial institutions, domestic and foreign lenders, and through access to the capital markets. Our ability to obtain funding to finance our growth or operate our business depends on several factors, including our level of indebtedness and market conditions. Global market and economic conditions have been, and continue to be, disruptive and volatile. The debt capital markets have been impacted by significant write-offs in the financial services sector and the re-pricing of credit risk, sovereign defaults, political and economic developments in and affecting Brazil such as the “Lava Jato” scandal, among other things. These events have negatively affected general economic conditions. In particular, the cost of raising money in the debt capital markets has increased substantially while the availability of funds from those markets for Brazilian companies has diminished significantly. Also, as a result of concerns about the stability of financial markets generally and the solvency of counterparties specifically, the cost of obtaining money from the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards and reduced and, in some cases, ceased to provide funding to borrowers on commercially reasonable terms or at all. Our failure to obtain the necessary resources on reasonable terms may adversely affect our investment strategy. If we decide to increase our debt levels, we may be subject to risks, including our inability to pay outstanding debt, which may adversely affect our financial condition.

In addition, in connection with any new indebtedness we incur, we may be required to meet certain covenants in our financing arrangements, such as maintaining financial ratios, and may be subject to restrictions on our ability to incur new debt or make new investments. A breach of these covenants may result in a mandatory prepayment or acceleration of the maturity of our outstanding debt. In the event of a prepayment or acceleration, our assets and cash flow might not be sufficient to pay the full amount due, which would have a material adverse effect on our financial condition.

Volatility in the price of the products we sell may have a material adverse effect on us.

Our results of operations may be significantly affected by volatility in the prices of the products we sell. The prices of these products are subject to significant fluctuation as a result of domestic and international demand, production volumes and global stock levels. Price volatility may have a significant impact on our results of operations, particularly if our revenues fall below our production costs.

The prices at which we are able to sell our products depend on market conditions, both in Brazil and internationally, which are outside of our control. The prices at which we are able to sell our products have a significant impact on our results of operations. As is the case with other commodities, the prices of the products we sell are subject to significant fluctuation as a result of natural disasters, harvest levels, agricultural investments, governmental policies (in particular with regards to the agricultural sector), trade policies, changes in supply and demand patterns, increases or decreases in purchasing power, the production of similar or competing products and other factors beyond our control. A significant portion of our products are also traded on commodities exchanges and their prices may therefore be affected by speculation on financial markets.

 

 

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In addition, the price of sugar is also affected by the obligation to comply with certain requirements relating to exports and the consequent effects on supply within Brazil. As a result, the price of sugar has historically been subject to greater volatility than the prices of other products. Sugar prices may decrease as a result of, directly or indirectly, competition from alternative sweeteners, include saccharine and high-fructose corn syrup, changes in agricultural policies or international or Brazilian trade policies (including those mandated by the World Trade Organization).

Any significant or prolonged decrease in the price of sugar and/or ethanol may have adverse effects on our business, financial condition and results of operations.

Risks related to developments in international trade may negatively affect our business.

Sugarcane derivatives such as sugar and ethanol are key commodities as sugar is consumed as food in several countries and ethanol accounts for a significant portion of the energy consumption of Brazil and certain other countries. As is the case with other commodities, the prices of sugarcane derivatives in international markets may fluctuate as a result of the imposition of tariff and non-tariff barriers, such as embargos, sanitary restrictions, quotas, taxes, international trade disputes and other matters. Any fluctuation in the price of sugarcane derivatives as a result of developments in international trade may affect our ability to produce, sell and/or export our products and consequently have a material adverse effect on our business, financial condition and results of operations.

Raízen Combustíveis may not be able to successfully integrate the operations of Shell Argentina and faces other risks associated with the acquisition.

Raízen Combustíveis may not be able to successfully integrate Shell Argentina into its business, or successfully implement appropriate operational, financial or administrative systems and controls to achieve the benefits that we expect to result from the acquisition of Shell Argentina. The risks faced by Raízen Combustíveis include but are not limited to: (1) failure of Shell Argentina to achieve expected results; (2) inability to retain key personnel of Shell Argentina; (3) failure to successfully migrate Shell Argentina’s current customer and supplier relationships to the business as acquired by us; and (4) possible inability to achieve expected synergies or economies of scale. In addition, the business of Shell Argentina could cause interruption of, or loss of momentum in, the activities of the existing business of Raízen Combustíveis. The diversion of our management’s attention and any delays or difficulties encountered in connection with the integration of Shell Argentina could adversely affect the business, results of operations or prospects of Raízen Combustíveis.

The acquisition of Shell Argentina also exposes Raízen Combustíveis to the risk that it will inherit pre-existing business, labor, environmental or other issues which may result in temporary shutdowns, labor disputes, obligations to compensate third parties for environmental damage or repair environmental damage or which may otherwise have an adverse effect on Raízen Combustíveis if not managed properly.

In addition, the acquisition of Shell Argentina may expose Raízen Combustíveis to successor liability relating to certain prior actions of Shell Argentina and its management or certain contingent liabilities incurred prior to its involvement. It will also expose Raízen Combustíveis to certain liabilities associated with ongoing operations (including, without limitation, environmental liabilities), especially to the extent that Raízen Combustíveis is unable to adequately and safely manage such acquired operations. Also, undisclosed liabilities from the acquisition of Shell Argentina may harm the financial condition and operating results of Raízen Combustíveis.

Risks Related to Our Common Shares

We are a Bermuda company, and it may be difficult for you to enforce judgments against us or our directors and executive officers.

We are a Bermuda exempted company, so that the rights of holders of our shares will be governed by Bermuda law and our bye-laws. The rights of shareholders under Bermuda law may differ from the rights of shareholders of companies incorporated in other jurisdictions. All of our directors and some of the experts referred to in this annual report are not citizens or residents of the United States, and most of our assets are located outside the United States. As a result, it may be difficult for investors to effect service of process on those persons in the United States or to enforce judgments obtained in U.S. courts against us or those persons based on the civil liability provisions of the U.S. federal or state securities laws. We have been advised by our Bermuda counsel, ASW Law Limited, that uncertainty exists as to whether courts in Bermuda will enforce judgments obtained in other jurisdictions, including the United States, against us or our directors or officers under the securities laws of those jurisdictions or entertain actions in Bermuda against us or our directors or officers under the securities laws of other jurisdictions. The United States and Bermuda do not currently have a treaty providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. Therefore, a final judgment for the payment of money rendered by any federal or state court in the United States based on civil liability, whether or not based solely on U.S. federal or state securities laws, may not necessarily be enforceable in Bermuda.

 

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Bermuda law differs from the laws in effect in the United States and Brazil and may afford less protection to shareholders.

Our shareholders may have more difficulty protecting their interests than shareholders of a company incorporated in the United States or Brazil. As a Bermuda company, we are governed by the Companies Act 1981. The Companies Act 1981 differs in material respects from laws generally applicable to U.S. or Brazilian corporations and their shareholders, including the provisions relating to interested directors, amalgamations, takeovers, shareholder lawsuits and indemnification of directors.

Under Bermuda law, directors and officers of a company generally owe fiduciary duties to the company and not to individual shareholders. Class actions and derivative actions are generally not available to shareholders under Bermuda law. The Bermuda courts may, however, in certain circumstances permit a shareholder to commence an action in the name of a company to remedy a wrong to the company where the act complained of is alleged to be beyond the corporate power of the company or illegal, or would result in the violation of the company’s memorandum of association or bye-laws. Consideration would be given by a Bermuda court to acts that are alleged to constitute a fraud against the minority shareholders or, for example, where an act requires the approval of a greater percentage of the company’s shareholders than that which actually approved it. The Companies Act 1981 imposes a duty on directors and officers to act honestly and in good faith with a view to the best interests of the company and to exercise the care and skill that a reasonably prudent person would exercise in comparable circumstances. Directors of a Bermuda company have a duty to avoid conflicts of interest. However, if a director discloses a direct or indirect interest in any contract or arrangement with us as required by Bermuda law, our bye-laws provide that such director is entitled to be counted for quorum purposes, but may not vote in respect of any such contract or arrangement in which he or she is interested. In addition, the rights of our shareholders and the fiduciary responsibilities of our directors under the Companies Act 1981 are not as clearly established as under statutes or judicial precedent in jurisdictions in the United States, particularly in the State of Delaware.

Provisions in our bye-laws may discourage takeovers, which could affect the return on the investment of our shareholders.

Our bye-laws contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions provide, among other things, for:

 

   

a classified board of directors with staggered three-year terms;

 

   

restrictions on the time period in which directors may be nominated;

 

   

the affirmative vote of a majority of our directors in office and the resolution of the shareholders passed by a majority of votes cast at a general meeting or, if not approved by a majority of the directors in office, the resolution of the shareholders at a general meeting passed by 66 and 2/3% of all votes attaching to all shares then in issue for amalgamation and other business combination transactions; and

 

   

the tag-along rights described under “Item 10. Additional Information—B. Memorandum and By-laws—Tag-along Rights.”

These bye-law’s provisions could deter a third party from seeking to acquire us, even if the third party’s offer may be considered beneficial by many shareholders.

As a holding company, we may face limitations on our ability to receive distributions from our subsidiaries.

We conduct all of our operations through subsidiaries and are dependent upon dividends or other intercompany transfers of funds from our subsidiaries to meet our obligations. For example, Brazilian law permits the Brazilian government to impose temporary restrictions on conversions of Brazilian currency into foreign currencies and on remittances to foreign investors of proceeds from their investments in Brazil, whenever there is a serious imbalance in Brazil’s balance of payments or there are reasons to expect a pending serious imbalance. The Brazilian government last imposed remittance restrictions for approximately six months in 1989 and early 1990. The Brazilian government may take similar measures in the future. Any imposition of restrictions on conversions and remittances could hinder or prevent us from converting into U.S. dollars or other foreign currencies and remitting abroad dividends, distributions or the proceeds from any sale in Brazil of common shares of our Brazilian subsidiaries. We currently conduct all of our operations through our principal Brazilian subsidiaries, Cosan S.A. and Cosan Logística. As a result, any imposition of exchange controls restrictions could reduce the market prices of the class A common shares.

 

 

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Our bye-laws restrict shareholders from bringing legal action against our directors and officers and also provide our directors and officers with indemnification from their actions and omissions, although such indemnification for liabilities under the Securities Act is unenforceable in the United States.

Our bye-laws contain a broad waiver by our shareholders of any claim or right of action, both individually and on our behalf, against any of our officers or directors. The waiver applies to any action taken by an officer or director, or the failure of an officer or director to take any action, in the performance of his or her duties, except with respect to any matter involving any fraud or dishonesty on the part of the officer or director. This waiver limits the right of shareholders to assert claims against our officers and directors unless the act or failure to act involves fraud or dishonesty. Our bye-laws also indemnify our directors and officers in respect of their actions and omissions, except in respect of their fraud or dishonesty. The indemnification provided in our bye-laws is not exclusive of other indemnification rights to which a director or officer may be entitled, provided these rights do not extend to his or her fraud or dishonesty. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling us pursuant to the foregoing provisions, we understand that, in the opinion of the staff of the SEC, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable in the United States.

The sale or issuance of a significant number of our common shares may adversely affect the market value of our class A common shares.

The sale of a significant number of our common shares, or the perception that such a sale could occur, may adversely affect the market price of our class A common shares. We have an authorized share capital of 1,000,000,000 class A common shares and 188,886,360 class B common shares, of which 134,115,534 class A common shares are issued and outstanding and 96,332,044 class B series 1 common shares are issued and outstanding as of the date of this annual report. Our bye-laws establish that our board of directors is authorized to issue any of our authorized, but unissued share capital. Our shareholders at a shareholders general meeting may authorize the increase of our authorized share capital. As a result, we will be able to issue a substantial number of new shares after the lock-up period, which, if we decided to do so, could dilute the participation of our shareholders in our share capital.

Actual dividends paid on our shares may not be consistent with the dividend policy adopted by our board of directors.

Our board of directors has a dividend policy that provides, subject to Bermuda law, for the payment of dividends to shareholders equal to approximately 25% of our annual consolidated net income (as calculated in accordance with IFRS as issued by IASB). Our board of directors may, in its discretion and for any reason, amend or repeal this dividend policy. Our board of directors may decrease the level of dividends provided for in this dividend policy or entirely discontinue the payment of dividends. Future dividends with respect to our common shares, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, distribution of dividends made by our subsidiaries, contractual restrictions, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant.

To the extent we pay dividends to our shareholders, we will have less capital available to meet our future liquidity needs.

Our business strategy contemplates substantial growth over the next several years, and we expect that such growth will require considerable liquidity. To the extent that we pay dividends in accordance with our dividend policy, the amounts distributed to our shareholders will not be available to us to fund future growth and meet our other liquidity needs.

We may require additional funds in the future, which may not be available or which may result in dilution of the interests of shareholders in our company.

We may need to issue debt or equity securities in order to obtain additional public or private financing. The securities that we issue may have rights, preferences and privileges senior to those of our shares. If we decide to raise additional capital through an offering of common shares, the participation of our shareholders in our share capital may be diluted. Moreover, additional funding that may be required in the future may not be available under favorable terms.

The price of our class A common shares is subject to volatility.

The market price of our class A common shares could be subject to significant fluctuations due to various factors, including actual or anticipated fluctuations in our financial performance, losses of key personnel, economic downturns, political events in Brazil or other jurisdictions in which we operate, developments affecting the ethanol and sugar industries, changes in financial estimates by securities analysts, the introduction of new products or technologies by us or our competitors, or our failure to meet expectations of analysts or investors.

 

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Risks Related to Brazil

Historically, the Brazilian government has influenced and continues to influence the economy in the country, which may negatively affect our business and financial performance.

Political and economic conditions directly affect our business and can result in a material adverse effect on our operations and financial condition. Macroeconomic policies imposed by the government can have significant impacts on Brazilian companies, including Cosan S.A., Rumo and Comgás and their respective subsidiaries, as well as market conditions and securities prices in Brazil.

The Brazilian economy has been characterized by frequent and occasionally extensive intervention by the Brazilian government and unstable economic cycles. The Brazilian government has often changed monetary, taxation, credit, tariff and other policies to influence the course of Brazil’s economy. The Brazilian government’s actions to control inflation have at times involved setting wage and price controls, blocking access to bank accounts, imposing exchange controls and limiting imports into Brazil.

In recent years, there has been significant political turmoil in connection with the impeachment of Dilma Rousseff, the former president (who was removed from office in August 2016), and ongoing investigations of her successor, Michel Temer (who left office in January 2019), as part of the ongoing “Lava Jato” investigations. Presidential elections were held in Brazil in October 2018. The resolution of the political and economic crisis in Brazil still depends on the outcome of the “Lava Jato” investigation and approval of reforms that are expected to be promoted by the new president, Jair Bolsonaro. We cannot predict which policies Jair Bolsonaro, who assumed office on January 1, 2019, may adopt or change during his mandate or the effect that any such policies might have on our business and on the Brazilian economy. Any such new policies or changes to current policies may have a material adverse effect on us. The political uncertainty resulting from the presidential elections and the transition to a new government may have an adverse effect on our business, results of operations and financial condition.

Our business, financial performance and prospects, as well as the market prices of our shares, may be adversely affected by, among others, the following factors:

 

   

inflation;

 

   

exchange rate movements;

 

   

exchange rate control policies;

 

   

interest rate fluctuations;

 

   

liquidity available in the domestic capital, credit and financial markets;

 

   

expansion or contraction of the Brazilian economy, as measured by rates of growth in GDP;

 

   

oil and gas sector regulations, including price policies;

 

   

ports, customs and tax authorities’ strikes;

 

   

changes in transportation market regulations;

 

   

energy and water shortages and rationing;

 

   

price increases of oil and other inputs;

 

   

price instability;

 

   

social and political instability;

 

   

fiscal policies; and

 

   

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

 

 

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Instability resulting from any changes made by the Brazilian government to policies or regulations that may affect these or other factors in the future may contribute to economic uncertainty in Brazil and intensify the volatility of Brazilian securities markets and securities issued abroad by Brazilian companies. The President of Brazil has the power to define the policies and actions of the Brazilian government in relation to the Brazilian economy and thereby affect the operations and financial performance of Brazilian companies. The Brazilian government may be subject to internal pressure to indent the current macroeconomic policies in order to achieve higher rates of economic growth. We cannot predict what policies will be adopted by the Brazilian government. Moreover, in the past, the Brazilian economy has been affected by the country’s political events, which have also affected the confidence of investors and the public in general, thereby adversely affecting the performance of the Brazilian economy. Furthermore, any indecisiveness by the Brazilian government in implementing changes to certain policies or regulations may contribute to economic uncertainty in Brazil and heightened volatility for the Brazilian securities markets and securities issued abroad by Brazilian companies.

These factors, as well as uncertainty as to whether the Brazilian government will apply changes to its policy or regulations that may affect any of the above-mentioned factors or other factors in the future, can lead to economic uncertainty and increase the volatility of the capital markets and the securities issued by Brazilian companies. Changes in such policies and regulations may have a negative impact on our operating results and financial position and the price of the shares.

The levels of economic activity, reflected in Brazilian GDP, can influence our distributed volumes. The growth rates in natural gas consumption may occur primarily by substituting other resources, notably fuel oil, gasoline and to a lesser extent other products derived from oil, depending on the prices of each kind of fuel.

We, our subsidiaries and jointly-controlled entities generally invoice our sales in reais, but a substantial portion of our, our subsidiaries’ and jointly-controlled entities’ net sales is from export sales that are billed in U.S. dollars. At the same time, the majority of our, our subsidiaries’ and jointly-controlled entities’ costs are denominated in reais. As a result, our operating margins are negatively affected when there is an appreciation of the real to the U.S. dollar. Additionally, we have indebtedness with fixed and floating rates, and we are thus exposed to the risk of fluctuations in interest rates. If there is an increase in interest rates, our financial results may be affected.

Political instability in Brazil may adversely affect Brazil’s economy and investment levels, and have a material adverse effect on us.

Brazil’s political environment has historically influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect the confidence of investors and the general public and have historically resulted in economic deceleration and heightened volatility in the securities issued by Brazilian companies.

The recent economic instability in Brazil has contributed to a decline in market confidence in the Brazilian economy as well as to a deteriorating political environment. Despite the ongoing recovery of the Brazilian economy, weak macroeconomic conditions in Brazil are expected to continue throughout early 2019. In addition, various ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation known as “Lava Jato,” have negatively impacted the Brazilian economy and political environment.

In August 2016, the Brazilian Senate approved the removal of then-President Dilma Rousseff from office, after completion of the legal and administrative impeachment proceedings, on the grounds of violation of budgetary laws. Michel Temer, who had been serving as acting president since her removal in May, assumed full power for the remaining portion of the presidential term, which ended in 2018.

In addition, the Dilma/Temer campaign was prosecuted for abuse of political and economic power and illegal campaign financing in the 2014 presidential campaign. On June 9, 2017, the Brazilian Superior Electoral Court cleared Mr. Temer of wrongdoing regarding the 2014 presidential campaign. However, Mr. Temer’s approval ratings remained historically low and he faced scrutiny over other matters, including allegations of bribery and other corrupt acts, which has contributed to the uncertain political and economic environment in Brazil.

After a tumultuous presidential campaign, Congressman Jair Bolsonaro defeated Fernando Haddad in the second round of the presidential elections, held on October 28, 2018, and became president of Brazil on January 1, 2019. It is not clear if, and for how long, the political divisions in Brazil that emerged before the election, will continue under the Bolsonaro presidency. It is also not clear what effects, if any, such political division will have on the ability of President Bolsonaro to govern Brazil and implement reforms. Any continuation of such division could result in an impasse in Brazil’s Congress, political unrest and massive protests and/or strikes that could adversely affect our operations.

 

 

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Furthermore, Brazil’s federal budget has been in deficit since 2014. Similarly, the governments of Brazil’s constituent states are also facing fiscal concerns due to their high debt burdens, declining revenues and inflexible expenditures. While the Brazilian Congress has approved a ceiling on government spending that will limit primary public expenditure growth to the prior year’s inflation for a period of at least 10 years, local and foreign investors believe that fiscal reforms, and in particular a reform of Brazil’s pension system, will be critical for Brazil to comply with the spending limit. As of the date of this annual report, a reform of Brazil’s pension system is still under discussion by the government and Brazilian Congress. Diminished confidence in the Brazilian government’s budgetary condition and fiscal stance could result in downgrades of Brazil’s sovereign debt by credit rating agencies, negatively impact Brazil’s economy, lead to further depreciation of the real and an increase in inflation and interest rates, thus adversely affecting our business, results of operations and financial condition.

Uncertainty about the Brazilian government’s implementation of changes in policies or regulations that affect such implementation may contribute to economic instability in Brazil and increase the volatility of securities issued abroad by Brazilian companies, including our securities.

The ongoing economic and political crisis in Brazil may have a material adverse effect on our business, operations and financial condition.

The recent economic instability in Brazil caused by the rise of inflation, a slowdown in GDP growth and uncertainty as to whether the Brazilian government will enact the necessary economic reforms to improve Brazil’s deteriorating fiscal accounts and economy have led to a decline in market confidence in the Brazilian economy and a government crisis.

Moreover, the Brazilian government may be subject to internal pressure to change its current macroeconomic policies in order to achieve higher rates of economic growth. We cannot predict what policies will be adopted by the Brazilian government. As has happened in the past, the Brazilian economy has been affected by the country’s political events, which have also affected the confidence of investors and the public in general, thereby adversely affecting the performance of the Brazilian economy. Furthermore, any indecisiveness by the Brazilian government in implementing changes to certain policies or regulations may contribute to economic uncertainty in Brazil and heightened volatility for the Brazilian securities markets and securities issued abroad by Brazilian companies.

We are not able to fully estimate the impact of global and Brazilian political and macroeconomic developments on our business. In addition, due to the current political instability, there exists substantial uncertainty regarding future economic policies and we cannot predict what policies will be adopted by the Brazilian government and whether these policies will negatively affect the economy or our business or financial performance. Recent economic and political instability has led to a negative perception of the Brazilian economy and higher volatility in the Brazilian securities markets, which also may adversely affect us and our securities. Any continued economic instability and political uncertainty may have a material adverse effect on our business.

Inflation and government measures to curb inflation may adversely affect the Brazilian economy, the Brazilian securities market, our business and operations and the market prices of our shares.

Brazil has experienced extremely high rates of inflation in the past and has therefore implemented monetary policies that have resulted in one of the highest interest rates in the world. According to the IGP-M, a general price inflation index, the inflation rates in Brazil were, 3.7% in 2014, 10.5% in 2015, 7.2% in 2016, a decrease of 0.5% in 2017 and 7.5% in 2018. In addition, according to the National Extended Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo), published by the IBGE, the Brazilian price inflation rates were 6.2% in 2014, 11.3% in 2015, 6.6% in 2016, 3% in 2017 and 4.3% in 2018. Despite the Brazilian Central Bank’s repeated increases of interest rates during the period from 2013 to 2015, the IPCA has continued to increase, reaching 10.7% in 2015 (the highest level recorded since 2003), and 3.8% in 2018.

The Brazilian government’s measures to control inflation have often included maintaining a tight monetary policy with high interest rates, thereby restricting availability of credit and reducing economic growth. Inflation, actions to combat inflation and public speculation about possible additional actions have also contributed materially to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets. The Brazilian government’s measures to fight inflation, principally through the Brazilian Central Bank, have had and may in the future have significant effects on the Brazilian economy and our business.

 

 

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Brazil may experience high levels of inflation in future periods. Periods of higher inflation may slow the rate of growth of the Brazilian economy, which could lead to reduced demand for our products in Brazil and decreased net sales. Inflation is also likely to increase some of our costs and expenses, which we may not be able to pass on to our customers and, as a result, may reduce our profit margins and net income. In addition, high inflation generally leads to higher domestic interest rates, and, as a result, the costs of servicing any floating-rate real-denominated debt may increase, resulting in lower net income. Inflation and its effect on domestic interest rates can, in addition, lead to reduced liquidity in the domestic capital and lending markets, which could affect our ability to refinance our indebtedness in those markets. Future Brazilian governmental actions, including interest rate decreases, intervention in the foreign exchange market and actions to adjust or fix the value of the real, may trigger increases in inflation and adversely affect the performance of the Brazilian economy as a whole. Any of the aforementioned developments may adversely affect the Brazilian economy as a whole, as well as on our financial conditions, operations and profits. Any decline in our net sales or net income and any deterioration in our financial performance would also likely lead to a decline in the market price of our shares.

High interest rates may adversely affect our operations and financial condition.

The Brazilian government’s measures to control inflation have frequently included maintaining a restrictive monetary policy with high interest rates, thereby limiting the availability of credit and reducing economic growth. As a consequence, official interest rates in Brazil at the end of 2018, 2017 and 2016 were 6.25%, 7% and 13.75% per year, respectively, as established by the monetary policy committee of the Brazilian Central Bank (COPOM). Brazilian interest rates have remained high and any increase of such interest rates may negatively affect our profits and results of operations, thereby increasing the costs of financing our operations.

High interest rates may impact our cost of obtaining loans and also the cost of indebtedness, resulting in an increase in our financial expenses. This increase may adversely affect our ability to pay our financial obligations, as it reduces our cash availability. Mismatches between contracted indexes for assets versus liabilities and/or high volatilities in interest rates may result in financial losses for us.

As of December 31, 2018, our consolidated gross debt was either fixed or linked to interest rates based on the CDI (Interbank Deposit Certificate) rate, the TJLP (Long-Term Interest Rate), the IPCA and the SELIC rate. We enter into certain financial instruments to mitigate our exposure to interest rate fluctuations.

Significant volatility in the value of the real in relation to the U.S. dollar could harm our ability to meet our U.S. dollar-denominated liabilities.

Due to inflationary pressures and adjustments to economic policy, the Brazilian currency has historically experienced volatility against the U.S. dollar and other foreign currencies. In the past, the Brazilian government has implemented various economic plans and exchange rate policies, including sudden devaluations and periodic mini-devaluations, during which the frequency of adjustments has ranged from daily to monthly, fluctuation band exchange rate systems, exchange controls and dual exchange rate markets.

There have been significant fluctuations in the exchange rate between the Brazilian currency and the U.S. dollar and other currencies. For example, the Brazilian real depreciated 19.7% and 53.2% against the U.S. dollar in 2001 and 2002, respectively and appreciated 18.0%, 8.0%, 12.3%, 8.5% and 17.0% against the U.S. dollar in 2003, 2004, 2005, 2006 and 2007, respectively. In 2008, the real depreciated again approximately 31.9% against the U.S. dollar. In 2009, the real appreciated 25.3% against the U.S. dollar, while in December 31, 2010 the real to U.S. dollar exchange rate was R$1.6662, according to the Brazilian Central Bank. In 2011, the real depreciated by 13.6% against the U.S. dollar, from R$1.6510 in the beginning of the period to R$1.8758 by the end of the period, and in 2012 the real went from R$1.8683 in the beginning of the year to R$2.0435 by the end of the period, amounting to a 9.4% depreciation against the U.S. dollar. In 2013, the real went from R$2.0415 in the beginning of the year to R$2.3426 by the end of the period. In 2014, the real went from R$2.3975 in the beginning of the year to R$2.6562 by the end of the period, corresponding to a 10.8% depreciation against the U.S. dollar.

However, during 2015, due to the poor economic conditions in Brazil, including as a result of political instability, the real has devalued at a rate that is much higher than in previous years. On September 24, 2015, the real fell to the lowest level since the introduction of the currency, at R$4.1949 per U.S.$1.00. In 2015, the real depreciated 45%, reaching R$3.9048 per U.S.$1.00 on December 31, 2015. Conversely, in 2016, the real went from R$4.0387 per U.S.$1.00 at the beginning of the year to R$3.2591 per U.S.$1.00 on December 31, 2016, corresponding to a 19.3% appreciation against the U.S. dollar. In 2017, the real went from R$3.2729 per U.S.$1.00 at the beginning of the year to R$3.3080 per U.S.$1.00 on December 31, 2017, corresponding to a 1% depreciation against the U.S. dollar. In 2018, the real went from R$3.2470 per U.S.$1.00 at the beginning of the year to R$3.8748 per U.S.$1.00 on December 31, 2018, corresponding to a 16% depreciation against the U.S. dollar. There can be no assurance that the real will not depreciate or appreciate further against the U.S. dollar.

 

 

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Because our subsidiaries and jointly-controlled entities generally invoices its sales in reais, devaluation of the real against foreign currencies may generate losses from our foreign currency-denominated liabilities as well as an increase in our funding costs with a negative impact on our ability to finance our operations through access to the international capital markets and on the market value of the shares. A strengthening of the real in relation to the U.S. dollar generally has the opposite effect. Further devaluations of the Brazilian currency may occur and impact our business in the future. These foreign exchange and monetary gains or losses can be substantial, which can significantly impact our earnings from one period to the next. In addition, depreciation of the real relative to the U.S. dollar could (1) result in additional inflationary pressures in Brazil by generally increasing the price of imported products and services and requiring recessionary government policies to curb demand and (2) weaken investor confidence in Brazil and reduce the market price of the shares. On the other hand, further appreciation of the real against the U.S. dollar may lead to a deterioration of the country’s current account and the balance of payments and may dampen export-driven growth.

In addition, we are active in the credit market, obtaining funds denominated in national and foreign currencies to finance our investments and working capital. Our foreign currency exposure related to indebtedness as of December 31, 2018 was R$14,149.9 million compared to R$10,376.4 million at December 31, 2017. We manage a portion of our exchange rate risk through foreign currency derivative instruments, but our foregoing currency debt obligations are not completely hedged. As a result, the possible depreciation of the real against the U.S. dollar could increase the cost of our obligations in foreign currency, and therefore significantly affect our liquidity and our cash flows in the short term. The depreciation of the real may limit our access to international capital markets and may favor state intervention in the economy, including the imposition of potentially recessionary policies.

Infrastructure and workforce deficiency in Brazil may impact economic growth and have a material adverse effect on us.

Our performance depends on the overall health and growth of the Brazilian economy. Brazilian GDP growth has fluctuated over the past few years, with growth of 2.7% in 2013 decreasing to 0.1% in 2014 and then to a contraction of 3.8% in 2015, a contraction of 3.6% in 2016, an increase of 1% in 2017 and an increase of 1.3% in 2018. Growth is limited by inadequate infrastructure, including potential energy shortages and deficient transportation, logistics and telecommunication sectors, the lack of a qualified labor force and the lack of private and public investments in these areas, which limit productivity as well as efficiency. Any of these factors could lead to labor market volatility and generally impact income, purchasing power and consumption levels, which could limit growth or result in contraction and ultimately have a material adverse effect on our business.

Furthermore, deficiencies in the road, rail or waterway network of the areas in which we operate, such as unpaved or maintenance-free roads lack of railroads, especially in regions farthest from the ports, result in high logistics costs and, consequently, reduce the profitability of our sugarcane operations. Likewise, failure or malpractice in transportation handling, whether on trains, trucks or vessels, may lead to loss of production, waste of quantities or damage to sugarcane. Constant climate change, such as excessive rainfall, has led to a worsening of the road’s conservation status, which may lead to an increase in over-production losses. The aforementioned infrastructure deficiencies may make it more difficult for us to conduct our business in the areas in which we operate and thereby adversely affect us.

Developments and the perception of risk in other countries may adversely affect the Brazilian economy and market price of Brazilian issuers’ securities.

The market value of securities of Brazilian issuers is affected by economic and market conditions in other countries, including the United States, European countries, as well as in other Latin American and emerging market countries. Although economic conditions in Europe and the United States may differ significantly from economic conditions in Brazil, investors’ reactions to developments in these other countries may have an adverse effect on the market value of securities of Brazilian issuers. Additionally, crises in other emerging market countries may diminish investor interest in securities of Brazilian issuers, including our securities, as well as adversely affect the availability of credit to Brazilian companies in the foreign market, with the significant outflow of resources from the country and decrease in the amount of foreign currency invested in the country. In addition, negative events in the Brazilian financial and capital markets, any news or evidence of corruption in publicly traded companies and other issuers of securities, and the lack of rigorous application of investor protection rules or lack of transparency of information or eventual crisis situations in the Brazilian economy and in other economies may influence the Brazilian capital markets and negatively impact the securities issued in Brazil. This could adversely affect the market price of our securities, restrict our access to capital markets and compromise our ability to finance our operations in the future on favorable terms, or at all.

In recent years, there was an increase in volatility in all Brazilian markets due to, among other factors, uncertainties about how monetary policy adjustments in the United States would affect the international financial markets, the increasing risk aversion to emerging market countries and the uncertainties regarding Brazilian macroeconomic and political conditions. These uncertainties adversely affected us and the market value of our securities.

 

 

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In addition, we continue to be exposed to disruptions and volatility in the global financial markets because of their effects on the financial and economic environment, particularly in Brazil, such as a slowdown in the economy, an increase in the unemployment rate, a decrease in the purchasing power of consumers and the lack of credit availability.

Disruption or volatility in the global financial markets could further increase negative effects on the financial and economic environment in Brazil, which could have a material adverse effect on our business, results of operations and financial condition.

Events in other countries may have a negative impact on the Brazilian economy.

Global economic conditions may affect the Brazilian economy as well as the demand for our products (including ethanol). For example, a global recession may lead to a reduction in global demand for our products, either through lower consumption or via measures to protect local production. In both cases the consequence would be to reduce prices for our products in the foreign market, affecting our financial performance. In addition, as a portion of our net operating revenues is generated from export activities and normally billed in U.S. dollars and, at the same time, most of our costs are denominated in reais, our operating margins may be adversely affected when the real appreciates against the U.S. dollar. In addition, we have indebtedness at pre-and post-fixed rates and, therefore, we are exposed to the risk of interest rate variations. If there is an increase in interest rates, our financial results may be affected.

On January 20, 2017, Donald Trump became the President of the United States. Certain of Donald Trump’s economic and trade policies, in particular the ongoing trade disputes with China, have generated volatility in the global capital markets. Such volatility and uncertainty, as well as changes in administrative and governmental policies of the administration may have a material adverse effect on global economic conditions and the stability of global financial markets. Asset valuations, currency exchange rates and credit ratings may be especially subject to increased market volatility. We have no control over and cannot predict the effects arising from the new United States administration or its policies. Any disruption to global economic conditions and the stability of global financial markets could have a material adverse effect on us and the market value of our securities.

On June 23, 2016, the United Kingdom electorate voted in a general referendum in favor of the United Kingdom’s exit from the European Union (so-called “Brexit”). On March 29, 2017, the United Kingdom gave formal notice under Article 50 of the Treaty on European Union of its intention to leave the European Union. Although the United Kingdom was due to leave the European Union on March 29, 2019, on March 14, 2019, the United Kingdom Parliament voted to seek an agreement with the European Union for an extension to its withdrawal request pursuant to Article 50 of the Treaty on European Union. The Article 50 negotiating period was extended until April 12, 2019 and, on April 11, 2019, it was extended again until October 31, 2019. The ongoing process of negotiations between the United Kingdom and the European Union will determine the future terms of the United Kingdom’s relationship with the European Union, including access to European Union markets, either during a transitional period or more permanently. Brexit could lead to potentially divergent laws and regulations as the United Kingdom determines which European Union laws to replace or replicate. As a result, Brexit could impair our ability to transact business in the United Kingdom and in countries in the European Union. In particular, Brexit may have an adverse impact on the ability of our lubricants business, Moove, to conduct business within the European Union given that Moove has operations in both the United Kingdom and the European Union and that both Comma and Stanbridge (subsidiaries of Moove) are headquartered in the United Kingdom. If the United Kingdom were to significantly alter its regulations affecting the lubricants industry, we could face significant new costs. It may also be time-consuming and expensive for us to alter our internal operations in order to comply with new regulations. Furthermore, uncertainty regarding the terms of Brexit, and its eventual effects once implemented, could adversely affect global economic or market conditions and investor confidence. Brexit has already and could continue to adversely affect European and/or worldwide economic and market conditions and could continue to contribute to instability in the global financial markets. The long-term effects of Brexit will depend in part on any agreements the United Kingdom makes to retain access to markets in the European Union following the United Kingdom’s withdrawal from the European Union. Any of the effects of Brexit could adversely affect our business and/or the market value of our securities.

A reduction in the volume of foreign investments in Brazil may have a negative impact on us.

Any reduction in the volume of foreign investments in Brazil may have an impact on the balance of payments, which may force the Brazilian government to have a greater need to raise funds, both in the domestic and in the international markets, at higher interest rates. Likewise, any significant increase in Brazilian inflation rates and the current slowdowns of the European and American economies may have a negative impact on the Brazilian economy and affect interest rate levels, raising expenses on loans already obtained and costs of new funding from resources by Brazilian companies, including us.

 

 

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Future governmental policy and regulations may adversely affect our operations and profitability.

Our activities may be materially affected by policies and regulations from Brazilian and foreign federal, state and municipal government. Governmental policies affecting economic activity such as tariffs, taxes, subsidies and restrictions on the import and export of agricultural goods and commodities, which represent a substantial part of the cargo we transport, may influence the profitability of the industry as well as the volume and type of imports and exports.

Future Brazilian and foreign governmental policies may adversely affect the supply, demand and prices of our products and services or otherwise restrict our capacity to operate in our current or prospective markets, potentially affecting our financial performance.

Changes in taxes and other assessments may adversely affect us.

The legislatures and tax authorities in the tax jurisdictions in which we operate regularly enact reforms to the tax and other assessment regimes to which we and our customers are subject. Such reforms include changes in tax rates and, occasionally, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. In addition, the interpretation of tax laws by courts and taxation authorities is constantly evolving. In Brazil, the tax system is highly complex and the interpretation of the tax laws and regulations is commonly controversial. The effects of these changes and any other changes that result from enactment of additional tax reforms or changes to the manner in which current tax laws are applied cannot be quantified and there can be no assurance that any such reforms or changes would not have an adverse effect upon our business.

The Brazilian government regularly implements changes to tax regimes that may increase the tax burden on us, our subsidiaries and jointly-controlled entities and their respective customers. These changes include modifications in the rate of assessments and the enactment of new or temporary taxes, the proceeds of which are earmarked for designated governmental purposes. Future changes in tax policy laws may adversely affect our financial and operating results.

Ongoing investigations relating to corruption and diversion of public funds that are being conducted by the Brazilian federal police as well as other Brazilian and non-Brazilian regulators and law enforcement officials may adversely affect the growth of the Brazilian economy and could have a material adverse effect on us.

Certain Brazilian companies active in the oil and gas, energy, construction and infrastructure sectors are facing investigations by the CVM, the SEC, the U.S. Department of Justice, the Brazilian Federal Police and the Brazilian Federal Prosecutor’s Office, the Comptroller General of Brazil and other relevant governmental authorities, in connection with corruption allegations (the so called “Lava Jato” investigations). The Brazilian federal police is also investigating allegations of improper payments made by Brazilian companies to officials of the Board of Tax Appeals (Conselho Administrativo de Recursos Fiscais), or “CARF,” a tax appeals tribunal (the so-calledOperação Zelotes”). It is alleged that the purpose of such improper payments was to induce those officials to reduce or waive certain tax-related penalties imposed by the Brazilian federal revenue authority, which were under appeal in the CARF. Such investigations involve several companies and individuals, including representatives of various companies, politicians and third parties. Certain of these individuals are being investigated by the Brazilian Federal Police and others were formally charged and are facing criminal proceedings and/or have already been convicted by the Brazilian Federal Courts.

Depending on the duration and outcome of such investigations, the companies involved may face a reduction in their revenues, downgrades from rating agencies or funding restrictions, among other negative effects. Given the significance of the companies cited in these investigations in the Brazilian economy, the investigations and their fallout have had an adverse effect on Brazil’s economic growth prospects in the near, short to medium term. Furthermore, the negative effects on such companies and others may also impact the level of investments in infrastructure in Brazil, which may lead to lower economic growth or contraction in the near to medium term (according to data from the IBGE, the Brazilian economy’s gross domestic product, or “GDP,” contracted by 3.5% in 2015 and 3.5% in 2016 but increased by 1.0% in 2017 and 1.3% in 2018).

As a result of the allegations under the “Lava Jato” investigations and the economic downturn, Brazil was downgraded to non-investment grade status by Standard & Poor’s, or “S&P,” in September 2015, by Fitch Ratings, or “Fitch,” in December 2015, by Moody’s Investors Service in February 2016 and downgraded again by Fitch in May 2016. In addition, Brazil was further downgraded by S&P to BB- with a stable outlook in January 2018 as a result of the failure of the current Brazilian government to approve certain pension reforms. Brazil’s sovereign rating is currently rated by the three major risk rating agencies as follows: BB- by S&P and Fitch Ratings and Ba2 by Moody’s. Various major Brazilian companies were also downgraded. Such downgrades have further worsened the conditions of the Brazilian economy and the condition of Brazilian companies, especially those relying on foreign investments.

 

 

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In addition, such investigations have extended to persons in high positions in the executive and legislative branches of the Brazilian government, which has caused considerable political instability. It is difficult to predict the effects of such political instability. Persistently poor macroeconomic conditions in Brazil resulting from, among other things, the “Lava Jato” investigations, their consequences and political instability could have a material adverse effect on us.

If we do not successfully comply with laws and regulations designed to prevent governmental corruption in countries in which we sell our products, we could become subject to fines, penalties or other regulatory sanctions and our sales and profitability could suffer.

Our anti-corruption policies and procedures designed to prevent governmental corruption violations may not prevent our management, employees or third parties acting on our behalf in the countries in which we operate from taking actions that violate applicable laws and regulations on improper payments to government officials for the purpose of obtaining or keeping business or business advantages. Laws prohibiting such behaviors include (but are not limited to) laws relating to the OECD’s 1997 Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, such as the U.S. Foreign Corrupt Practices Act, and Brazilian Law No. 12,846/13, or the Anticorruption Act, which has been in effect since January 29, 2014. Any breach thereof may have a material adverse effect on our business, including the acceleration of loans and financing.

The Anticorruption Act imposes strict liability on companies for acts of corruption, fraud or manipulation of public tenders and government contracts; and interference with investigations or inspections by governmental authorities. Companies found liable under the Anticorruption Act face fines of up to 20% of their gross revenue in the immediately preceding year or, if such annual gross revenue cannot be estimated, such fines may range from R$6 thousand to R$60 million. Among other sanctions, the Anticorruption Act also provides for the seizure of assets or benefits obtained illegally, the suspension or partial prohibition of operations, the dissolution of the entity and/or the prohibition to receive incentives, subsidies, donations or financing from the government or from government-controlled entities for up to five years. In assessing penalties under the Anticorruption Act, Brazilian authorities may consider the adoption of an effective compliance program. Other relevant laws applicable to corruption-related violations, such as Law No. 8.492/92, or the Administrative Improbity Law, also provide for penalties that include the prohibition to enter into government contracts for up to ten years.

Consequently, if we, our management, employees or third parties acting on our behalf in the countries in which we sell our products become involved in any anti-corruption or criminal investigations or proceedings in connection to our business in Brazil or in any other jurisdiction, our business could be materially adversely affected.

 

Item 4.

Information on the Company

 

A.

History and Development of the Company

General

We are a limited liability exempted company incorporated under the laws of Bermuda on April 30, 2007 for an indefinite term. Cosan Limited is registered with the Registrar of Companies in Bermuda under registration number EC 39981. Our legal name is Cosan Limited and our commercial name is Cosan. Our registered office is located at Crawford House, 50 Cedar Avenue, Hamilton HM11, Bermuda. Our principal executive office is located at Av. Faria Lima, 4,100 – 16th floor, São Paulo – SP, 04543-011, Brazil and our general telephone and fax numbers are 55 11 3897-9797 and 55 11 3897-9799, respectively. Our website is http://ir.cosanlimited.com/enu. The information contained on our website, any website mentioned in this annual report or any website directly or indirectly linked to these websites, is not part of, and is not incorporated by reference in, this annual report and you should not rely on such information.

See also Exhibit 8.1 to this annual report, which contains a list of our subsidiaries.

History

Our history dates back to 1936 when the Costa Pinto mill was established by the Ometto family in the city of Piracicaba in the state of São Paulo. As of the mid-1980s, we began to expand our operations through the acquisition of various milling facilities in the state of São Paulo.

In 2011, Cosan S.A. and Shell established our Joint Venture, Raízen, to produce sugar and ethanol and to distribute fuel. See “—C. Organizational Structure,” for further information on the Joint Venture.

 

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On February 24, 2014, Cosan S.A., through its subsidiary Rumo submitted to ALL a binding proposal for the merger of ALL by Rumo. The proposal entailed the merger of all the shares issued by ALL into Rumo, with the existing shareholders of Rumo and ALL receiving 36.5% and 63.5%, respectively, of the capital stock of the combined company. The merger was subject to certain conditions precedent, notably the following: (1) Rumo had to become registered as a Brazilian publicly held company and simultaneously join the “Novo Mercado” segment of B3; (2) regulatory approvals from CADE and the ANTT being obtained; and (3) all corporate and third-party approvals required by applicable laws and the by-laws of the companies being obtained.

At an extraordinary general meeting held on October 1, 2014, Cosan S.A.’s shareholders approved a spin-off of the logistics business of Cosan S.A. and the merger of the spun-off portion into Cosan Logística (the “Partial Spin-off”). The Partial Spin-off sought to segregate Cosan S.A.’s logistics activities, focused on Rumo, in order to allow each of our business segments to be more sector-focused, and to establish a suitable capital structures for each business segment. It also seeks to provide the market with greater transparency on each business segment’s performance, which will give shareholders and investors an improved ability to analyze each individual business’ performance. Cosan Limited controls both Cosan S.A. and Cosan Logística, with a 62.51% and 62.51% interest in each of them, respectively. At September 30, 2014 the portion spun-off to Cosan Logística had a book value of R$1,059.5 million. Due to the Partial Spin-off, all of the shares issued by Cosan Logística previously held by Cosan S.A. were canceled and subsequently 405,856,814 new Cosan Logística shares were issued to the shareholders of Cosan S.A. (including Cosan Limited) at an exchange ratio of 1:1. Cosan S.A.’s shares were traded ex-rights to receive Cosan Logística’s shares as from October 6, 2014. Cosan Logística’s shares are currently traded on the B3 under the ticker “RLOG3,” with trading having started on October 6, 2014. As a result, shareholders had been provided with the same political and economic privileges in Cosan Logística as those conferred on them by the shares of the company they previously held. Furthermore, the Partial Spin-off did not result in any change in the characteristics of Cosan S.A.’s shares or the advantages conferred by them. Due to the Partial Spin-off and consequent transfer of the spun-off portion to Cosan Logística, the share capital of Cosan S.A. was reduced by R$1,059,591, corresponding to the book value of the spun-off portion, without any cancellation of Cosan S.A.’s shares. As such, Cosan S.A.’s share capital reduced from the current R$4,691,822 to R$3,632,231, and it remains divided into 407,214,353 registered common, nominative and without par value shares.

On April 1, 2015, following the completion of the applicable conditions precedent, the merger between Rumo and ALL was effected with an adjusted exchange ratio (adjusted by the dividends distributed per each company during the period) that gave Rumo’s shareholders 34.3% and ALL’s shareholders 65.7% of the capital stock of the combined company. As a result, ALL’s shares (B3 ticker: ALLL3) were delisted from B3 as of March 31, 2015. As of April 1, 2015, Rumo’s public shares listed on the B3 (under the ticker “RAIL3”) fully reflected the effects of the merger.

On April 13, 2016, Rumo completed a capital increase in an amount of R$2.6 billion through a public offering of its common shares to investors in Brazil and abroad. Rumo used the net proceeds from the offering to strengthen its working capital and make investments.

In June 2016, Cosan Luxembourg S.A., or “Cosan Luxembourg,” a subsidiary of Cosan S.A., commenced a cash tender offer, or the tender offer, for any and all of (i) the R$850.0 million 9.50% Senior Notes due 2018, or the “2018 Notes,” and (ii) the U.S.$500.0 million 5.00% Senior Notes due 2023, or the “2023 Notes.”

In conjunction with the tender offer, Cosan Luxembourg also solicited consents of the holders of the 2018 Notes and the 2023 Notes to eliminate substantially all of the restrictive covenants and certain events of defaults and related provisions contained in the applicable indenture governing such series of notes. As of July 1, 2016, the expiration date for the consent solicitation, (i) R$686,538,000 in aggregate principal amount of the 2018 Notes, or approximately 80.8% of the outstanding 2018 Notes, and (ii) U.S.$378,687,000 in aggregate principal amount of the 2023 Notes, or approximately 75.7% of the outstanding 2023 Notes, had been validly tendered pursuant to the tender offer. The requisite consents were obtained and a supplemental indenture eliminating the restrictive covenants and certain events of default was executed.

Concurrently with the tender offer, on June 9, 2016, Cosan Luxembourg sold an aggregate principal amount of U.S.$500 million in 7.000% senior notes due 2027. An additional U.S.$150 million in aggregate principal amount of 7.000% senior notes due 2027 were issued on July 18, 2016. The senior notes due 2027 are unconditionally and irrevocably guaranteed by Cosan S.A. The net proceeds from the offering of the senior notes due 2027 were used to pay the tender price of any 2018 Notes and/or 2023 Notes that were tendered in connection with the tender offer. Any remaining funds were used for general corporate purposes.

 

 

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On September 30, 2016, Cosan S.A. entered into a Share Purchase Agreement with Mansilla Participações Ltda. (a vehicle of TIAA Teachers Insurance and Annuity Association of America), another shareholder in Radar Propriedades Agrícolas S.A. and Radar II Propriedades Agrícolas S.A., or “Radar and Radar II,” through which Cosan S.A. sold part of its shares in Radar and Radar II for an amount of R$1,053.8 million. The consideration was received on November 4, 2016. As a result of this transaction, Cosan S.A. reduced its equity interest in Radar and Radar II from 37.7% to 3%. Cosan S.A. retains significant influence over Radar and Radar II through a shareholders’ agreement as described in “Item 7. Major Shareholders and Related Party Transactions.” The criteria used to measure the remaining stake of the investment was the equity method, in accordance with IAS 28, although it is not consolidated due to the inhibition of Cosan S.A.’s decision-making power defined on the shareholders agreement. The comparative consolidated statement of profit or loss and statements of cash flows have been restated to show the discontinued operation separately from continuing operations.

On October 8, 2016, ALL – América Latina Logística S.A. changed its corporate name to Rumo S.A. Subsequently, on December 31, 2016, Rumo Logística was merged into its wholly-owned subsidiary Rumo S.A., as a result of which Rumo S.A. is the successor entity to Rumo Logística.

In November 2016, Cosan S.A. and Shell executed amendments to certain agreements between them to remove the fixed date call options over Raízen Energia and Raízen Combustíveis shares exercisable in 2021 and 2026, and replace them with certain call and put options exercisable by Shell or Cosan S.A. upon the occurrence of certain events including, among others: (i) fundamental breaches of the obligations provided for in the agreements governing the Joint Venture; (ii) breach of anticorruption laws, (iii) insolvency or bankruptcy of a party, (iv) change of control, and (v) in the event of the death or disability of Cosan S.A.’s current Chairman, Mr. Rubens Ometto Silveira Mello. Moreover, Cosan S.A. and Shell agreed to renew the existing lock-up period for five years from the date of the execution of the amendment, following which the parties may sell their shares in each of Raízen Energia and Raízen Combustíveis subject to compliance with certain preemption rights in each other’s favor.

On January 20, 2017, Raízen completed an offering of 5.300% senior notes due 2027 in an aggregate principal amount of U.S.$500 million. The net proceeds from this offering were used by Raízen to repay certain existing indebtedness with the remaining funds being used for general corporate purposes.

On February 9, 2017, Cosan Logística’s subsidiary, Rumo, completed an offering of 7.375% senior notes due 2024 in an aggregate principal amount of U.S.$750 million. The proceeds of this offering were used to repay certain short-term indebtedness and the remainder (if any) for general corporate purposes.

On June 16, 2017, we acquired two sugarcane crushing plants. The acquisition was approved by the CADE, the Brazilian antitrust authority on August 8, 2017 and the transaction closed on September 8, 2017. The two mills included are located in the cities of Bocaina and Brotas, in the state of São Paulo, a region where Raízen already operates, and have a combined annual crushing capacity of approximately 5.5 million tons of sugarcane.

On September 20, 2017, we completed an offering of 5.950% senior notes due 2024 in an aggregate principal amount of U.S.$500 million. The proceeds of this offering were used to for general corporate purposes, including but not limited to, the repayment of our outstanding indebtedness and investments in our logistics business.

On October 10, 2017, Rumo completed a capital increase in an amount of R$2.6 billion through a public offering of its common shares to investors in Brazil and abroad. Rumo used the net proceeds from the offering to improve its leverage, reduce its net indebtedness and increase its cash reserves.

On October 16, 2017, Shell Gas B.V., Integral Investments B.V. and Shell Brazil Holding B.V. exercised their put option on the shares issued by Comgás against Cosan Limited. The option was exercised in compliance with the option agreement between Shell and Cosan Limited executed on November 5, 2012 and amended on October 16, 2017. The exercise was concluded on December 12, 2017, when Shell transferred its 16.77% of Comgás share capital to Cosan Limited and received from Cosan Limited 17,187,937 shares issued by Cosan S.A. (4.21% share capital) and two installments in cash. As part of the process of simplifying its corporate structure, the Company offered Cosan S.A. the possibility of acquiring the Comgás shares, at the same price and conditions. The transaction was concluded on December 12, 2017. Cosan S.A. now holds 79.9% of Comgás shares and Cosan Limited now holds 58.21% of Cosan S.A. shares.

 

 

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On November 1, 2017, we acquired Stanbridge, which distributes lubricants and fuels in some regions of the United Kingdom.

On December 22, 2017, Cosan S.A. entered into a definitive agreement with Jus Capital Gestão de Recursos Ltda. and Farallon Latin America Investimentos Ltda., for the purchase and sale of credit rights arising from severance claims filed against the Brazilian federal government, which was required to pay compensation for material damages resulting from the fixing of sugar and alcohol prices below their cost of production, in a total amount of R$1,340 million. In addition to the acquisition price, Cosan S.A. will be entitled to receive certain additional payments which are contingent upon the purchaser’s actual receipts from the receivables.

On December 22, 2017, we acquired 22,025,248 of our Class A common shares pursuant to a tender offer at a purchase price of U.S.$9.65 per share, for a total cost of approximately U.S.$212.5 million, excluding fees and other related expenses. These shares represented 13.04% of the issued and outstanding Class A common stock of Cosan Limited as of December 21, 2017. The shares accepted for purchase included 1,299,859 additional shares that Cosan Limited elected to purchase pursuant to its right to purchase up to an additional 2% of its outstanding Class A common shares. After giving effect to the purchase, we had 146,867,137 outstanding Class A common shares remaining.

On January 18, 2018, Cosan Logística’s subsidiary, Rumo, completed an offering of 5.875% senior notes due 2025 in an aggregate principal amount of U.S.$500 million. The proceeds of this offering were used for general corporate purposes, including but not limited to the repayment of outstanding indebtedness and investments in our logistics business.

On March 19, 2018, we entered into an agreement with ExxonMobil Lubricants Trading Company which grants our subsidiary Moove the exclusive production, import, distribution and marketing rights in Brazil, Bolivia, Paraguay and Uruguay of lubricants and certain other related products under the Mobil brand until November 30, 2038. This agreement came into force on December 1, 2018.

On April 19, 2018, we submitted to the B3 a proposal relating to the discontinuation of our Brazilian Depositary Receipts, or “BDRs,” program pursuant to the procedure set forth in the B3’s Issuer Guide (Manual do Emissor). On October 10, 2018, we completed the deregistration with the CVM and the delisting of our BDRs from the B3. The discontinuation of our BDR program was intended to reduce our regulatory costs and concentrate liquidity of the Company’s stock on the NYSE.

On April 24, 2018, Raízen Combustíveis and its subsidiary Raízen Argentina Holdings S.A.U. entered into an agreement for the acquisition of Shell Argentina from Shell Overseas Investments B.V. and B.V. Dordtsche Petroleum Maatschappij for an amount of U.S.$916 million. Shell Argentina operates a petroleum refinery and distributes fuel through a network of 645 petrol stations in Argentina (of which 10% are owned by Raízen Combustíveis). It is expected that Shell Argentina will enter into several agreements with Shell entities, on market terms, including a supply agreement for the import of hydrocarbons and a license to use certain Shell brands in Argentina. The acquisition was completed on October 1, 2018.

On May 31, 2018, Cosan S.A., through its subsidiary CLI, acquired control of TTA Holding, or “TTA,” and Lubrigrupo II — Comércio e Distribuição de Lubrificantes, S.A., or “LubrigrupoII,” R$44.2 million and R$11.3 million, respectively, generating an additional goodwill in the lubricants segment of R$23.6 million and R$6.8 million, respectively. The total consideration paid for these acquisitions, net of cash received, amounted to R$33.0 million and R$10.0 million, respectively.

On December 20, 2018, Cosan S.A., through its subsidiary CLI, acquired control of Metrolube, for an initial consideration of R$112.8 million, generating an additional goodwill in the Moove segment of R$67.5 million. The total consideration, net of cash received, amounted to R$112.8 million.

On December 21, 2018, CLI and CVC entered into an investment agreement pursuant to which CVC will subscribe for shares in Moove’s capital in a total amount of R$562 million (which is equivalent to approximately 30% of Moove’s capital). Considering all conditions precedent provided in the investment agreement were satisfied, the transaction was concluded on March 29, 2019. As a result and pursuant to the terms of the investment agreement, Moove received R$434 million at the closing of the transaction and may receive up to approximately R$128 million until 2021.

On January 3, 2019, we acquired 14,228,134 of our Class A common shares pursuant to a tender offer at a purchase price of U.S.$8.88 per share, for a total cost of approximately U.S.$126.3 million, excluding fees and other related expenses. These shares represented 9.6% of the issued and outstanding Class A common stock of Cosan Limited as of December 31, 2018. The shares accepted for purchase included 2,966,873 additional shares that Cosan Limited elected to purchase pursuant to its right to purchase up to an additional 2% of its outstanding Class A common shares. After giving effect to the purchase, we had 134,115,534 outstanding Class A common shares remaining.

 

 

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On March 8, 2019, Cosan S.A. announced the conclusion of the tender offer held on the same date for acquisition of class A preferred shares issued by Comgás. A total of 19,496,165 preferred shares of Comgás were acquired by Cosan S.A. in the tender offer at a price of R$82.00 per preferred share, representing approximately 14.77% of Comgás’s capital stock. As a result, we increased our interest in Comgás from 80.12% prior to the tender offer to 94.88% following the conclusion of the tender offer.

On March 28, 2019, Rumo announced that it has won the tender (International Bidding No. 02/2018) organized by ANTT to operate the railway network located between the cities of Porto Nacional, in the state of Tocantins and Estrela d’Oeste, in the state of São Paulo. Rumo’s bid was of R$2,719.0 million. The final granting of the concession to Rumo is subject to the completion of the remaining stages of the tender detailed in the tender notice, including an analysis of Rumo’s licensing documents. Rumo will be required to pay (i) 5% of the value of its bid within 45 days of the publication of the ANTT’s final decision, and (ii) the remainder in 120 quarterly instalments calculated pursuant to the terms of the concession agreement to be entered into in connection with the concession.

On April 24, 2019, we announced the cancellation of 32,239,807 Class A common shares held in treasury, representing 11.91% of Cosan Limited’s capital stock. After giving effect to the cancellation, we had 142,115,534 total Class A common shares remaining.

Capital Expenditures

For a description of our principal capital expenditures over the fiscal years ending December 31, 2018, 2017 and 2016, see “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Expenditures.” For more information concerning our principal capital expenditures currently in progress, see “—D. Property, Plant and Equipment—Capital Expenditures.”

 

B.

Business Overview

We are one of the largest companies in Brazil, as ranked by the Exame magazine’s annual Melhores e Maiores publication, with businesses in strategic sectors to Brazil’s development, such as energy and logistics. The following companies are part of the organization: Cosan S.A. and its subsidiaries, Comgás and Moove, Raízen (which is under joint control) and Cosan Logística with its subsidiary Rumo.

Through Raízen, a joint venture between Cosan S.A. and Shell created in June of 2011, the company produces more than 2.2 billion liters of ethanol per year to supply both domestic and international markets and 4.3 million tons of sugar, with 981 MW of installed capacity—making it the largest sugar exporter and one of the world’s largest power generators of electricity from sugarcane bagasse. The company plants, harvests and processes sugarcane, the main raw material used in the production of sugar and ethanol. Raízen also distributes fuel to over 6,524 service stations throughout Brazil under the Shell brand, with approximately 989 convenience stores, 67 distribution terminals and presence in 68 airports supplying jet fuel. On April 24, 2018, Raízen Combustíveis and its subsidiary Raízen Argentina Holdings S.A.U. entered into an agreement for the acquisition of Shell Argentina from Shell Overseas Investments B.V. and B.V. Dordtsche Petroleum Maatschappij for the amount of U.S.$916 million. Shell Argentina operates a petroleum refinery and distributes fuel through a network of 645 petrol stations in Argentina (of which 10% are owned by Raízen Combustíveis).

Acquired in 2012, Comgás is Brazil’s largest natural gas distributor. It has a network of over 16,747 kilometers, bringing natural gas to 1.9 million residential, commercial and industrial consumers in 177 cities. Its concession area accounts for approximately 26% of Brazil’s GDP, covering approximately 88 municipalities in the São Paulo, Campinas and Santos metropolitan areas and the Paraíba Valley.

Through Moove, we produce and distribute automotive and industrial lubricants. Under the Mobil brand, Cosan S.A. operates in Brazil and in nine other countries: Argentina, Bolivia, Uruguay and Paraguay (South America), United States of America, Spain, France, Portugal and the United Kingdom, aligned with its strategy to leverage the ExxonMobil partnership and expand abroad. Under the Comma brand, Moove also operates in the United Kingdom, selling its products to over 40 other countries in Europe and Asia.

 

 

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In the logistics sector, Rumo is a leader in the transport of sugar for exportation and is creating an integrated transport platform that will significantly increase the efficiency of Brazilian exports. Cosan S.A. has spun-off its logistics segment, including Rumo, into a listed company called Cosan Logística. In addition, Rumo has merged with ALL, which has made it one of the most important transportation and port operator for grains and other commodities in Brazil. For further details, see “—A. History and Development of the Company.”

Cosan Limited (NYSE ticker: “CZZ”) has been listed since 2007 on the NYSE. Cosan S.A. (B3 ticker: “CSAN3”) has been listed since 2005 and Cosan Logística (B3 ticker: “RLOG3”) has been listed since 2014, both on the B3 segment with the highest standards of corporate governance, the “Novo Mercado.” Comgás (B3 ticker: “CGAS3” and “CGAS5”) has been listed since 1997 on the B3. Rumo (B3 ticker: “RAIL3”) has been listed since 2015 on the B3, with the highest standards of corporate governance, the “Novo Mercado.”

Raízen Combustíveis

Overview

Through Raízen Combustíveis, our downstream Joint Venture Company, we are engaged in sourcing, storing, blending and distributing gasoline, ethanol, diesel, fuel oil and aviation fuel through our network of 6,524 Shell-branded retail service stations, 67 distribution terminals and 68 airport terminals supplying aviation fuel. Following the formation of the Joint Venture on June 1, 2011, we are currently among the three largest Brazilian fuel distributors, with approximately 32% market share in Brazil in terms of volume of fuel sold in the fiscal year ended December 31, 2018, according to Plural.

The following are the three main lines of activity in which Raízen Combustíveis is engaged:

 

   

Retail: Raízen Combustíveis operates in the retail segment of the fuels distribution market through a network of Shell-branded retail service gas stations which on December 31, 2018 totaled 6,524 stations throughout Brazil. Raízen Combustíveis is a “Shell” brand licensed company, which is recognized as a symbol of quality and technology. The main products that Raízen Combustíveis sells at gas stations are Shell V-Power (ethanol and gasoline with additives) and Shell Evolux.

 

   

Business to Business (B2B): Raízen Combustíveis operates in the B2B segment with more than 3,000 customers such as cargo and passenger transport companies and companies in the agricultural and mining industries, among others. Our B2B strategy is focused on customer loyalty through premium technology products (Shell V-Power and Shell Evolux portfolios), digital payment methods and carrier fleet control tools.

 

   

Aviation: Raízen Combustíveis operates in the aviation sector through its 68 supply bases in Brazilian airports, providing services to commercial and business aviation companies. Raízen Combustíveis invests in the improvement of customer services and marketing strategies to differentiate its product offering in the business aviation market. The product marketed by this segment is Shell Aerojet.

 

   

Raízen Argentina: Raízen acquired the downstream assets of Shell in Argentina, including a petroleum refinery and a network of 645 petrol stations in Argentina (of which 10% are owned by Raízen Combustíveis).

 

Raízen Combustíveis Highlights

   As of and For the Fiscal Year Ended  
     December 31,
2018
     December 31,
2017
     December 31,
2016
 

Service stations

     6,524        6,272        6,027  

Fuel sold (billion liters)

     27.5        25.6        24.8  

Ethanol sales (R$ million)

     7,535.7        4,926.2        5,246.6  

Gasoline sales (R$ million)

     32,565.8        31,878.8        29,162.1  

Diesel sales (R$ million)

     38,062.8        31,786.9        29,812.9  

Jet fuel sales (R$ million)

     5,867.5        3,709.6        3,414.2  

Other products (R$ million)

     1,172.3        487.6        507.2  
  

 

 

    

 

 

    

 

 

 

Net sales (R$ million)(1)

     85,204.1        72,789.1        68,143.0  
  

 

 

    

 

 

    

 

 

 

 

(1)

Raízen Combustíveis is accounted for under the equity method, and therefore, net sales are not consolidated in the Company’s statement of profit or loss and other comprehensive income. See “—E. Supplemental Information About Joint Venture.”

 

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Currently, Raízen Combustíveis and its competitors purchase all or nearly all oil-derivative fuels from Petrobras under a formal supply contract that establishes the volume and the terms for supply. The contract is renewed periodically and the volume contracted for is based on the volume purchased in the previous year. There have been no significant interruptions in the supply of fuels from Petrobras to the distributors.

Ethanol is sourced from various third-party suppliers and from Raízen Energia as well. The prices of ethanol supplied are generally determined by the ESALQ index. The prices of oil-derivative fuels supplied to us by Petrobras generally vary according to international oil prices.

All of our fuel distribution operations are in the domestic Brazilian and Argentinian markets. Our operations are not subject to significant seasonality; however, the price of hydrous ethanol at the pump is typically more volatile than the prices of gasoline or diesel, as a result of the seasonality of the sugarcane harvest and the limited storage facilities for ethanol in Brazil. This in turn impacts the proportion of our revenue mix that is derived from either gasoline or ethanol throughout the year, as consumers who own flex fuel vehicles switch between the two fuels according to the relative price of each.

As hydrous ethanol is less energy intense than gasoline, consumers will usually switch to ethanol if the price is significantly lower than gasoline. When hydrous ethanol is retailed at 70% of the price of gasoline, the two fuels are considered to be at price parity with each other. At a level below 70%, the demand for ethanol will significantly increase at the expense of gasoline.

Raízen Combustíveis supplies aviation fuel at 68 airports across Brazil, including at the major hubs of Congonhas and Guarulhos airports in São Paulo, and Brasília airport in the Federal District, to Brazilian and foreign airlines.

In addition, as of December 31, 2018, we had 989 convenience stores (compared to 950, 961 and 944 as of December 31, 2017, 2016 and 2015, respectively) throughout Brazil.

Regulation

The National Agency of Petroleum, Natural Gas and Biofuels, or “ANP,” is a federal agency responsible for the control, supervision and implementation of the government’s oil, gas and biofuel regulations. The ANP regulates all aspects of the production, distribution and sale of oil, natural gas, and biofuels products in Brazil. With respect to regulation relating to gasoline and biofuels, the ANP determines the product quality standards and minimum storage capacities required to be maintained by distributors and is also responsible for establishing the limits of oil-based fuel volume purchased by distributors based on their storage capacity.

 

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Fuel distributors are subject to Brazilian federal, state and municipal laws and regulations relating to environmental protection, safety and occupational health and safety, licensing by fire departments, environment and transport authorities. The National Environmental Council (Conselho Nacional do Meio Ambiente), or “CONAMA,” is the main government body responsible for issuing environmental standards and regulations at the federal level. Environmental state agencies and municipal departments are also responsible for establishing and supervising complementary laws and regulations within their areas of operation.

Fuel distributors must obtain authorizations and/or licenses from federal, state and/or municipal environmental agencies and fire departments to implement and operate their facilities. They are required to develop programs to control air, soil and water pollution, including management of hazardous waste.

Raízen Energia (Sugar, Ethanol and Cogeneration)

Overview

Raízen Energia is our upstream Joint Venture company. Raízen Energia’s core business is the production and sale of a variety of products derived from sugarcane, including VHP sugar, anhydrous and hydrous ethanol, as well as activities related to energy cogeneration from sugarcane bagasse and ethanol trading. Raízen Energia operates 26 sugar, ethanol and energy cogeneration mills, with a current crushing capacity of 73 million tons of sugarcane per year.

 

Raízen Energia Highlights

   As of and for Fiscal Year Ended  
     December 31,
2018
     December 31,
2017
     December 31,
2016
 

Crushed sugarcane (million tons)

     60.1        60.7        62.2  

Sugar volume sold (thousand tons)

     3,493.5        4,559.9        4,694.6  

Ethanol volume sold (million liters)

     4,685.6        3,841.1        3,614.3  

Energy sold (MWh)

     11,186.5        3,520.7        2,871.9  

Net sugar sales (R$ million)

     3,670.8        5,377.4        5,794.8  

Domestic market

     1,218.4        1,295.5        1,437.4  

External market

     2,452.4        4,081.8        4,357.4  

Net ethanol sales (R$ million)

     8,569.4        6,550.7        6,480.4  

Domestic market

     6,254.9        4,474.9        3,810.4  

External market

     2,314.5        2,075.8        2,670.0  

Net energy cogeneration sales (R$ million)

     2,836.7        884.3        520.5  

Other products and services (R$ million)

     4,721.7        340.3        338.1  

Net sales (R$ million)(1)

     19,798.6        13,152.7        13,133.8  

 

(1)

Raízen Energia is accounted for under the equity method; therefore, net sales are not consolidated in the Company’s statement of profit or loss and other comprehensive income. See “—E. Supplemental Information About Joint Venture.”

Our production is based on sugarcane, the most competitive and viable feedstock for sugar and ethanol because of its low production cost and high energy efficiency ratio relative to other energy sources, such as corn and sugar beet. Sugarcane is our principal raw material. It is a tropical grass that grows best in locations with stable warm temperatures and high humidity, although cold and dry winters are an important factor for the sucrose concentration of sugarcane. The climatic conditions of the central-south region of Brazil are ideal for growing sugarcane.

Raízen Energia’s sugarcane production is sourced from leased lands, as well as from third-party suppliers. The following table compares the amount of sugarcane grown on leased land with the amount purchased from third parties during the periods set out below.

 

     As of and for Fiscal Year
Ended December 31
 
     2018      %      2017      %      2016      %  
     (millions of tons, except percentages)  

Own sugarcane harvested from leased land

     28.9        48.0        29.1        47.9        31.3        50.4  

Sugarcane purchased from third parties

     31.2        52.0        31.6        52.1        30.9        49.6  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     60.1        100        60.7        100        62.2        100  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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In accordance with the land lease contracts, we pay the lessors a certain fixed number of tons of sugarcane per hectare as consideration for the use of the land, and a certain fixed productivity per ton of sugarcane in terms of TSR. The overall volume of TSR is obtained by multiplying the number of hectares leased by the committed tons of sugarcane per hectare by the TSR per ton of sugarcane. The price that we pay for each kilogram of TSR is set by Consecana. The price that we pay to third-party sugarcane growers is based on the total amount of sugar content in the sugarcane, measured by the amount of sugar recovered and on the prices of ethanol and sugar sold by each mill.

Our mills have the capacity to crush 73 million tons of sugarcane per year and in the fiscal year ended December 31, 2018, we crushed 60.1 million tons of sugarcane, or 12% of Brazil’s central-south region total sugarcane production (which was 497.5 million tons as of December 31, 2018, according to UNICA). For further information on our sugarcane mills see “—D. Property, Plant and Equipment.” The mills that are equipped to produce both sugar and ethanol can typically adjust their proportion of output from anywhere between 57% sugar and 43% ethanol to 47% sugar and 53% ethanol. We track the current and future prices of each product relative to the other, as well as forecasts of global output volumes of each product, to decide on the production mix to be set across our mills in order to maximize our sales revenue. All of our mills are energy self-sufficient from burning sugarcane bagasse at very high temperatures in boilers, to heating water that is transformed into steam. Thirteen of our mills generate surplus electrical energy that we sell to the Brazilian energy grid.

We produce and sell a wide variety of standard sugars, including VHP sugar, crystal sugar and organic sugar, and refined sugars, including granulated refined white sugar, amorphous refined sugar, refined sucrose liquid sugar and refined inverted liquid sugar.

Standard sugars. VHP sugar, a raw sugar with approximately 99% sucrose content, is similar to the type of sugar traded in major commodities exchanges, including through the standard NY11 contract. The main difference between VHP sugar and the sugar that is typically traded in the major commodities exchanges is the sugar content of VHP sugar and the price premium that VHP sugar commands in comparison to most sugar traded in the commodities exchanges. We export VHP sugar in bulk, to be refined at its final destination. We also sell a small amount of VHP sugar to the Brazilian market. Crystal sugar is a non-refined sugar produced directly from sugarcane juice and sold to industrial companies in Brazil to be used as an ingredient for food products. We also sell a small amount of crystal sugar to the Brazilian retail market and to export markets. Organic sugar is a kind of raw sugar produced from organic sugarcane and is not submitted to any chemical treatments during its manufacturing process. We sell organic sugar in the international and Brazilian markets.

Refined sugars. We refine VHP sugar and crystal sugar into both granulated and amorphous (non-crystallized) sugar. We sell refined sugar in the Brazilian and export retail and industrial markets. Refined sugar is used as an ingredient in processed food products such as milk and chocolate powders, bakery products, powder refreshments, and pharmaceutical syrups.

Liquid sugars. We refine crystal sugar to produce sucrose liquid sugar and inverted liquid sugar, which has a higher percentage of glucose and fructose than sucrose liquid sugar. We sell both types of sugar for industrial use, mainly for the production of soft drinks.

We sell sugar to a wide range of customers in Brazil and in the international markets. Our customers in Brazil include Docelar, which was previously held by Cosan S.A. and sold to Camil on October 24, 2012, and food manufacturers, for which we primarily sell refined and liquid sugar. We primarily sell raw sugar in the international markets through international commodities trading firms and Brazilian trading companies. In the fiscal year ended December 31, 2018 we exported 65.6%, by volume, of the sugar we sold. Rumo handles most of the transportation by rail and logistics of our sugar exports to their sugar loading terminal at the port of Santos in the state of São Paulo.

 

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Prices for raw sugar are established in accordance with the NY11 futures contracts. Prices for refined sugar are established in accordance with the London# 5 futures contract, traded on the LIFFE. Prices for sugar we sell in Brazil are set in accordance with Brazilian market prices, using an index calculated by the ESALQ.

We produce and sell three different types of ethanol: hydrous ethanol and anhydrous ethanol for fuel and industrial ethanol. The primary type of ethanol consumed in Brazil is hydrous ethanol, which is used as an alternative to gasoline for flex fuel vehicles (as opposed to anhydrous ethanol which is used as an additive to gasoline). As a result, hydrous ethanol represented 64.7% of our ethanol production in the fiscal year ended December 31, 2018 and 58.8% of our ethanol production in the fiscal year ended December 31, 2017. Our sales are mainly to fuel distributors in Brazil, of which the three largest are Petrobras Distribuidora S.A. (BR Distribuidora), Raízen Combustíveis S.A. (Shell) and Cia. Brasileira de Petróleo Ipiranga (Ipiranga). We also sell industrial alcohol, which is used in the chemical and pharmaceutical sectors. In the fiscal year ended December 31, 2018, we exported 24.7%, by volume, of the ethanol we sold. Our main export customers are trading companies which distribute our products mainly to the United States, Japan and Europe. Our exports are conducted through TEAS, an ethanol loading terminal at the port of Santos in the state of São Paulo.

Ethanol Production Process

We produce ethanol through a chemical process called yeasting, which is a process of fermenting the sugars contained in both sugarcane juice and molasses. Initially, we process the sugarcane used in ethanol production the same way that we process sugarcane for sugar production. The molasses resulting from this process is mixed with clear juice and then with yeast in tanks, and the by-product resulting from the yeasting process, called “yeasted wine,” has an ethanol content of approximately 7% to 9%. After the yeasting process, which takes approximately ten hours, the yeasted wine is centrifuged, so that we can separate the yeast from the liquid. We use the separated yeast in the ethanol production process. We then boil the yeasted wine at different temperatures, which causes the ethanol to separate from other liquids. Hydrous ethanol is produced after different distillation stages. In order to produce anhydrous ethanol, hydrous ethanol undergoes a dehydration process. The liquid remaining after these processes is called vinasse, a by-product we use as fertilizer in our sugarcane fields. After the distillation and dehydration processes, we produce hydrous, anhydrous, neutral and industrial ethanol, and store the ethanol in large tanks.

The ethanol production flow can be summarized as follows:

 

   

Preparation of the juice. The fermentation is fed with a juice composed of approximately 20% sugar, which is prepared with juice (from the treatment), molasses (from sugar production) and water. This juice must be cooled to approximately 30°C.

 

   

Fermentation. The fermentation of the juice is the result of the action of yeast, which first inverts the sucrose to glucose and fructose (monosaccharide), and then converts the monosaccharide into ethanol and carbon dioxide. This reaction occurs in a fermenter, which is fed with juice and yeast.

 

   

Centrifuging. After the fermentation, the resulting product is carried to centrifuges that separate the yeast from the beer, a solution of approximately 9%v/v (oGL) of ethanol.

 

   

Treatment of the yeast. The yeast that comes from the centrifuges is treated with sulfuric acid and returned to the fermenter tank to be utilized again.

 

   

Distillation. The beer is distilled in a sequence of distillation columns, which separate the water from the ethanol. This process occurs basically due to the differences of ethanol’s and water’s ebullition temperatures. In order to produce hydrous ethanol, two columns are used to achieve the concentration of 94%v/v (oGL) ethanol. From the first column, a slop called vinasse is obtained, which is used as a fertilizer in the sugarcane fields.

 

   

Dehydration. In order to produce anhydrous ethanol, two more columns are used to achieve the concentration of 99%v/v (oGL) ethanol. In the first column, the excess of water is separated with the aid of cycle-hexane.

 

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Ethanol Production Capacity and Output

Our current annual ethanol production capacity is approximately 2.6 billion liters. We were the largest producer of ethanol in Brazil in the fiscal year ended December 31, 2018, producing approximately 2.6 billion liters of ethanol, representing 10% of the total ethanol production in Brazil’s central-south region, according to UNICA. We are one of the largest exporters of ethanol in the world, having sold abroad R$2.3 billion including trading in the foreign markets, having exported 1.2 billion liters in the fiscal year ended December 31, 2018 and 1.2 billion liters in the fiscal year ended December 31, 2017.

Cogeneration

Raízen Energia currently has an installed energy capacity of 981 MW per year from our 26 mills, of which 13 mills sold their excess energy to the Brazilian energy grid. We view our cogeneration business as strategic since it generally allows for a stable cash flow stream across commodity cycles, helping to reduce the volatility of our cash flows and operations.

 

Energy Cogeneration Highlights

   As of and for Fiscal Year Ended  
     December 31,
2018
     December 31,
2017
     December 31,
2016
 

Energy sold (MWh)

     11,186.5        3,520.7        2,871.9  

Net sales (R$ million)(1)

     2,836.7        884.3        520.5  

 

(1)

Raízen Energia is accounted for under the equity method, therefore, net sales are not consolidated in the Company’s statement of profit or loss and other comprehensive income. See “—E. Supplemental Information About Joint Venture.”

Alternative sources of electricity, such as cogeneration from sugarcane bagasse, have become increasingly important within the Brazilian hydro-dependent energy matrix, particularly because the harvest period for sugarcane coincides with generally drier periods for hydraulic energy, when the overall energy supply is, therefore, more constricted. We are self-sufficient for our energy needs. In the fiscal years ended December 31, 2018, 2017 and 2016, we sold 11,186.5 MWh, 3,520.7 MWh and 2,871.9 MWh, respectively, of energy to third parties. Our main customers, besides the energy sold to the Brazilian grid, are utility companies. In the fiscal year ended December 31, 2018, approximately 80% of our excess cogeneration volume was sold through long-term contracts.

Seasonality

Raízen Energia is subject to the seasonality of the annual sugarcane harvesting period in the Central-South region of Brazil, which begins in April or May and ends in November or December. This creates fluctuations in our inventory, usually peaking in December to cover sales between crop harvests (i.e., January through March), and a degree of seasonality in gross profit. See also “Item 5. Operating and Financial Review and Prospects—Principal Factors Affecting Our Results of Operations—Seasonality.”

Regulation

Raízen Energia is subject to several Brazilian federal, state and municipal environmental protection and health and safety laws and regulations governing, among other things, the generation, storage, handling, use, transportation and discharge of hazardous materials into the ground, air and water as well as regulation concerning electricity generation. Below is a summary of the principal rules and regulations to which Raízen Energia is subject.

Permits. Certain environmental laws require us to obtain from governmental authorities permits, licenses and authorizations to install and operate our mills, to burn sugarcane and to perform other activities.

 

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We are subject to the regulations of the pollution control and remediation agencies of several Brazilian states, such as:

 

   

Environmental Company of the state of São Paulo (Companhia Ambiental do Estado de São Paulo—CETESB);

 

   

Environmental Agency of the State of Goiás (Secretaria de Meio Ambiente, Recursos Hídricos, Infraestrutura, Cidades e Assuntos Metropolitanos—SECIMA); and

 

   

Environmental Institute of the state of Mato Grosso do Sul (Instituto de Meio Ambiente do Mato Grosso do Sul—IMASUL).

Environmental Licensing of Raízen. We operate mills, transport facilities and numerous warehouses. CONAMA is the government agency responsible for issuing rules and resolutions on environmental licensing at a national level. Environmental licensing is required for the development of new facilities and for alterations in existing operations. Environmental licenses must be periodically renewed.

Sugarcane Burning. The state of São Paulo and certain municipal governments have established laws and regulations that limit or eliminate the burning of sugarcane entirely. We have voluntarily signed the Agro-Environmental Sugarcane Protocol, which establishes accelerated deadlines for the reduction of sugarcane burning.

Brazilian Forestry Code. We are subject to the Brazilian Forest Code, which prohibits land use in certain permanently protected areas, and obligates us to maintain and register a forest reserve in each of our rural landholdings covering from 20% to 80% of the total area of such land, known as “Legal Reserve.”

Environmental Liabilities. We are involved in certain administrative and judicial proceedings for alleged failure to comply with environmental laws and regulations (especially relating to environmental damages caused by sugarcane burning and contaminated areas). The Brazilian Federal Constitution provides for three different types of environmental liabilities: (1) civil, (2) administrative and (3) criminal. Non-compliance with environmental law is subject to administrative, civil and/or criminal sanctions, regardless of the civil impacts such as the obligation to repair, compensate or indemnify any damages caused to the environment or third parties. Public attorneys’ offices, foundations, state agencies, state-owned companies and environmental protection associations are all authorized by law to file public civil actions seeking compensation for environmental damages.

Electricity Regulation. The Brazilian power industry is regulated by ANEEL, a federal regulatory agency, in accordance with the general guidelines set forth by the Ministry of Mines and Energy. In order to perform power generation activities, the power agent must obtain authorizations granted by ANEEL or execute concession and permission agreements with the Brazilian government through ANEEL. The activities related to generation and commercialization of electricity performed by Raízen Energia are subject to ANEEL’s supervision. Pursuant to Law No. 9,427 dated December 26, 1996 and ANEEL’s Resolution No. 63/2004, within the scope of its powers of inspection of electrical energy plants and services, ANEEL may impose penalties (including warnings, fines, temporary suspension of the right to participate in bidding procedures for new concessions, licenses or authorizations and forfeiture) on power industry participants based on the nature of its relation with the agency (concessionaires or agents who hold permission or authorization) and the materiality of the infraction. In case of fines, the limit of 2.0% of the revenue of the concessionaire in the 12-month period preceding any assessment notice must be respected or, for independent producers or self-producers (authorized agents), 2.0% of the estimated amount of energy produced in the same period. In addition, pursuant to ANEEL’s Resolution No. 63/2004 some infractions may result in fines related to the failure of the agent in requesting ANEEL’s prior approval to certain conduct, including the following:

 

   

entering into certain related party transactions, pursuant to ANEEL’s Resolution No. 699/2016;

 

   

sale or assignment of the assets related to services rendered as well as the imposition of any encumbrance (including any security, bond, guarantee, pledge and mortgage) on them or any other assets related to the concession or permission, or the revenues of the electricity services;

 

   

changes in corporate control of the holder of the authorization, permission or concession, as per terms of ANEEL’s Resolution No. 484/2012; and

 

   

as applicable, submit to ANEEL projects of electric works and plants and their modifications, as well as proceed with its execution in disagreement with the project approved and with the established scheduled.

 

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Comgás (Natural Gas Distribution)

Overview

Comgás is Brazil’s largest distributor of piped natural gas, with a network reaching over 16,747 kilometers and delivering natural gas to more than one million residential, commercial and industrial consumers in over 177 cities. The Comgás concession area covers approximately 26% (according to the IBGE) of Brazil’s GDP, including approximately 88 municipalities in the metropolitan areas of São Paulo, Campinas and Santos as well as the Paraíba Valley.

We are the largest natural gas distributor in Brazil, with approximately 30% market share in Brazil in terms of volume sold in 2018, according to ABEGAS. We believe the prospects for future availability of natural gas in Brazil are positive based on expected exploration of carbon deposits discovered in the pre-salt layer offshore of Brazil’s coast. Comgás’ supply of natural gas is currently sourced primarily from Petrobras, with contracts in Bolivia and Brazil having been entered into. Our natural gas supply agreement with Petrobras that is sourced out of Bolivia was recently renewed until 2021. See “Item 3. Key Information––D. Risk Factors—Risks Related to Our Businesses, the Operations of Our Joint Venture, and Industries in Which We Operate—Our business would be materially adversely affected if operations at our transportation and distribution facilities experienced significant interruptions. Our business would also be materially adversely affected if the operations of our customers and suppliers experienced significant interruptions.”

 

Comgás Highlights

   As of and for
Fiscal Year Ended
 
     December 31,
2018
     December 31,
2017
     December 31,
2016
 

Natural gas sold (million cbm)

     4,543.3        4,292.9        4,323.0  

Net sales (R$ million)

     6,840.0        5,537.9        5,657.2  

Regulation

The National Agency of Petroleum, Natural Gas and Biofuels, or the “ANP,” is responsible for the control, supervision and implementation of the government’s oil, gas and biofuel policies. The ANP regulates all aspects of the production, distribution and sale of oil products in Brazil, including product quality standards and minimum storage capacities required to be maintained by distributors and is also responsible for establishing the limits of oil-based fuel volume purchased by distributors based on their storage capacity.

In addition to the regulation by ANP, Comgás’ activities are also supervised and regulated by ARSESP, with which it maintains continuous dialogue through its directorate for Regulatory and Institutional Affairs, in order to enhance or formulate industry policies. In light of the approach shown by regulators in recent years, Comgás does not believe that there will be any sudden changes that may affect its business.

Moove

Moove is responsible for the manufacturing and distribution of passenger vehicle lubricants, commercial vehicle lubricants, industrial lubricants and special application products such as greases, cutting oils and car care products under the Mobil and Comma brands in Brazil, Argentina, Bolivia, Uruguay, Paraguay, Spain, France, Portugal, the United States of America, the United Kingdom and Asia.

 

Moove Highlights:

   As of and for
Fiscal Year Ended
 
     December 31,
2018
     December 31,
2017
     December 31,
2016
 

Volume of lubricants sold (thousand liters)

     345.9        347.8        328.9  

Net sales (R$ million)

     3,449.9        2,129.5        1,883.7  

We have a wholly-owned lubricants oil blending plant, located in Rio de Janeiro, with an annual production capacity of 2.5 million barrels of lubricants per year, and a pier facility that allows us to import base stocks. We produce over 600 different lubricants, and purchase more than 400 raw materials, including basic oils and additives.

We sell our lubricant products, mainly through distributors and direct sales to industrial customers, as well as to wholesale customer accounts and car and motorcycle dealerships.

 

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We have exclusive distribution rights for Mobil brand products in Bolivia, Paraguay and Uruguay following the purchase of ExxonMobil’s lubricant distribution business in these three countries in 2011.

In July 2012, we acquired Comma Oil and Chemicals Limited (currently known as Moove Lubricants), which reinforced our strategy to enter into the European lubricants and specialties markets. As a result, we acquired finished lubricants and the manufacture and sale of chemicals to third parties, all of Comma’s assets at the Gravesend site in Kent, England, United Kingdom, as well as ownership of Comma’s trademarks and brand names. In addition, agreements will be in place to allow Comma to continue to distribute select Mobil-brand lubricants into specific sales channels in the United Kingdom and to continue to manufacture and distribute a range of seasonal and ancillary automotive products to ExxonMobil.

We have exclusive distribution rights for Mobil brand products in Bolivia, Paraguay and Uruguay following the purchase of ExxonMobil’s lubricant distribution business in these three countries in 2011. Since December 2016, Moove has had the exclusive distribution rights for Mobil brand products in Spain and, more recently, in the United Kingdom, Argentina, France, Portugal and the United States of America.

Our lubricants business is not subject to significant seasonality. However a significant proportion of our raw material purchases are invoiced in U.S. dollars and we hedge part of our shipments of base oils against variations in exchange rates.

Regulation

Moove is subject to substantially the same regulation by the same regulatory bodies to which our fuel distribution business, Raízen Combustíveis, is subject. See “—Raízen Combustíveis.”

Cosan Logística

Overview

Our logistics operations are operated through Cosan Logística, which holds our interest in Rumo see “—A. History and Development of the Company.” Rumo offers an integrated logistics solution to agricultural commodity producers located in the central-south region of Brazil by transporting produce from the mills and depots by truck or rail to be loaded and stored in our port facility at the port of Santos in the state of São Paulo. Rumo also offers warehousing services.

Following Rumo’s merger with ALL which was completed on April 1, 2015, Rumo has expanded its offering of logistics services, including, among other things, by providing port handling services. Furthermore, Rumo acquired control of ALL’s former concessions which include the main railroads between the sugar and grain producing areas of the central-south region of Brazil and the ports of Santos, Paranaguá, São Francisco and Rio Grande. As a result, Rumo now operates in the states of Mato Grosso and São Paulo as well as the southern region of Brazil where four of the most active ports in the country are located and through which most of Brazil’s grain production is exported. Moreover, Rumo started operating twelve main inland terminals, either directly or through partners. For further information, see “—A. History and Development of the Company.”

The following table sets for the certain financial and other information of Rumo for the periods indicated:

 

Logistics Highlights:

   As of and for
Fiscal Year Ended
 
     December 31,
2018
     December 31,
2017
     December 31,
2016
 

Transported volume (million RTK)

     56,351.5        49,690.5        40,270.4  

Port elevation volume (thousand tons)

     10,771.5        13,133.0        13,113.7  

North operations (R$ million)

     4,913.4        4,439.7        3,651.5  

South operations (R$ million)

     1,412.3        1,283.1        1,097.7  

Container operations (R$ million)

     259.2        223.5        265.4  

Net sales (R$ million)

     6,584.9        5,946.3        5,014.6  

 

 

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Currently, Rumo owns and operates a large asset base, including a rail network consisting of four concessions that extend over approximately 12,000 kilometers of railway lines, more than 1,180 locomotives, over 30,200 rail cars, as well as distribution centers and warehousing facilities. Rumo provides efficient and complete logistics services to its clients through its operation of 12 transshipment terminals, either directly or through partnerships, which have a static storage capacity of approximately 900,000 tons, and where we store grains, sugar and other commodities. At its most important terminal, the logistics complex of Rondonópolis (in the state of Mato Grosso), Rumo has the capability to load over one million tons of grains per month. Moreover, Rumo controls two port terminals in Santos in the state of São Paulo, and holds equity interests in four other port terminals, three of which are in the port of Santos in the state of São Paulo and one in the state of Paraná, with a static storage capacity of approximately 1.3 million tons and a total loading capacity of approximately 29 million tons per year. The real estate Rumo leases in connection with its concessions contains areas available for construction and development of warehouses and logistics terminals, which makes it possible for Rumo to expand its operations and improve our logistics and other services. For example, the Grain Terminal of Guarujá (TGG) in the port terminal in Santos, in which Rumo currently has a 10% equity interest, is a significant port project that has been constructed and has the capacity to handle approximately 8 million tons of grain per year.

Operational Segments

Rumo organizes its operations into three segments that correspond to the main markets in which it operates: (1) the north operations segment, or “Northern Operations,” comprising the Malha Norte and Malha Paulista rail concessions, Rumo’s transshipment terminals located in the states of Mato Grosso and São Paulo, and Rumo’s port operation in Santos, (2) Rumo’s south operations business segment, or “Southern Operations,” comprising Malha Oeste and Malha Sul, as well as Rumo’s transshipment terminals in the state of Paraná, and (3) Rumo’s container operations business segment, or “Container Operations,” which comprise the operations of Brado Logística and other container operations.

The table below shows Rumo’s net sales by segment as well as a percentage of total net sales for the periods indicated:

 

     As of and for
Fiscal Year Ended
 
     December 31,
2018
    December 31,
2017
    December 31,
2016
 
     (in R$ millions, except percentages)  

Northern Operations

     4,913.4        74.62     4,439.7        74.66     3,651.5        72.8

Southern Operations

     1,412.3        21.45     1,283.1        21.58     1,097.7        21.9

Container Operations

     259.2        3.94     223.5        3.76     265.4        5.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Net sales

     6,584.9        100     5,946.3        100     5,014.6        100

Major Customers

The majority of the cargo Rumo transports is for the agricultural commodities industry. Rumo’s major clients are export companies participating in this market, such as Amaggi, ADM, Bunge, Cargill, Louis Dreyfus and Raízen. In the fiscal year ended December 31, 2018, Bunge accounted for 13.9% of Rumo’s total net revenue from services, while Rumo’s six major clients accounted for 48% of Rumo’s total net revenue from services. In the fiscal year ended December 31, 2017, Bunge accounted for 15.0% of Rumo’s total net revenue from services, while Rumo’s six major clients accounted for 52.5% of Rumo’s total net revenue from services in the same period. Bunge is the principal customer of Rumo’s Northern Operations and Southern Operations and is active in agricultural commodities, especially corn, soy and derivatives thereof, loading cargo in transshipment terminals destined for ports which Rumo operates.

Rumo’s major clients in the rail sector are export companies such as Amaggi, ADM, Bunge, Cargill, Louis Dreyfus and Raízen. In the fiscal year ended December 31, 2018, Bunge accounted for 15.6% of Rumo’s net revenue from services in the rail sector, while Rumo’s six major clients in the rail sector jointly accounted for 53.9% of Rumo’s net revenue from services in that sector. In 2017, Bunge accounted for 14.5% of Rumo’s net revenue from services in the rail sector, while Rumo’s six major clients in the rail sector accounted for 46.4% of Rumo’s net revenue from services in that sector.

Rumo’s largest clients in the port elevation sector include Engelhart, Czarnikow, Cofco, Wilmar, Raízen and Sucden. In the fiscal year ended December 31, 2018, Engelhart accounted for 17.8% of our net revenue from services in the port elevation sector, while Rumo’s six largest clients in the port elevation sector collectively accounted for 70% of Rumo’s net revenue from services in that sector. In the fiscal year ended December 31, 2017, Raízen accounted for 17.9% of Rumo’s net revenue from services in the port elevation sector, while Rumo’s six largest clients in the port elevation sector accounted collectively for 52.3% of Rumo’s net revenue from services in that sector.

 

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Seasonality

Rumo is subject to the seasonality that influences the sugarcane and grain harvest. During the peak months of the harvests, there is higher demand for transport and logistics operations. Rumo is also subject to the risk that sugarcane mills may change their production mix in favor of ethanol if the relative prices of the two products swing that way. This could reduce the demand for sugar logistics and transport. See also “Item 5. Operating and Financial Review and Prospects—Principal Factors Affecting Our Results of Operations—Seasonality.”

Regulation

Port Regulation

The Brazilian constitution provides that the federal government, directly or by delegation to third parties, shall exploit port activities in Brazil. In 2001, the National Waterway Transportation Agency (Agência Nacional de Transportes Aquaviários), or “ANTAQ,” was created in order to regulate the Brazilian port industry and to enter into the relevant concession and adhesion agreements regarding the provision of port services.

Until December 6, 2012, port operations in Brazil were governed by Federal Law No. 8,630, dated February 25, 1993, or the “Ports Modernization Law,” which provided the legal framework applicable to the exploitation of the publicly-owned port terminals and facilities in Brazil. In view of the need to improve the applicable legislation, the Brazilian government implemented Law 12,815 dated June 5, 2013, or the “New Ports Law,” which has been further amended by Decree No. 8,033/2013, as amended by Decree No. 9,084/2017. The New Ports Law revoked the Ports Modernization Law and established a new legal framework for port operations in Brazil.

Before the enactment of the Ports Modernization Law, most of the port terminals were exploited by the government. The Ports Modernization Law was enacted to enable the participation of private investors in the Brazilian port industry by the creation of different port terminal exploitation models: public and private.

The Ports Modernization Law assured to any private party the right to construct, reform, expand, improve, lease and operate a public port terminal located within the “organized port area,” which are designated areas where ports must serve the public interest and the need for port service, subject to an authorization from the relevant authority. The development of port activities in an organized port area should be preceded by a competitive bidding process and the execution of a concession agreement with the federal government.

In the case of Rumo, the Docks Company of the state of São Paulo (Companhia Docas do Estado de São Paulo), or “CODESP,” granted us the right to exploit public terminals at the port of Santos. The respective concessions agreements are dated as from 1996 and 2001. Accordingly, such agreements are governed by the Ports Modernization Law.

Rumo was qualified as a port operator under the Port Modernization Law and is currently subject primarily to the regulation of CODESP, which acts under the regulation of ANTAQ.

Public ports are governed by Law 12,815 dated June 5, 2013 and regulations that are still to be published by the Government in order to complement the provisions of Law 12,815 dated June 5, 2013. Law 12,815 dated June 5, 2013 does not provide for the need of adjustments of the terms of any concession agreements in force, requiring adjustments to be made only if both parties intend to extend the agreement. As a result, until new regulation provides otherwise, the concession agreements entered into by and between CODESP and us shall not be amended in order to adjust its terms to Law 12,815 dated June 5, 2013.

Rail Transportation Regulation

Following Rumo’s merger with ALL, we are subject to the regulation of the ANTT, which is responsible for monitoring road and rail transport operations and the federal concessions of road and rail infrastructure in Brazil. Previously, we were indirectly subject to such regulation due to the agreements we had in place with ALL.

Rail transportation activities in Brazil are subject to a wide variety of laws and regulations, such as: Law 8,987 dated February 13, 1995 (the “Concession Law”); ANTT Resolution 3,694 dated July 14, 2011 (which approves Regulations for Users of Rail Freight Services); ANTT Resolution 3,695 dated July 14, 2011 (which approves the Regulations of “Right of Passage” and “Mutual Traffic” operations); ANTT Resolution 3,696 dated July 14, 2011 (which approves the regulations for agreeing to production targets per stretch of railway and safety targets for concessionaires).

 

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The Concession Law requires that the granting authority and concession holder enter into a concession agreement regulating the terms of such exploration and setting forth the terms applicable to the performance of the services (including with regards to the applicable penalties).

Waterborne Transportation Regulation

In Brazil, there are two main regulatory regimes affecting waterborne transportation: (i) the concession regime, which regulates the exploitation of publicly-owned port terminals and the leasing of publicly-owned terminals and (ii) the authorization regime, relating to new private port terminals and facilities. The main legislation applicable to this sector is: Law 12,815 dated June 5, 2013 (Ports Law) and Decree 8,033 of June 27, 2013.

Environmental Regulation

We are subject to various Brazilian federal, state and municipal environmental laws and regulations, among other matters, regarding to: (1) the issuance and renewal of valid environmental permits and authorizations; (2) the generation, storage, handling, use and transportation of hazardous materials; (3) the wildlife and natural resources preservation; (4) the protection of cultural and historic sites; (5) the emission and discharge of hazardous materials into the ground, air or water; and (5) the health and safety of our employees.

We are also required to obtain environmental permits and/or authorizations (such as installation and operation permits as well as permits for vegetation suppression and the storage, use and transportation of hazardous products) from governmental authorities for certain aspects of our operations. Failure to obtain environmental permits or comply with the conditions under which such permits are issued could subject us to criminal, administrative and/or civil liabilities. These laws, regulations and permits often require us to purchase and install pollution control equipment or to make operational changes to mitigate actual or potential impacts on the environment and/or health of our employees. In addition, Brazilian environmental laws restrict our ability to obtain financing from public entities in the event of a breach of certain environmental protection obligations. Any violations of these laws and regulations or permit conditions can result in substantial fines, criminal sanctions, revocation of operating permits and/or shutdowns of our facilities.

Under Brazilian environmental laws, we could be held strictly liable for all of the costs relating to any contamination at our or our predecessors’ current and former facilities and at third-party waste disposal sites used by us or any of our predecessors (propter rem liability). We could also be held responsible for any and all consequences arising out of human exposure to hazardous substances, such as pesticides, herbicides, soil or groundwater contamination.

We are party to a number of administrative and judicial proceedings for alleged failure to comply with environmental laws, which may result in fines, suspension of activities or other adverse effects on our operations. Infractions that give rise to administrative proceedings may also lead to civil or criminal claims against us.

Rail Concessions

We conduct our rail activities through the following concession agreements: (1) the concession agreement entered into on December 30, 1998 involving Malha Paulista, expiring in 2028 (which may be extended for a further 30 years); (2) the concession agreement entered into on May 19, 1989 involving Malha Norte, expiring in 2079; (3) the concession agreement entered into on July 7, 1996 involving Malha Oeste, expiring in 2026; and (4) the concession agreement entered into on February 27, 1997 involving Malha Sul, expiring in 2027 (which may be extended for a further 30 years).

In September 2015, we filed formal requests for the renewal of the Malha Sul and Malha Paulista concession agreements with the ANTT. Such requests are currently under review by the ANTT. The request relating to the Malha Paulista concession was duly approved by the ANTT and is currently under review by the Brazilian Federal Court of Auditors pursuant to Law No. 13,488/2017. Our expectation is that this review will be completed during the course of 2019. The analysis of the Malha Sul renewal request should resume following the conclusion of the ANTT’s analysis of the renewal request relating to Malha Paulista.

 

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The granting authority may unilaterally rescind all of our rail concession agreements prior to their expiration in the following circumstances:

 

   

encampação, which is the takeover of the provision of the services by the granting authority by means of specific legal order and prior payment of indemnity;

 

   

forfeiture, which means the complete or partial non-performance of the concession agreement or failure to comply with the financial terms of the concession agreement and the lease agreement (when there is one force);

 

   

bankruptcy or dissolution of the concession holder; or

 

   

cancellation of the bidding process.

The enforcement of any of the unilateral termination provisions of the concession agreement must be preceded by the relevant administrative proceeding with ANTT and may result in indemnity to us for assets that revert to the granting authority. As of the date of annual report, there is no fact enabling the application of any of the unilateral termination events of the concessions.

See also “Item 3. Key Information—D. Risk Factors—Risks Related to Our Businesses, the Operations of Our Joint Venture, and Industries in Which We Operate––The loss of Brazilian railway concessions may have a material adverse effect on our business.” and “Item 3. Key Information––D. Risk Factors—Risks Related to Our Businesses, the Operations of Our Joint Venture, and Industries in Which We Operate–– Rumo may not obtain early renewals of Rumo Malha Paulista S.A., or “Malha Paulista,” and Rumo Malha Sul S.A., or “Malha Sul,” concession agreements, currently under review by the ANTT, which may have a material adverse effect on Rumo’s investment plan and growth strategy.”

Port Lease Agreements

We lease 118,434.38 square meters of property located in the port of Santos (state of São Paulo), which has two docking cradles for loading sugar and solid agricultural bulk (corn and soy). We lease this property pursuant to lease agreement PRES-05/96, which matures on March 6, 2036. Pursuant to Article 57 of the Ports Modernization Law and Article 19 of Decree No. 8,033/2013. This lease can be legally extended up to 2066 through new investments. Pursuant to the lease agreement, we have an obligation to make investments totaling an estimated R$308 million, which we estimate to complete by February 2019.

We also hold equity interests in: (1) Terminal XXXIX and the adjacent areas for moving agricultural products and bulk as well as other goods capable of being transported in those port installations, through a port lease agreement due to expire in 2050; (2) facilities, equipment and track for rail transport of goods and import/export through the right and left banks of the port of Santos, by means of a lease agreement with Portofer Transporte Ferroviário Ltda. due to expire in 2025; (3) Terminal de Granéis do Guarujá (TGG) located on the left bank of the port of Santos, for the transport of solid and liquid bulk, through an area used by Malha Norte via a leasing agreement due to expire in 2022; and (4) Terminal Marítimo do Guarujá (TMG), located on the left bank of the port of Santos, mainly for the transport of solid and liquid bulk, through an area used by Malha Norte via a lease agreement due to expire in 2022.

There are ongoing legal proceedings regarding whether the lease agreements relating to Terminal XXXIX, Terminal de Granéis do Guarujá and Terminal Marítimo do Guarujá should be subject to the public procurement regime. These proceedings are currently under appeal in the Brazilian superior courts (Superior Tribunal de Justiça and Supremo Tribunal Federal). With regards to the Portofer lease agreement, there is an ongoing investigation by the Brazilian Federal Prosecutors’ Office, of a non-criminal nature, to assess the legal validity of the agreement.

If we fail to comply with the applicable regulatory rules or contractual obligations, our lease may be terminated early pursuant to the Concessions Law (Law No. 8,987/1995), which applies to port leases.

 

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Competition

Fuel Distribution

In the fuel distribution business, we are subject to competition, both from companies in the industries in which we operate and from companies in other industries that produce similar products. Our competitors include service stations of large integrated oil companies, independent gasoline service stations, convenience stores, fast food stores, and other similar retail outlets, some of which are well-recognized national or regional retail systems. The Brazilian fuel distribution industry has consolidated significantly in recent years, with the three major distributors increasing their combined market share from 65.2% in 2000 to approximately 69.1% in 2018, according to ANP and considering all products.

According to Plural, formerly known as Sindicom, as of January 1, 2018, the top-three distributors in Brazil are: Petrobras, operating through the BR Distribuidora brand, Raízen, through the Shell brand and Ultrapar S.A., through the Ipiranga brand. The main competitive factors affecting the retail marketing operations include site location, product price, selection and quality, site appearance and cleanliness, hours of operation, store safety, customer loyalty and brand recognition.

Sugar, Ethanol and Cogeneration

The sugar industry in Brazil has experienced increased consolidation through merger and acquisition activity during the past decades. Most of this activity has involved companies and facilities located in the central-south region of Brazil, one of the most productive sugar producing regions in the world.

We also face competition from international sugar producers. According to UNICA, as of December, 2018, we are the largest sugar producer in Brazil and the largest sugar exporters in the world with 4.3 million tons of sugar produced in the 2017/18 harvest, compared to Tereos (5.3 million tons of sugar produced in the 2017/2018 harvest) and Südzucker AG of Germany (with 5.9 million tons of sugar produced in the 2017/2018 harvest). These producers, however, are the beneficiaries of considerable governmental subsidies in their principal sales markets.

We also face competition from international ethanol producers that use other ethanol sources, such as corn, for the generation of fuel ethanol.

Natural Gas

Comgás’ concession area covers approximately 26% of Brazil’s GDP, including approximately 88 municipalities in the metropolitan areas of São Paulo, Campinas and Santos as well as the Paraíba Valley. Comgás distributes natural gas for residential, commercial and industrial customers, and also supplies gas for use as fuel for vehicles and electricity generation. For the residential and commercial customers, Comgás holds exclusivity rights within its area of concession. For industrial customers, Comgás has exclusive distribution rights until 2029. Comgás faces competition from electricity concessionaires, oil and ethanol producers in its activities.

Logistics

Companies active in the Brazilian railroad transport market generally provide logistics services in their respective regions, with regions being allocated to various companies based on the public concessions granted by the ANTT. The necessity of obtaining a concession from the ANTT represents a barrier to the entry of new competitors into the market given that each concession area is granted to a single operator. As there are currently no parallel rail tracks in the Brazilian railway network, the competition in the market in which we operate primarily derives from truck transportation, which can compete for the same freight as rail operators. Clients generally select a mode of transportation based on the best terms and conditions offered to them in the market.

The main factors on which transport companies compete are the freight rates charged, efficiency and volume. Given our offering of advantageous prices coupled with our significant transport capacity and greater efficiency, we believe we have significant opportunities to increase our current market share within the areas in which we operate and that we are in a better strategic position than our competitors to seize the growth opportunities in these industries.

Historically, railroad freight prices have varied in conjunction with road freight prices. Freight prices in the road transportation market have increased significantly in the past years, as illustrated below. We expect this increase to also benefit railroad operators such as us, given the correlation between road and rail freight prices.

 

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Patents, Licenses, Contracts and Processes

In Brazil, ownership of trademarks can be acquired only through a validly approved registration with the National Institute of Intellectual Property (Instituto Nacional de Propriedade Industrial, or “INPI”), the agency responsible for registering trademarks, patents and designs in Brazil. After registration, the owner has exclusive rights of use of the trademark throughout Brazil for a ten-year period that can be successively renewed for equal periods.

As of the date of this annual report, we own 324 trademarks in Brazil, 81 of which are owned by Cosan S.A., 20 of which are owned by Cosan Logística, with the remaining 223 owned by other companies of the Cosan group. All material trademarks for our business are registered or have been submitted to INPI by us or our affiliates.

Research and Development

Our main research and development activities for the fiscal years ended December 31, 2018, 2017 and 2016 concentrated in the following key areas:

 

   

We engage CanaVialis S.A., or “CanaVialis,” to provide us with access to its sugarcane genetic improvement program specifically tailored to Raízen Energia’s mills. CanaVialis, which is a subsidiary of Monsanto, is a privately owned firm focused on the genetic improvement of sugarcane. We benefit from their support services and use of their bio factory, which allows us to decrease the amount of time required for seedling production and grants us access to new, improved sugarcane varieties through their genetic improvement program. CanaVialis also conducts field trials and region-specific genetic selection programs to develop sugarcane varieties for our greenfield projects for the construction of new sugarcane mills.

 

   

Raízen also invests in innovation in the ethanol manufacturing process. Raízen has an interest in Shell’s commercialization rights of Iogen Energy, which conducts research into advanced fuels, including ethanol extracted from the cellulose of sugarcane and other plants.

 

   

We conduct research and development into renewable base oils through Novvi S.A., a Joint Venture between Cosan S.A. and Amyris formed in 2011. Novvi was established for the worldwide development, production and commercialization of renewable base oils made from Biofene, Amyris’ renewable farnesene.

 

   

We originally established Payly in November 2018 to operate a digital payment scheme to consumers and B2B partners. Payly provides payment processing services to consumers through a digital wallet, and delivers a payment arrangement solution to enterprises. This provides Payly with deep insights into the needs of merchants and end consumers, thereby becoming a comprehensive platform and entry point for payment, lifestyle and innovative financial services. Payly charges a fee based on a certain percentage of the payment amount processed and also generates value through the accounts balance investment.

Our total research and development expenditure amounted to R$2.8 million in the fiscal year ended December 31, 2018, R$2.9 million in the fiscal year ended December 31, 2017 and R$3.7 million in the fiscal year ended December 31, 2016, respectively.

 

C.

Organizational Structure

We are an integrated energy and infrastructure company and, when considered together with the Joint Venture, a Brazilian market leader in fuel distribution, sugar and ethanol production, natural gas distribution and logistics. Our main operations include: (1) the distribution of fuels in the Brazilian market through Raízen Combustíveis, our downstream Joint Venture company; (2) the production and sale of sugar and ethanol and the cogeneration of electricity from sugarcane bagasse through Raízen Energia, our upstream Joint Venture company; (3) the distribution of piped natural gas in part of the state of São Paulo through our subsidiary Comgás, which has been consolidated since November 2012; (4) logistics services including transportation, port loading and storage of sugar, through our indirectly owned subsidiary Rumo; (5) the production and distribution of lubricants under the Mobil licensed trademark in Brazil, Bolivia, Uruguay and Paraguay, in addition to the European and Asian markets under the Comma brand; and (6) an online payment services platform and certain other investments, or “Cosan Corporate.”

At October 1, 2014, the Partial Spin-off of the “Rumo” segment of Cosan S.A. to “Cosan Logística S.A.” was approved by Cosan S.A.’s shareholders, becoming fully effective on October 6, 2014. This Partial Spin-off does not affect the consolidated financial statements of Cosan Limited.

 

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LOGO

A list of the Company’s subsidiaries is included in note 8.1 of our audited consolidated financial statements for the fiscal years ended December 31, 2018, 2017 and 2016 attached hereto. See also Exhibit 8.1 to this annual report, which contains a list of our subsidiaries.

Until the adoption of IFRS 11, these investments were accounted for using the proportional consolidation method. Upon the adoption of IFRS 11 in the transition period ended December 31, 2013, these investments are accounted for under the equity method. The Joint Venture consists of three separate legal entities:

 

   

Raízen Combustíveis S.A.: a downstream company, which conducts the supply, distribution and sale of fuels in Brazil. In 2017, the resulting company had a network of 6,524 fuel stations throughout Brazil. Cosan S.A. and its subsidiaries and Shell and its affiliates likewise each own 50% common equity interest in this entity. In this entity, however, Cosan S.A. and its subsidiaries own 50% minus one of the voting shares, whereas Shell and its affiliates own 50% plus one of the voting shares. Cosan S.A. and its subsidiaries and Shell and its affiliates also hold preferred shares bearing preferential dividend rights in certain circumstances if certain contingent targets are met.

 

   

Raízen Energia S.A.: a sugar and ethanol company, which, among other things, conducts the production of sugar and ethanol, as well as all cogeneration activities. Cosan S.A. and its subsidiaries and Shell and its affiliates each own 50% common equity interest in this entity. In addition, Cosan S.A. and its subsidiaries own 50% plus one share of the voting shares (and preferred shares bearing preferential dividend rights in certain circumstances), whereas Shell and its affiliates own 50% minus one of this entity’s voting shares.

 

   

Raízen S.A.: previously, Raízen S.A. was a management company, which is the Joint Venture’s face to the market and facilitates the building of a unified corporate culture. Cosan S.A. and its subsidiaries and Shell and its affiliates each used to own 50% of the equity and voting interests in this company. On November 18, 2016, both Cosan S.A. and Shell sold 100% of their respective shares in the share capital of Raízen S.A. to Raízen Combustíveis, as a result of which Raízen Combustíveis is currently the sole shareholder of Raízen S.A.

 

D.

Property, Plant and Equipment

For more information related to property, plant and equipment see note 10.1 of our audited consolidated financial statements for the fiscal years ended December 31, 2018, 2017 and 2016 attached hereto. See also “—Capital Expenditures” for a description of our ongoing expansions and renovations of our property, plant and equipment.

We present a summary below of our material tangible fixed assets, including investment properties and intangible assets (concessions), by segment:

Raízen Combustíveis

Raízen Combustíveis distributes fuels through 67 distribution terminals to 6,524 service stations throughout Brazil under the Shell brand and also has 68 airport terminals supplying aviation fuel. For the next year, new investments are expected to be made in port terminals, increasing trading capacity and, consequently, expanding our operations.

In 2018, Raízen Combustíveis acquired Shell’s downstream operations in Argentina. The assets acquired consist of a refinery, located in the Buenos Aires metropolitan region, with a refining capacity of 108 thousand barrels per day, which distributes fuels and lubricants through 645 strategically-located service stations under the Shell brand, of which 10% are owned by Raízen Combustíveis.

 

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Raízen Energia

Raízen Energia operates 26 mills with a crushing capacity of 73 million tons and 981 MW of annual generation capacity. All of these facilities are located in the central and southeastern regions of Brazil, which is one of the world’s most productive sugarcane regions, primarily because of its favorable soil, topography and climate, nearby research and development organizations and logistics infrastructure.

Comgás

Comgás is Brazil’s largest natural gas distributor with a pipeline network of over 16,747 kilometers, supplying natural gas to 1.9 million residential, commercial and industrial consumers in over 177 cities. Its concession area accounts for approximately 26% of Brazil’s GDP, covering approximately 88 municipalities in the metropolitan areas of São Paulo, Campinas, Santos and the Paraíba Valley.

Moove

Moove has a production plant located on the Ilha do Governador, Rio de Janeiro, with a production capacity of 2.5 million barrels of lubricants per year, storage capacity for base oils and lubricants (620,000 barrels) and a pier facility for docking ships of up to 20,000 tons. Moove also has another production plant located in Kent, England, United Kingdom, with a production capacity of 440,000 barrels per year and storage capacity of 31,000 barrels.

Cosan Logística

Rumo concluded the ALL Acquisition on April 1, 2015 and is Brazil’s largest railroad-based logistics operator in terms of total volume transported, providing rail transport logistics, port handling and warehousing services. We operate in the states of Mato Grosso and São Paulo as well as the southern region of Brazil. According to MDIC and IBGE data as of 2018, our rail network extends over an area that accounts for approximately 80% of Brazil’s GDP, where four of the most active ports in the country are located and through which most of Brazil’s grain production is exported.

Rumo owns and operates a large asset base, including a rail network consisting of four concessions that extend over approximately 12,000 kilometers of railway lines, over 1,180 locomotives, over 30,200 rail cars, as well as distribution centers and warehousing facilities. Rumo provides efficient and complete logistics services to its clients through its operation of 12 transshipment terminals, either directly or through partnerships, which have a static storage capacity of approximately 900,000 tons, and where it stores grains, sugar and other commodities. At its most important terminal, the logistics complex of Rondonópolis (in the state of Mato Grosso), Rumo has the capability to load over 1 million tons of grains per month. Moreover, it controls two port terminals in Santos in the state of São Paulo, and holds equity interests in four other port terminals, three of which are in the port of Santos and one in the state of Paraná, with a static storage capacity of approximately 1.3 million tons and a total loading capacity of approximately 29 million tons per year. The real estate it leases in connection with its concessions contains areas available for construction and development of warehouses and logistics terminals, which makes it possible for Rumo to expand its operations and improve its logistics and other services.

The transportation of agricultural commodities, primarily for export, represented approximately 82%, 83% and 82% of Rumo’s transported volume in the fiscal years ended December 31, 2018, 2017 and 2016, respectively. The transportation of industrial products represented approximately 18%, 17% and 18% of Rumo’s transported volume in the same periods, respectively. In addition, in the fiscal years ended December 31, 2018, 2017 and 2016, approximately 73%, 60.1% and 70%, respectively, of Rumo’s transported volume derived from the transportation of grains.

Rumo also provides intermodal transportation logistics services, which is the movement of freight via container using two or more modes of transportation (generally rail and truck). We believe that these methods of transportation reduce the costs of cargo handling, because containers are typically consolidated from trucks onto trains or ships that can carry mass loads, allowing for fuel efficiency.

 

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Capital Expenditures

Our capital expenditure program is currently focused on the following areas (each of these primarily within Brazil):

Raízen Energia

Raízen Energia invests in biological asset and intercrop maintenance as well certain operational and other projects expenditures, as set forth below. The funds used by Raízen Energia for making capital expenditures are generated from its working capital and existing or new indebtedness.

Biological Asset and Intercrop Maintenance

Raízen Energia invests in maintaining and renewing sugarcane fields at approximately 70% of its total capital expenditures per year. Raízen Energia also invests every year in intercrop maintenance (i.e., primarily in plant and agricultural machine repairs during the times in which no operations are ongoing). The biological asset and intercrop maintenance capital expenditures totaled approximately R$1,828 million in the fiscal year ended December 31, 2018.

Operational and Other Projects Expenditures

Raízen Energia has several other investments that include health, safety and environmental initiatives, sustaining, ethanol and sugar logistics, harvest and planting mechanization, expansion through brownfield projects among other projects. An important part of these investments aims to increase the productivity and efficiency of its operations. The operational and other projects capital expenditures totaled approximately R$748 million in the fiscal year ended December 31, 2018.

Raízen Combustíveis

Raízen Combustíveis invests in maintaining and expanding infrastructure, including, among others, its service stations network expansion. The capital expenditure of Raízen Combustíveis in the fiscal year ended December 31, 2018 amounted to R$994 million, of which 86% was invested in Brazil (R$857 million) mainly in its service station network, and the remaining 14% was invested in Argentina (R$137 million). The funds used by Raízen Combustíveis for making capital expenditures are generated from its working capital and existing or new indebtedness.

We are required by Resolution No. 1,283/2006, an environmental regulation issued by the Argentinian Energy Secretariat (Secretaría de Energía de Argentina), to perform certain mandatory capital expenditures related to product quality (PQU) at the Buenos Aires refinery. Pursuant to the applicable rules, we are required to complete this investment by 2022.

Comgás

Comgás has been investing in its network expansion and during the fiscal year ended December 31 2018, it invested R$530 million, of which approximately 60% was associated with expansion programs, approximately 28% was related to network support investments, and approximately 12% was related to administrative and software investments. The funds used by Comgás for making capital expenditures are generated from its working capital and existing or new indebtedness.

Cosan Logística

Rumo’s strategy is focused on investments in the renovation of assets, in particular its locomotives and railcar fleet, through the purchase of new rolling stock to replace assets in poor condition of use. The purpose of Rumo’s investment in rail tracks is to reduce its operating costs and maximize its transported volume. As result of Rumo’s ongoing efforts, Rumo is increasing capacity while reducing transit time along some of our major routes. During the fiscal year ended December 31, 2018, Rumo’s total investments in property, plant and equipment and intangible assets amounted to R$2,020 million in the aforementioned initiatives, including overhauling 393 km of tracks and, purchasing 163 railcars and 19 new locomotives. Approximately 61% of the capital expenditure mentioned above was invested in nonrecurring expansion projects and 39% in recurring projects.

The funds used by Rumo for making capital expenditures are generated from Rumo’s operating results and from financings and credit extended by private banks, as well as by publicly-owned banks such as BNDES. Since the beginning of Rumo’s rail operations, BNDES has been an important partner in the development of Rumo’s infrastructure, providing support through long-term credit lines in line with Rumo’s investment plan published in April 2015.

 

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Moove

During the fiscal year ended December 31, 2018, Moove’s capital expenditure totaled R$47.8 million, of which 47% (R$22.6 million) was invested in Moove’s Brazilian operations and the remainder in European operations. Approximately half of the capital expenditure in Brazil was invested in renewing and increasing tank capacity. The other half was mostly invested in recurring projects. In Europe, approximately 70% was invested in recurring projects, while the remainder was invested in expansion projects. The funds used by Moove for making capital expenditures are generated from its working capital and existing or new indebtedness.

 

E.

Supplemental Information About Joint Venture

Upon the application of IFRS 11, the Company retrospectively changed the accounting for its investments in Raízen Combustíveis and Raízen Energia, classifying them as jointly-controlled entities (Joint Ventures) under the new standard. Although, Raízen Combustíveis and Raízen Energia are not consolidated in our financial statements (since March 31, 2013) we have included below a summary of business performance derived from note 4 (Segment information) to our audited financial statements for the periods indicated.

The discussion in this section is based on a comparison of the audited fiscal year ended December 31, 2018 with the audited fiscal year ended December 31, 2017, and on a comparison of the audited fiscal year ended December 31, 2017 with the audited fiscal year ended December 31, 2016.

Results of Operations for the Joint Venture for the Fiscal Year Ended December 31, 2018 Compared to the Fiscal Year Ended December 31, 2017

Net Sales

 

     For the Fiscal
Year Ended
December 31, 2018
     For the Fiscal
Year Ended
December 31, 2017
     %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     19,798.6        13,152.8        50.53

Ethanol

     8,569.4        6,550.7        30.82

Sugar

     3,670.8        5,377.4        (31.74 )% 

Cogeneration

     2,836.7        884.3        220.78

Other

     4,721.7        340.4        N/A  

Raízen Combustíveis(1)

     85,204.1        72,789.1        17.06

Fuel

     84,031.8        72,789.1        15.45

Other

     1,172.3                

 

(1)

Includes 100% of these entities’ net sales. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2018 and 2017.

The change in the various components consists of the following:

Raízen Energia

Raízen Energia’s sales in the fiscal year ended December 31, 2018 amounted to R$19,798.6 million, an increase when compared to net revenues of R$13,152.8 million for the fiscal year ended December 31, 2017. This was primarily due to a 38% increase in volumes sold arising from the acquisition of WX Energia, as a result of which there was an increase of 221% in cogeneration sales and energy trading in the fiscal year ended December 31, 2018 as compared to the fiscal year ended December 31, 2017. This increase was offset by a 32% decrease in sugar sales, mainly due to 20% lower average prices and 23.4% lower sales volume.

Raízen Combustíveis

Raízen Combustíveis’ net sales increased from R$72,789.1 million in the fiscal year ended December 31, 2017 to R$85,204.1 million in the fiscal year ended December 31, 2018, or 17%. This increase reflects an increase in volume sold as a result of the improvements in Brazil’s macroeconomic environment during the course of 2018.

 

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Cost of Sales

 

     For the Fiscal
Year Ended
December 31, 2018
    For the Fiscal Year
Ended
December 31, 2017
    %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     (18,136.4     (10,907.7     66.27

Raízen Combustíveis(1)

     (81,298.4     (68,875.3     18.04
  

 

 

   

 

 

   

 

 

 

Cost of Sales

     (99,434.8     (79,783.0     24.63
  

 

 

   

 

 

   

 

 

 

 

(1)

Includes 100% of these entities’ cost of sales. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2018 and 2017.

Raízen Energia

The cost of sales in the fiscal year ended December 31, 2018 increased 66.27%, or R$7,228.7 million, as compared to the fiscal year ended December 31, 2017, due mainly to (i) higher diesel costs, which affected agricultural operations; (ii) lower sugarcane field productivity; and (iii) cost inflation.

Raízen Combustíveis

The cost of sales in the fiscal year ended December 31, 2018 increased 18.04%, or R$12,423.1 million, as compared to the fiscal year ended December 31, 2017. This increase is due to higher sales volume (1.7%) and increases in gasoline and diesel prices (of 5.97% and 3.75%, respectively), pursuant to the pricing policy implemented by Petrobras in October 2016.

Selling Expenses

 

     For the Fiscal
Year Ended
December 31, 2018
    For the Fiscal Year
Ended
December 31, 2017
    %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     (768.8     (803.2     (4.28 )% 

Raízen Combustíveis(1)

     (1,506.7     (1,345.8     11.96
  

 

 

   

 

 

   

 

 

 

Selling expenses

     (2,275.5     (2,149.0     5.89
  

 

 

   

 

 

   

 

 

 

 

(1)

Includes 100% of these entities’ selling expenses. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2018 and 2017.

Raízen Energia

Raízen Energia’s selling expenses decreased R$34.4 million, or 4.28%, in the fiscal year ended December 31, 2018 as compared to the fiscal year ended December 31, 2017, due primarily to a R$33.6 million decrease in expenses with logistics. The lower logistics expenses can be principally attributed to the higher efficiency of the loading and unloading process in the fiscal year ended December 31, 2018 as compared to the fiscal year ended December 31, 2017 as a result of initiatives implemented to improve this process.

Raízen Combustíveis

Raízen Combustíveis’ selling expenses increased to R$1,506.7 million, or 11.96%, in the fiscal year ended December 31, 2018, from R$1,345.8 million in the fiscal year ended December 31, 2017, due primarily to a R$117 million increase in expenses with logistics attributed to the consolidations of Raízen’s operations in Argentina in the fourth quarter of 2018.

 

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General and Administrative Expenses

 

     For the Fiscal
Year Ended
December 31, 2018
    For the Fiscal Year
Ended
December 31, 2017
    %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     (664.7     (618.1     7.54

Raízen Combustíveis(1)

     (526.2     (455.7     15.47
  

 

 

   

 

 

   

 

 

 

General and administrative expenses

     (1,190.9     (1,073.8     10.91
  

 

 

   

 

 

   

 

 

 

 

(1)

Includes 100% of these entities’ general and administrative expenses. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2018 and 2017.

Raízen Energia

General and administrative expenses totaled R$664.7 million in the fiscal year ended December 31, 2018, an increase of 7.54% compared to the fiscal year ended December 31, 2017, primarily due to a 8% increase in personnel expenses due to salary inflation.

Raízen Combustíveis

General and administrative expenses totaled R$526.2 million in the fiscal year ended December 31, 2018, an increase of 15.47%, or R$70.5 million, compared to the fiscal year ended December 31, 2017, primarily due to the impact of inflation on general expenses.

Results of Operations for the Joint Venture for the Fiscal Year Ended December 31, 2017 Compared to the Fiscal Year Ended December 31, 2016

Net Sales

 

     For the
Fiscal Year
Ended
December 31,
2017
     For the
Fiscal Year
Ended
December 31,
2016
     %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     13,152.8        13,133.8        0.14

Ethanol

     6,550.7        6,480.4        1.08

Sugar

     5,377.4        5,794.8        (7.20 )% 

Cogeneration

     884.3        520.5        69.89

Other

     340.4        338.1        0.68

Raízen Combustíveis(1)

     72,789.1        68,143.0        6.82

Fuel

     72,789.1        68,143.0        6.82

 

(1)

Includes 100% of these entities’ net sales. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2017 and 2016.

The change in the various components consists of the following:

Raízen Energia

Raízen Energia’s sales in the fiscal year ended December 31, 2017 amounted to R$13,152.8 million, in line with net revenues of R$13,133.8 million the fiscal year ended December 31, 2016. Higher average electric energy prices on top of higher volumes sold generated an increase of 69.9% in cogeneration sales, reflecting better market prices in the period. This effect was partially offset by a 7.2% decrease in sugar sales, mainly due to lower international prices.

 

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Raízen Combustíveis

Raízen Combustíveis’ net sales in the fiscal year ended December 31, 2017 increased from R$68,143.0 million to R$72,789.1 million, or 6.8%, as compared to the fiscal year ended December 31, 2017. This growth reflects higher volume sold, mainly gasoline and diesel, and higher prices of (i) gasoline (5%) and diesel (1%) adjusted by Petrobras; and (ii) ethanol (ESALQ base). This increase in prices and in volume sold is a result of the improvements in Brazil’s macroeconomic environment during the course of 2017.

Cost of Sales

 

     For the
Fiscal Year
Ended
December 31,
2017
    For the Fiscal
Year Ended
December 31,
2016
    %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     (10,907.7     (9,967.5     9.43

Raízen Combustíveis(1)

     (68,875.3     (64,445.9     6.87
  

 

 

   

 

 

   

 

 

 

Cost of Sales

     (79,783.0     (74,413.4     7.22

 

(1)

Includes 100% of these entities’ cost of sales. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2017 and 2016.

Raízen Energia

The cost of sales in the fiscal year ended December 31, 2017 increased 9.4%, or R$10,907.7 million, as compared to the fiscal year ended December 31, 2016, due mainly to higher resale and trading costs (26%) reflecting greater volumes in the sales mix, which has higher unitary cost.

Raízen Combustíveis

The cost of sales in the fiscal year ended December 31, 2017 increased 6.9%, or R$4,429.4 million, as compared to the fiscal year ended December 31, 2016. This increase is due to higher sales volume (2.9%) and increases in gasoline and diesel prices, according to the pricing policy implemented by Petrobras in October 2016 and higher logistics costs as a result of our supply strategy.

Selling Expenses

 

     For the
Fiscal Year
Ended
December 31,
2017
    For the Fiscal
Year Ended
December 31,
2016
    %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     (803.2     (732.7     9.62

Raízen Combustíveis(1)

     (1,345.8     (1,303.3     3.26
  

 

 

   

 

 

   

 

 

 

Selling expenses

     (2,149.0     (2,036.0     5.55
  

 

 

   

 

 

   

 

 

 

 

(1)

Includes 100% of these entities’ selling expenses. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2017 and 2016.

Raízen Energia

Raízen Energia’s selling expenses increased R$70.5 million, or 9.6%, in the fiscal year ended December 31, 2017 as compared to the fiscal year ended December 31, 2016, due primarily to 7.2% higher expenses with freight. These higher freight expenses can be principally attributed to the higher volume of sales, driven primarily by ethanol resale and trading volumes, which increased by 40.2%.

 

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Raízen Combustíveis

Raízen Combustíveis’ selling expenses increased to R$1,345.8 million, or 3.3%, in the fiscal year ended December 31, 2017, from R$1,303.3 million in the fiscal year ended December 31, 2016, due primarily to an increase of 19% in freight and logistics expenses, which partly offset by lower tax expenses when compared to 2016.

General and Administrative Expenses

 

     For the Fiscal
Year Ended
December 31, 2017
    For the Fiscal Year
Ended
December 31, 2016
    %
Variation
 
     (in millions of reais, except percentages)  

Raízen Energia(1)

     (618.1     (567.4     8.94

Raízen Combustíveis(1)

     (455.7     (447.8     1.76
  

 

 

   

 

 

   

 

 

 

General and administrative expenses

     (1,073.8     (1,015.2     5.77
  

 

 

   

 

 

   

 

 

 

 

(1)

Includes 100% of these entities’ general and administrative expenses. The Company holds a 50% equity interest in each of these entities, which upon the application of IFRS 11 are recorded in the “Equity income of jointly-controlled entity” line item in the consolidated statements of profit or loss and comprehensive income for the fiscal years ended December 31, 2017 and 2016.

Raízen Energia

General and administrative expenses totaled R$618.1 million in the fiscal year ended December 31, 2017, an increase of 8.9% compared to the fiscal year ended December 31, 2016, primarily due to an increase in depreciation expenses which was attributable in the most part to a 27% increase in depreciation expenses recorded in connection with property, plant and equipment.

Raízen Combustíveis

General and administrative expenses totaled R$455.7 million in the fiscal year ended December 31, 2017, an increase of 1.8%, or R$8 million, compared to the fiscal year ended December 31, 2016, primarily due to the impact of inflation on general expenses.

Legal and Administrative Proceedings of the Joint Venture

Overview

In the ordinary course of business, Raízen and its subsidiaries are parties to numerous judicial and administrative proceedings of a tax, civil, regulatory, environmental, criminal and labor nature, including proceedings with probable, possible and remote risks of loss.

Pursuant to the framework agreement which was entered into during the formation of the Raízen joint venture, Raízen has agreed that it will reimburse its shareholders, i.e., Cosan S.A. and Shell, or will be reimbursed by them, as applicable, for any amounts received or paid in connection with legal proceedings, provided that the triggering events for such payments or receipts occurred before the formation of the Raízen joint venture on April 1, 2011 and provided that any such sums have actually been paid or received.

As of December 31, 2018, Raízen and its subsidiaries were party to proceedings with a probable risk of loss involving an aggregate amount of R$1,366 million for which provisions have been made. Raízen and its subsidiaries were also party to proceedings for which our risk of loss was deemed possible which involved an aggregate amount of R$14,280 million and for which no provision has been made.

Raízen and its subsidiaries constitute provisions for tax, civil, environmental and labor contingencies in which our risk of loss is considered probable in accordance with IFRS. Determination of the likelihood of loss includes determination of available evidence, hierarchy of laws, jurisprudence available, more recent court decisions and relevance thereof in the legal system, as well as an evaluation by internal and external attorneys. Such provisions are reviewed and adjusted to take into account changes in circumstances, such as statute of limitations applicable, tax inspection conclusions or additional exposures identified based on new matters or court decisions.

 

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Certain Material Legal Proceedings of the Joint Venture

Below is a description of Raízen and its subsidiaries’ principal proceedings:

 

   

Corporate Income Taxes and Social Contribution on Net Profits. Raízen Energia has received:

 

   

tax assessments, from the Brazilian federal tax authorities seeking to collect corporate income tax and social contributions (specifically, CSLL) with regards to the years 2006 to 2009. The assessments challenged (1) the deductibility of certain amortization expenses and goodwill; (2) the offset of tax losses and the use of a negative calculation basis in connection with CSLL; and (3) certain taxes due in connection with discrepancies in the revaluations of certain assets. As of December 31, 2018, the aggregate amount under discussion was R$460 million, including interest and a 150% fine, of which R$239.5 million was classified as having a possible risk of loss and R$220.5 million was classified as having a remote risk of loss. Raízen Energia filed its defense in January 2012. Raízen Energia was notified of the partially favorable decision rendered by the Administrative Court of Tax Appeals to cancel item (3) described above and reduce the fine from 150% to 75%. Raízen Energia filed an appeal to the final level administrative court to discuss the remaining items. Tax authorities also filed an appeal to discuss the fine reduction. Both appeals are awaiting judgment;

 

   

a tax assessment notice related to goodwill amortization deductions from 2011 to 2012 in an amount of R$104.4 million which is classified as a possible risk of loss as of December 31, 2018; and

 

   

a tax assessment notice related to goodwill amortization deductions from 2013 to 2014, including interest and a 150% fine, of which R$102.6 million was classified as a possible risk of loss and R$29.3 million was classified as a remote risk of loss as of December 31, 2018. Raízen is awaiting judgment of the administrative court.

The alleged underlying facts in relation to each of the above occurred before the formation of the Raízen joint venture on April 1, 2011. Accordingly, these amounts are subject to reimbursement by shareholders in the event of an adverse decision.

 

   

Goodwill contributed in Raízen Combustíveis. CLE has received three assessment notices from the Brazilian federal tax authorities seeking to collect corporate income tax and social contributions (specifically, IRPJ and CSLL) arising in connection with the amortization of goodwill on certain investments in the 2011, 2012, 2013 and 2014 calculation periods. The first tax assessment notice related to 2011 and 2012 and was in a total amount of R$200.7 million, the second related to 2013 and was in a total amount of R$121.7 million, and the third tax assessment notice (received in March 2019) relates to 2014 and is in an amount of R$41.5 million. The risk of loss is estimated as possible with regards to each of these. The relevant proceedings are currently awaiting judgment in the administrative court. This goodwill is the responsibility of CLE and was contributed to Raízen Combustíveis.

 

   

Goodwill Raízen Tarumã. Raízen Tarumã received (i) a tax assessment notice related to goodwill amortization deductions from 2009 to 2012, in a possible amount of R$58.8 million; and (ii) a tax assessment notice related to goodwill amortization deductions from 2013 to 2014, in a possible amount of R$42.8 million as of December 31, 2018. Raízen is awaiting judgment of the administrative court. The alleged underlying facts occurred before the formation of the Raízen joint venture on April 1, 2011. Accordingly, these amounts are subject to reimbursement by shareholders in the event of an adverse decision.

 

   

Social Security Contributions. In June 2010, Raízen Energia filed an ordinary action challenging the obligation to accrue the social security contributions tax based on gross revenue. Currently, the case records are in the Court of Appeals awaiting judgment of the appeal filed by the Brazilian federal government against a favorable first level decision. The risk of loss is classified as probable and as of December 31, 2018, Raízen had recorded provisions in connection with this proceeding in the aggregate amount of R$327.5 million and had judicially deposited the same amount (the two together therefore cancel each other out). The alleged underlying facts occurred both before and after the formation of the Raízen joint venture on April 1, 2011 and, therefore, these amounts are subject to reimbursement by Raízen’s shareholders for a portion of any loss in the event of an adverse decision.

 

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Industrialized Products Tax. The Brazilian federal government filed a tax enforcement action pursuant to Normative Instruction No. 67/98 with regards to the industrialized products tax allegedly due as a result of the removal of certain types of sugar from Raízen Energia’s facilities from 1995 to 1997 and from 1992 to 1997. As of December 31, 2018, the aggregate amount under discussion was R$367.5 million. After Raízen Energia filed a motion to stay the tax enforcement action, the first level judge rendered a favorable decision and the Brazilian federal government filed an appeal. The risk of loss is classified as possible. The alleged underlying facts occurred before the formation of the Raízen joint venture on April 1, 2011 and, therefore, these amounts are subject to reimbursement by Raízen’s shareholders. In addition, Raízen is also a party to certain claims regarding the industrial products tax allegedly due on sugar products of certain polarity levels (sugar products with a polarity level of at least 99.5º are not subject to the industrialized products tax).

 

   

Industrialized Products Tax. In August 1998, Raízen Energia filed an offset request with the Brazilian federal tax authorities in order to offset debts already included in an installment payment plan against credits relating to undue payments made by Raízen Energia in relation to certain of its products, as allowed by Normative Instruction No. 67/98. The right to the credit was partially granted by the second administrative trial court. However, the calculation of the amount of credit is still pending in the first administrative trial court. As of December 31, 2018, the amount involved in this proceeding is R$113.4 million. The risk of loss is classified as possible. The alleged underlying facts occurred before the formation of the Raízen joint venture on April 1, 2011 and, therefore, these amounts are subject to reimbursement by our shareholders in the event of an adverse decision. No provision has been made for this proceeding in our consolidated financial statements.

 

   

MP 470. The Brazilian federal tax authorities have partially rejected Raízen Energia’s requests for payment of its federal tax debts, pursuant to provisional measure No. 470 on the grounds that the tax loss which Raízen Energia is proposing to use is not sufficient to settle the debts in question. The chance of loss is considered as possible. The amount involved in this proceeding is R$185.2 million.

 

   

PIS and COFINS Credits. The Brazilian federal tax authorities issued tax assessment notices against Raízen Energia related to the allegedly undue use of credits of PIS and COFINS. The notices refer to the credits taken from the costs and expenses with goods and services deemed by the company as inputs for its activities. In relation to the allegedly undue use of PIS and COFINS credits by Raízen Energia before the formation of the Raízen joint venture on April 1, 2011 (and, therefore, subject to reimbursement by our shareholders in case of an adverse decision), Raízen Energia received tax assessment notices which are currently pending a decision of the second administrative trial court and other assessments pending a decision of the lower administrative trial court. As of December 31, 2018, the aggregate amount involved in such proceedings was R$608.5 million. In relation to the allegedly undue use of credits of PIS and COFINS by Raízen Energia and/or Raízen Combustíveis after the formation of the Raízen joint venture on April 1, 2011 (and, therefore, these amounts are subject to reimbursement by Raízen’s shareholders in the event of an adverse decision), Raízen Energia has received tax assessment notices and these tax assessments are currently pending decision of the first administrative trial court. As of December 31, 2018, the aggregate amount involved in these proceedings is R$766 million. The risk of loss is classified as possible in each case.

 

   

ICMS – Diesel Oil. The tax authority of the state of São Paulo issued tax assessment notices against Raízen Energia in order to charge ICMS. According to the tax authority, Raízen Energia did not reverse the credit appropriated on the acquisition of diesel oil as feedstock production, due to the output of oil diesel of the establishment in marketing operations. In addition, Raízen Energia allegedly failed to issue tax invoices and also issued tax invoices with mistaken ICMS amounts. In relation to the facts alleged to have occurred before the formation of the Raízen joint venture on April 1, 2011 (Raízen’s shareholders are therefore required to reimburse Raízen for a portion of any loss in case of an adverse decision), Raízen Energia has received tax assessment notices, and with respect to the second instance administrative court issued a decision partially favorable to the company. Raízen Energia is awaiting a decision of the special appeals court. As of December 31, 2018, the amount involved in this proceeding was R$324.5 million. In relation to the facts which allegedly occurred after the formation of the Raízen joint venture on April 1, 2011 (therefore, these amounts are subject to reimbursement by Raízen’s shareholders in the event of an adverse decision), Raízen Energia has received tax assessment notices, which are currently pending decision of the first and second administrative court. As of December 31, 2018, the amount involved in this proceeding was R$501 million. The risk of loss is classified as possible in each case.

 

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ICMS. The tax authorities of the state of São Paulo issued a tax assessment notice against Raízen Energia in order to collect ICMS debts and impose penalties relating to (i) the alleged acquisition and sale of goods without proper registration of these transactions in the applicable tax books in the years of 2009 and 2010, and (ii) the alleged non-registration in the proper entry book of invoices issued as a result of the symbolic return of goods deposited in warehouses. A first instance decision providing that item (i) described above should be partially cancelled was issued. Raízen Energia and the tax authorities filed appeals to the State Council of Tax Payers (Tribunal de Impostos e Taxas), or “TIT.” In October 2016, a court decision was issued confirming the first decision and also reducing the penalties in connection with item (ii) by 90%. The tax authorities filed a special appeal against this decision. In November 2017, the Special Chamber of the State Council of Tax Payers ruled partially in favor of Raízen Energia by (i) rejecting the tax authorities’ special appeal against the reduction of the penalty and granting the abovementioned 90% in penalties; and (ii) accepting the tax authorities’ special appeal with respect to the annulment of the previous court decision regarding the alleged non-registration in the proper entry book of invoices, in respect to which the Special Chamber of the State Council of Tax Payers ruled that another second instance decision should be issued. In December 2017, Raízen Energia filed a rectifying appeal against this decision. In September 2018, the rectifying appeal filed by Raízen Energia was rejected by the president of the court. Currently, a new second instance judgment of the appeals is pending. The total amount involved is R$479.7 million. The risk of loss is classified as remote for R$473.9 million and as possible for the remaining R$5.7 million. The alleged underlying facts occurred before the formation of the Raízen joint venture on April 1, 2011. Accordingly, these amounts are subject to reimbursement by shareholders in the event of an adverse decision. No provision has been recorded for this proceeding in our financial statements.

 

   

PIS and COFINS Offsets (Raízen Combustíveis). The Brazilian federal tax authorities filed a tax assessment to charge PIS and COFINS for the years of 2006 to 2009 in connection with unauthorized offset of tax debts made by Raízen Combustíveis. Raízen Combustíveis obtained a partially favorable decision from the first tier administrative court, and the tax authorities filed an appeal to the second tier administrative court. The amount under dispute as of December 31, 2018 was R$580.7 million. The risk of loss is classified as possible. The alleged underlying facts occurred before the formation of the Raízen joint venture on April 1, 2011 and, therefore, these amounts are subject to reimbursement by Raízen’s shareholders in the event of an adverse decision.

 

   

PIS and COFINS (Raízen Combustíveis). The Brazilian federal tax authorities filed a judicial tax enforcement proceeding in order to charge PIS and COFINS debts originating from refund and offsetting claims made by Raízen Combustíveis. The amount under dispute as of December 31, 2018 was R$485.3 million and Raízen Combustíveis presented a surety bond in order to continue to litigate. The risk of loss is classified as possible. The alleged underlying facts occurred before the formation of the Raízen joint venture on April 1, 2011 and, therefore, these amounts are subject to reimbursement by Raízen’s shareholders in the event of an adverse decision.

 

   

Labor Civil Public Action No. 0000642-29.5-01.003. Raízen Paraguaçú Ltda. (formerly known as Raízen Tarumã Ltda.), among other defendants, is a party to a civil public action filed by the Labor Prosecutor’s Office of the city of Rio de Janeiro in the state of Rio de Janeiro relating primarily to the following matters: (1) exposure of employees to conditions that are allegedly degrading, (2) alleged irregularities in the outsourcing practices of the companies and (3) alleged noncompliance with health and safety rules and regulations relating to working hours. The Labor Court ruled the case groundless at first instance. The Public Prosecutor’s Office of Rio de Janeiro appealed against the decision to the Regional Labor Appeals Court. The risk of loss is classified as possible. Should the proceedings be decided against Raízen, this may result in Raízen being barred from outsourcing certain core activities, an obligation to comply with certain health and safety rules as well as rules applicable to employees’ working hours, the imposition of pecuniary fines in case of noncompliance and indemnification for the violation of employees’ rights (excluding collective moral damages) in an amount of R$11.7 million. The alleged underlying facts occurred before the formation of the Raízen joint venture on April 1, 2011 and, therefore, these amounts are subject to reimbursement by Raízen’s shareholders for a portion of any loss in the event of an adverse decision.

Criminal Investigations Involving Raízen Combustíveis

On July 31, 2018, the Civil Police of the state of Paraná launched Operation Controlled Margin to investigate the alleged involvement of Raízen Combustíveis in a scheme to control the final price of fuel sold in services stations located in such region. On the same date, search and seizure warrants were executed and three of Raízen’s employees were temporarily arrested.

In parallel, also on July 31, 2018, in connection with the so-called Operation Dubai, the Public Prosecutor’s Office of the Federal District filed a complaint against, among other parties, Raízen Combustíveis and one employee of Raízen Combustíveis in relation to certain alleged anticompetitive practices. In said complaint, the Public Prosecutor’s Office of the Federal District requested that certain assets and funds of Raízen Combustíveis in an amount of approximately R$120 million be frozen. This freezing of assets was not put in place as a result of certain guarantees being provided to the court.

Raízen Combustíveis is currently contesting both sets of proceedings.

 

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Item 4A.

Unresolved Staff Comments

None.

 

Item 5.

Operating and Financial Review and Prospects

The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements for the fiscal years ended December 31, 2018, 2017 and 2016, as well as with the information presented under the sections entitled “Presentation of Financial and Other Information” and “Item 3. Key Information—A. Selected Financial Data.”

The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those set forth in “Forward-Looking Statements” and “Item 3. Key Information—D. Risk Factors.”

The following discussion and analysis of our financial condition and results of operations presents the following:

 

   

a brief overview of our company and the principal factors that influence our results of operations, financial condition and liquidity;

 

   

a review of our financial presentation and accounting policies, including our critical accounting policies;

 

   

a discussion of the principal factors that influence our results of operations;

 

   

a discussion of developments that may materially affect our results of operations, financial condition and liquidity;

 

   

a discussion of our results of operations for the fiscal year ended December 31, 2018 compared with the fiscal year ended December 31, 2017, and for the fiscal year ended December 31, 2017 compared with the fiscal year ended December 31, 2016.

 

   

a discussion of our liquidity and capital resources, including our working capital at December 31, 2018, our cash flows for the year ended December 31, 2018, our cash flows for the year ended December 31, 2017, the year ended December 31, 2016, and our material short-term and long-term indebtedness at December 31, 2018; and

 

   

a discussion of our contractual commitments.

Financial Presentation and Accounting Policies

Presentation of Financial Statements

The discussion in this section is based on our audited consolidated financial statements for the fiscal years ended December 31, 2018, 2017 and 2016.

We use IFRS as issued by the IASB for financial reporting purposes. Our audited consolidated financial statements include the financial statements of Cosan Limited and its subsidiaries. Investments in entities in which the Company does not have control but either jointly controls or has significant influence over, are accounted for using the equity method. The results of operations of Raízen Energia and Raízen Combustíveis, our Joint Ventures, are accounted for using the equity method, under IFRS 11, which was adopted by the Company in the nine-month period ended December 31, 2013, and applied retrospectively.

The discussion in this section is also based on a comparison of the fiscal year ended December 31, 2018 with the fiscal year ended December 31, 2017, and a comparison of the fiscal year ended December 31, 2017 with the fiscal year ended December 31, 2016.

 

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Business Segments and Presentation of Segment Financial Data

The Company presents the following reportable segments:

(1) Raízen Energia: production and marketing of a variety of products derived from sugar cane, including raw sugar (VHP), anhydrous and hydrated ethanol, and activities related to energy cogeneration from sugarcane bagasse. In addition, this segment holds interests in companies engaged in research and development on new technology;

(2) Raízen Combustíveis: distribution and marketing of fuels, mainly through a franchised network of service stations under the “Shell” brand throughout Brazil, petroleum refining, the operation of fuel resellers, the manufacture and sale of automotive and industrial lubricants, and the production and sale of liquefied petroleum gas throughout Argentina;

(3) Comgás: distribution of piped natural gas in part of the state of São Paulo to customers in the industrial, residential, commercial, automotive and cogeneration sectors;

(4) Cosan Logística: logistics services for rail transportation, storage and port loading of commodities, mainly for grains and sugar, leasing of locomotives, wagons and another railway equipment;

(5) Moove, consisting of CLE, Stanbridge, Moove Lubricants, TTA, LubrigrupoII, Cosan S.R.L and Metrolube: production and distribution of lubricants under the Mobil brand in Brazil, Argentina, Bolivia, Uruguay, Paraguay, the United States of America and Europe, as well as in the European and Asian markets under the Comma trademark; and

Reconciliation

(6) Cosan Corporate: an online payment services platform and other investments, in addition to the corporate activities of the Company. The Cosan corporate segment includes the financing subsidiaries for the Cosan group.

Following the adoption of IFRS 11, as of April 1, 2013 Cosan S.A. no longer proportionally consolidates Raízen Energia and Raízen Combustíveis in its consolidated statement of financial position, consolidated statement of profit or loss and comprehensive income and consolidated cash flows, and the results from these businesses are accounted for under the line item “Equity in income of jointly-controlled entity” in our consolidated statement of profit or loss and other comprehensive income.

 

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Critical Accounting Policies and Estimates

The preparation of the Company’s consolidated financial statements requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, revenue and expenses at the end of the reporting period. Actual results may differ from these estimates. Such estimates and underlying assumptions are reviewed on an ongoing basis and changes are recognized in the period in which the estimates are revised and in any future periods affected.

Summary information about critical judgments, assumptions and estimation uncertainties in applying accounting policies that have the most significant effect on the amounts recognized in the financial statements is included as follows (see note 3.2 of our consolidated financial statements for further information):

Trade payables. The calculation of cost of gas in the closing of the legal disputes with Petrobras.

Recognized fair value measurements. When the fair value of financial assets and liabilities recorded in the consolidated financial statements cannot be derived from active markets, their fair value is determined using valuation techniques including the discounted cash flow model. The inputs to these models are taken from observable markets where possible, but where this is not feasible, a degree of judgment is required in determining fair values. Judgment is required in the determination of inputs such as liquidity risk, credit risk and volatility. Changes in assumptions on these factors could affect the reported fair value of financial instruments.

Investment in joint ventures. The Company has a 50% interest in a joint agreement. The joint venture agreements require unanimous consent from all parties for all relevant activities.

The two partners have direct rights to the assets of the partnership and are jointly and severally liable for the liabilities incurred by the partnership. This entity is therefore classified as a joint venture and the Company recognizes its interest in the joint venture using the equity method.

Property, plant and equipment and intangible assets and goodwill. The calculation of depreciation and amortization of intangible assets and property, plant and equipment is based on estimated useful lives. In addition, the determination of the fair value of intangible assets and property, plant and equipment acquired in a business combination or arising from the formation of a Joint Venture is a significant estimate.

The Company performs annually a review of impairment indicators for intangible assets and property, plant and equipment. Also, an impairment test is undertaken for goodwill. Impairment exists when the carrying value of an asset or cash generating unit exceeds its recoverable amount, which is the higher of its fair value less costs to sell and its value in use.

Commitments. The Company has entered into commercial property leases in relation to its investment property portfolio. The Company has determined, based on an evaluation of the terms and conditions of the arrangements, such as the lease term not constituting a substantial portion of the economic life of the commercial property and the present value of the minimum lease payments not amounting to substantially all of the fair value of the commercial property, that it retains all the significant risks and rewards of ownership of these properties and accounts for the contracts as operating leases.

Income tax. A deferred tax asset is recognized for loss carry forwards to the extent that it is probable that future taxable income will be generated to use such losses. Significant judgment is required to determine the amount of deferred tax assets that can be recognized, based upon the timing and the level of future taxable income together with tax planning strategies.

Provisions for legal proceedings. Provisions for legal proceedings resulting from business combinations are estimated at fair value.

Post-employment benefits. The cost of defined benefit pension plans and other post-employment benefits and the present value of the pension obligation is determined using actuarial valuations. An actuarial valuation involves the use of various assumptions which may differ from actual results in the future. These include the determination of the discount rate, future salary increases, mortality rates and future pension increases. A defined benefit obligation is highly sensitive to changes in these assumptions. All assumptions are reviewed by management at each reporting date.

 

 

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Share-based payment. Cosan S.A. measures employees’ share-based compensation cost by reference to the fair value of the shares at the grant date. The estimation of fair value for share-based payment transactions requires determining the most appropriate valuation model, which is dependent on the terms and conditions of the plan. This estimate also requires determining the most appropriate inputs to the valuation model including the assumption of the expected life of the stock option, volatility and dividend yield.

Recently Issued Accounting Standards

New IFRS accounting standards have been published and/or reviewed and were adopted for the current fiscal year, as described below. Except as described below, there are no other standards and interpretations issued but not yet adopted that may, in management’s opinion, have a significant impact on the results or equity disclosed by the Company.

IFRS 9 Financial Instruments: Classification and Measurement

The Company has applied IFRS 9 since January 1, 2018 except as described below:

 

   

the Company has adopted the exception of not re-presenting comparative information from previous periods relating to classification and measurement requirements (including impairment). Differences in the balances of financial assets and liabilities arising from the adoption of IFRS 9 were recorded in retained earnings and reserves on January 1, 2018. Thus, the information presented for 2017 generally does not reflect the requirements of IFRS 9, but the requirements of IAS 39;

 

   

certain determinations were made based on the facts and circumstances existing at the date of initial application, including: (i) determination of the business model in which a financial asset is held; and (ii) the designation and revocation of prior designations of certain financial assets and liabilities as measured at fair value through profit or loss; and

 

   

all hedge relationship designations in accordance with IAS 39 existing as of December 31, 2017 meet the hedging criteria in accordance with IFRS 9 as of January 1, 2018 and are therefore designated as continuing hedge relationships.

The total impact on the Company’s financial position as at January 1, 2018 is as follows:

 

     (in thousands of reais)  

Assets

Trades receivables

     (10,932

Investments in joint ventures

     (1,340

Deferred tax

     3,584  

Equity

  

Retained earnings

     8,688  

 

  a.

Classification and measurement

The Company initially measures a financial asset at its fair value and, in the case of a financial asset not at fair value, through profit or loss, plus transaction costs, except those measured at amortized cost for financial assets that are kept within a business model with the objective of obtaining contractual cash flows that meet the “SPPI criterion.”

Under IFRS 9, debt financial instruments are subsequently measured at fair value through profit or loss, or “FVPL,” amortized cost, or fair value through other comprehensive income, or “FVOCI.”

The classification is based on two criteria: the Company’s business model for managing the assets and whether the instruments’ contractual cash flows represent ‘solely payments of principal and interest’ on the principal amount outstanding, or the “SPPI criterion.”

The evaluation of the Company’s business models was carried out from the date of initial application on January 1, 2018 and retrospectively applied to financial assets that were not derecognized before January 1, 2018. The assessment of whether cash flows contractual debt instruments are solely composed of principal and interest was made based on the facts and circumstances as in the initial recognition of the assets. This category includes trade accounts receivable, cash and cash equivalents, restricted cash, receivables from related parties, other financial assets and dividends and interest on shareholders’ equity receivable. No new measurement of financial assets was carried out.

 

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  b

Impairment

The adoption of IFRS 9 has fundamentally changed the Company’s accounting for impairment losses for financial assets by replacing IAS 39’s incurred loss approach with a forward-looking expected credit loss (ECL) approach.

The Company recognizes a provision for expected credit loss for its trade receivable. The simplified standard approach is applied and the expected credit losses for the entire life of the asset are calculated. The Company has established a provisioning method that is based on the historical experience of credit loss of each business segment, adjusted for specific prospective factors for the debtors and for the economic environment.

The joint ventures Raízen Energia and Raízen Combustíveis have adopted an expected loss method considering the grouping of customers with similar default characteristics, by sales channel and internal rating. The impact of the adoption of this standard was a loss of R$2.7 million (R$1.35 million in the interest in earnings of joint ventures of Cosan S.A.).

 

  c

Hedge accounting

The Company applied the changes of hedge accounting prospectively. At the date of initial application, all of the Company’s existing hedging relationships were eligible to be treated as continuing hedging relationships. Consistent with previous periods, the Company continued to designate the change in the fair value of the entire forward contract in the Company’s cash flow hedge relationships and, as such, the adoption of the hedge accounting requirements of IFRS 9 had no significant impact on the Company’s consolidated financial statements.

According to IAS 39, all gains and losses arising from the Company’s cash flow hedge relationships were eligible to be subsequently reclassified to income. Therefore, after the adoption of IFRS 9, the net cash flow hedge gain or loss was presented under “Other comprehensive income not being reclassified to income.” This amendment applies only prospectively from the date of initial application of IFRS 9 and has no impact on the presentation of comparative figures.

 

  d.

Amendments to IFRS 9: Prepayment Features with Negative Compensation

Under IFRS 9, a debt instrument can be measured at amortized cost or at fair value through other comprehensive income, provided that the contractual cash flows are “solely payments of principal and interest on the principal amount outstanding” (the SPPI criterion) and the instrument is held within the appropriate business model for that classification. The amendments to IFRS 9 clarify that a financial asset passes the SPPI criterion regardless of the event or circumstance that causes the early termination of the contract and irrespective of which party pays or receives reasonable compensation for the early termination of the contract.

The amendments should be applied retrospectively and are effective from January 1, 2019. These amendments have no impact on the consolidated financial statements of the Company.

IFRS 15 Revenue from contracts with customers

The assets deriving from infrastructure concessions during the construction period at Comgás and contracts with clients at CLE, which were previously accounted as “intangible assets,” are now booked as “contract asset” and presented in the statement of financial position in the “Other non-current assets.”

The Company has adopted the retrospective method with cumulative transitional effect. In summary, the following adjustments were made to the amounts recognized in the balance sheet at the date of initial application:

 

     As of January 1, 2018  
     IAS 18      IFRIC 12      Reclassification     IFRS 15  
     (in thousands of reais)  

Other non-current assets (contract asset)

     —          —          188,498       188,498  

Intangible assets

     8,346        180,152        (188,498     —    

Additionally, the subsidiary CLE pays a commission fee to the customer in order to obtain a new contract. In most cases, these payments are associated with a volume acquired by the customer and are treated as cost of sales. On December 31, 2018, the incremental costs of obtaining a contract and costs to fulfil a contract was R$73.6 million.

In 2017, such commission fees were recognized as selling expenses when incurred in the amount of R$82.9 million.

 

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IFRS 16 Leases

These standards are effective for annual periods beginning after January 1, 2019 and change the recognition, measurement, presentation and disclosure of leases. It requires lessees to record all leases on the balance sheet with exemptions available for low value and short-term leases. During 2018, the Company concluded preparations for the new requirements in IFRS 16, except for technical discussions regarding the incremental discount rate and agricultural partnership contracts in joint ventures.

The Company leases various properties, equipment and cars. Rental contracts are typically made for fixed periods but may have extension options as described in below. Lease terms are negotiated on an individual basis and contain a wide range of different terms and conditions. The lease agreements do not impose any covenants, but leased assets may not be used as security for borrowing purposes.

Leases are recognized as a right-of-use asset and a corresponding liability at the date at which the leased asset is available for use by the Company. Each lease payment is allocated between the liability and finance cost. The finance cost is charged to profit or loss over the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period. The right-of-use asset is depreciated over the shorter of the asset’s useful life and the lease term on a straight-line basis.

Assets and liabilities arising from a lease are initially measured on a present value basis. Lease liabilities include the net present value of the following lease payments:

 

  i.

fixed payments (including in-substance fixed payments), less any lease incentives receivable;

 

  ii.

variable lease payment that are based on an index or a rate;

 

  iii.

amounts expected to be payable by the lessee under residual value guarantees;

 

  iv.

the exercise price of a purchase option if the lessee is reasonably certain to exercise that option; and

 

  v.

payments of penalties for terminating the lease, if the lease term reflects the lessee exercising that option.

The lease payments are discounted using the interest rate implicit in the lease, if that rate can be determined, or the Company’s incremental borrowing rate.

Right-of-use assets are measured at cost comprising the following:

 

  i.

the amount of the initial measurement of lease liability;

 

  ii.

any lease payments made at or before the commencement date less any lease incentives received;

 

  iii.

any initial direct costs; and

 

  iv.

restoration costs.

Payments associated with short-term leases and leases of low-value assets are recognized on a straight-line basis as an expense in profit or loss. Short-term leases are leases with a lease term of 12 months or fewer. Low-value assets comprise IT-equipment and small items of office furniture.

Extension and termination options are included in a number of property and equipment leases across the Company. These terms are used to maximize operational flexibility in terms of managing contracts. The majority of extension and termination options held are exercisable only by the Company and not by the respective lessor.

To optimize lease costs during the contract period, the Company sometimes provides residual value guarantees in relation to equipment leases.

 

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Impact on the statement of financial position (increase/(decrease)) as of January 1, 2019:

 

     Range  
     (in thousands of reais)  

Assets

       

Right-of-use assets

     1,100,000       to        1,200,000  

Deferred income tax

     40,000       to        50,000  
     1,140,000            1,250,000  

Liabilities

       

Leases

     1,600,000       to        1,700,000  

Equity

     (460,000        (450,000

The Company has applied IFRS 16 using the modified retrospective approach and therefore the comparative information has not been restated and continues to be reported under IAS 17 and IFRIC 4. The details of accounting policies are disclosed separately for each period.

The subsidiaries Raízen Energia and Raízen Combustíveis recognized the lease liability and the right to use asset at the date of the initial application for leases previously classified as operating leases, retrospectively, with cumulative effect. These joint ventures used as a practical expedient the use of a single discount rate on the lease portfolio with similar characteristics. The initial measurement of lease liabilities and rights-of-use assets is estimated between R$4,000,000 and R$5,000,000. There are still technical discussions that may have a significant impact on the initial effects of these jointly controlled companies, such as whether the agricultural partnership contracts are within the scope of the standard.

IFRIC Interpretation 23 Uncertainty over Income Tax Treatment

The interpretation is effective for annual periods beginning after January 1, 2019 and addresses the accounting for income taxes when tax treatments involve uncertainty that affects the application of IAS 12 and does not apply to taxes or levies outside the scope of IAS 12, nor does it specifically include requirements relating to interest and penalties associated with uncertain tax treatments.

The Company is subject to examination by the tax authorities, with the five fiscal years open in general. The Company has audits in progress at various stages of completion, one of which may be completed within the next 12 months. However, at that time, the Company had no uncertainties regarding the treatment of income tax.

Principal Factors Affecting Our Results of Operations

In addition to the factors that are described in “Item 4. Information on the Company—B. Business Overview,” our results of operations have been influenced and will continue to be influenced by the following key factors:

Brazilian Economic Environment

The Brazilian economic environment has historically been characterized by significant variations in economic growth, inflation and currency exchange rates. Our results of operations and financial condition are influenced by these factors and the effect that these factors have on employment rates, the availability of credit and average wages in Brazil. The following table sets forth Brazilian inflation rates, interest rates, and exchange rates for the periods indicated:

 

     For the Fiscal Year Ended December 31,  
     2018     2017     2016  

GDP growth

     1.1     1.0     (3.6 )% 

Inflation (IGP-M)

     7.5     (0.5 )%      7.2

Inflation (IPCA)(1)

     3.8     3.0     6.3

Interbank rate – CDI (average)(2)

     6.4     7.0     14.0

Long-term interest rates (average)(3)

     7.0     7.0     7.5

Exchange rate at the end of the period per U.S.$1.00

     R$3.87     R$ 3.31     R$ 3.26  

Average exchange rate per U.S.$1.00

     R$3.65     R$ 3.19     R$ 3.51  

Appreciation (depreciation) of the real against the U.S. dollar (4)

     (17.1 )%      (1.5 )%      16.5

 

Sources: IBGE, Brazilian Central Bank, CETIP S.A. — Mercados Organizados and FGV.

(1)

IPCA is a consumer price index calculated by IBGE.

(2)

CDI refers to the average overnight interbank loan rates in Brazil.

(3)

The Brazilian long-term interest rate (taxa de juros de longo prazo), or “TJLP,” is the rate applicable to long-term loans by BNDES.

(4)

Comparing the PTAX exchange rate (the rate calculated by the Brazilian Central Bank) at the end of the period’s last day with the day immediately prior to the first day of the period discussed, PTAX is the exchange rate calculated at the end of each day by the Brazilian Central Bank. It is the average rate of all business conducted in U.S. dollars on the determined date in the interbank exchange market.

 

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General economic stability in Brazil following the onset of the global financial crisis in 2009 allowed the Brazilian Central Bank to continue its policy of reducing interest rates. Due to inflation and other general macroeconomics concerns, the Brazilian Central Bank began increasing interest rates, with the SELIC, a benchmark interest rate, reaching 10.00% at the end of December 31, 2013, 11.75% at the end of December 31, 2014 and 14.25% at the end of December 31, 2015. The Brazilian Central Bank has been reducing interest rates since then, with the SELIC reaching 13.75% as of December 31, 2016, 7.00% as of December 31, 2017 and 6.5% as of December 31, 2018.

The recent economic instability in Brazil has contributed to a decline in market confidence in the Brazilian economy as well as to a deteriorating political environment. Despite the ongoing recovery of the Brazilian economy, weak macroeconomic conditions in Brazil are expected to continue throughout early 2019. In addition, various ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation known as “Lava Jato,” have negatively impacted the Brazilian economy and political environment.

In recent years, there has been significant political turmoil in connection with the impeachment of the former president (who was removed from office in August 2016) and ongoing investigations of her successor (who left office in January 2019) as part of the ongoing “Lava Jato” investigations. Presidential elections were held in Brazil in October 2018. We cannot predict which policies the new President of Brazil, who assumed office on January 1, 2019, may adopt or change during his mandate or the effect that any such policies might have on our business and on the Brazilian economy. Any such new policies or changes to current policies may have a material adverse effect on us. The political uncertainty resulting from the presidential elections and the transition to a new government may have an adverse effect on our business, results of operations and financial condition.

Furthermore, Brazil’s federal budget has been in deficit since 2014. Similarly, the governments of Brazil’s constituent states are also facing fiscal concerns due to their high debt burdens, declining revenues and inflexible expenditures. While the Brazilian Congress has approved a ceiling on government spending that will limit primary public expenditure growth to the prior year’s inflation for a period of at least 10 years, local and foreign investors believe that fiscal reforms, and in particular a reform of Brazil’s pension system, will be critical for Brazil to comply with the spending limit. As of the date of this annual report, a reform of Brazil’s pension system is still under discussion by the government and Brazilian Congress. Diminished confidence in the Brazilian government’s budgetary condition and fiscal stance could result in downgrades of Brazil’s sovereign debt by credit rating agencies, negatively impact Brazil’s economy, lead to further depreciation of the real and an increase in inflation and interest rates, thus adversely affecting our business, results of operations and financial condition.

Any deterioration in Brazil’s rate of economic growth, changes in interest rates, the unemployment rate or price levels generally may limit the availability of credit, income and purchasing power of our customers, thereby adversely affecting demand for our products.

Acquisitions, Partnerships and Corporate Restructurings

Our strategy is to be a leading Brazilian group in the energy and infrastructure businesses. For this reason, since May 2004, we have expanded our operations primarily through acquisitions, partnerships and corporate restructurings. We have also diversified into other operations to become a vertically integrated energy and infrastructure company. As a result, our net sales and gross profit have increased significantly.

Sugar

The profitability of our sugar products is mainly affected by fluctuations in the international price of raw sugar and in the real/dollar exchange rate. International raw sugar prices are determined based on the New York Board of Trade Futures Contract No. 11, or “NY11.” Refined sugar trades at a premium to raw sugar, known as the “white premium,” and its price is determined based on the London International Financial Futures and Options Exchange Contract No. 5, or “LIFFE No. 5.” Prices are affected by the perceived and actual supply and demand for sugar and its substitute products. The supply of sugar is affected by weather conditions, governmental trade policies and regulations and the amount of sugarcane and sugar beet planted by farmers, including substitution by farmers of other agricultural commodities for sugarcane or sugar beet. Demand is affected by growth in worldwide consumption of sugar and the prices of substitute sugar products. From time to time, imbalances may occur between overall sugarcane and sugar beet processing capacity, sugarcane and sugar beet supply and the demand for sugar products. Prices of sugar products are also affected by these imbalances, which, in turn, impact our decisions regarding whether and when to purchase, store or process sugarcane and whether to produce sugar or more ethanol.

 

 

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The table below sets forth the prices for raw sugar NY11 for the periods indicated:

 

     Sugar NY11  
     For the Fiscal Year Ended  
     December 31,
2018
     December 31,
2017
     December 31,
2016
 
     (U.S.$/lb)  

Initial quote

     0.1533        0.2051        0.1467  

Closing quote

     0.1203        0.1516        0.1925  

Daily average quote

     0.1224        0.1578        0.1811  

High quote

     0.1533        0.2118        0.2291  

Low quote

     0.0900        0.1255        0.1335  

 

Source: NYBOT; prices from the 1st Generic Future. Bloomberg.

Ethanol

Our ethanol products are affected by domestic Brazilian and international prices of ethanol, competition, governmental policies and regulations and market demand for ethanol as an alternative or additive to gasoline. The price for ethanol we sell in Brazil is set in accordance with market prices, using indices published by the Agriculture School of the University of São Paulo (Escola Superior de Agricultura Luiz de Queiroz—ESALQ) and B3 as a reference. Prices for ethanol we export are set based on international market prices, including the New York Board of Trade’s recently launched ethanol futures contract. Prices for the industrial alcohol and bottled alcohol products we sell are also set based on market prices and have been historically higher than market prices for ethanol.

The table below sets forth the prices for hydrous ethanol in the Brazilian market for the periods indicated:

 

     Hydrous Ethanol Esalq  
     For the Fiscal Year Ended  
     December 31,
2018
     December 31,
2017
     December 31,
2016
 
     (U.S.$/thousand liters)  

Initial quote

     560.60        573.70        442.30  

Closing quote

     427.90        535.20        562.00  

Daily average quote

     460.22        477.80        483.40  

Monthly average quote

     460.89        478.61        483.00  

High quote

     581.80        578.60        604.50  

Low quote

     356.90        384.80        379.10  

 

Source: ESALQ.

The table below sets forth the prices for anhydrous ethanol in the Brazilian market for the periods indicated:

 

     Anhydrous Ethanol Esalq  
     For Fiscal Year Ended  
     December 31,
2018
     December 31,
2017
     December 31,
2016
 
     (U.S.$/thousand liters)  

Initial quote

     595.00        642.20        500.40  

Closing quote

     469.40        584.20        618.10  

Daily average quote

     502.04        526.40        536.30  

High quote

     612.60        642.20        665.70  

Low quote

     390.10        430.80        434.60  

 

Source: ESALQ.

 

 

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The following table sets forth our average selling prices (in R$ per thousand liters) for ethanol in the export market for the periods indicated:

 

     Ethanol  
     For Fiscal Year Ended  
     December 31,
2018
     December 31,
2017
     December 31,
2016
 
     (R$/thousand liters)  

Average Unitary Price

     2,011        1,704.00        1,818  

 

Source: Cosan/Raízen.

Demand for Fuels

Demand for gasoline, ethanol and diesel is susceptible to volatility related to the level of economic activity in Brazil and may also fluctuate depending on the performance of specific industries in the Brazilian market. We expect that a decrease in economic activity would adversely affect demand for fuels.

Currency Fluctuations

A significant proportion of the sales of sugar of Raízen Energia, a significant proportion of natural gas purchase of Comgás, and a significant proportion of the base oil purchases of CLE are conducted in U.S. dollars. Therefore, a depreciation of the real against the U.S. dollar would have the effect of increasing our sales in Raízen Energia, and increasing our costs of sales in Comgás and Moove. An appreciation of the real against the U.S. dollar would have the opposite effect.

A significant proportion of our debt is denominated in U.S. dollars. A depreciation of the real against the U.S. dollar would increase our debt burden and our related financial expenses. However, we have receivables and other financial assets denominated in U.S. dollars, which would partially offset the impact that a depreciation of the real would have on our financial position. An appreciation of the real against the U.S. dollar would have the opposite effect.

See also “—Hedging Transactions and Exposures.”

Seasonality

Our business is subject to a degree of seasonality as described below. See also “Item 3. Key Information—D. Risk Factors—Risks Related to Our Businesses, the Operations of Our Joint Venture, and Industries in Which We Operate—Our business is subject to seasonal trends based on the sugarcane growing cycle in the Central-South region of Brazil.”

Raízen

Raízen’s sugar production depends on the volume and sucrose content of the sugarcane that it cultivates or that is supplied to it by growers located in the vicinity of Raízen’s mills. Crop yields and sucrose content depend primarily on weather conditions such as rainfall and temperature, which vary and may be influenced by global climate change. Weather conditions have historically caused volatility in the ethanol and sugar industries and, consequently, in our results of operations by causing crop failures or reduced harvests. Flood or drought, which may be influenced by global climate change, can adversely affect the supply and pricing of the agricultural commodities that we sell and use in our business. During the third and fourth quarter of 2014, a severe drought affected the areas in which Raízen operates.

Future weather patterns may reduce the amount of sugar or sugarcane that Raízen can recover in a given harvest or its sucrose content. In addition, the business of Raízen Energia in particular is subject to seasonal trends based on the sugarcane growing and harvesting cycle in the Central-South region of Brazil. The annual sugarcane harvesting period in the Central-South region of Brazil usually begins in April or May and ends in November or December. This creates fluctuations in our inventory, usually peaking in December to cover sales between crop harvests (i.e., December through April), and a degree of seasonality in our gross profit, with ethanol and sugar sales significantly lower in the quarter ended on December 31.

 

 

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Cosan Logística

Rumo is subject to the seasonality that influences the sugarcane and grain harvest. During the peak months of the harvests, there is higher demand for transport and logistics operations.

Inflation

Inflation rates in Brazil were 6.4% in 2014, 10.7% in 2015, 6.3% in 2016, 3% in 2017 and 3.8% in 2018, as measured by the Extended National Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo), or “IPCA,” published by the Brazilian Institute for Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or “IBGE.” The inflation rate reached a level of 3.8% for the twelve-month period ending December 31, 2018.

Inflation affects our financial performance by increasing certain of our operating expenses denominated in reais (and not linked to the U.S. dollar). These operating expenses include labor costs, leases, and selling and general administrative expenses. However, inflation did not have a material impact on our business for the periods presented.

See also “Item 3. Key Information—D. Risk Factors—Risks Related to Brazil—Inflation and government measures to curb inflation may adversely affect the Brazilian economy, the Brazilian securities market, our business and operations and the market prices of our shares.”

Cost Structure

Our cost structure for Raízen Energia may be divided into costs that are linked to the prices of our products and costs that are not linked to the prices of our products. Two of our principal cost components, raw materials and land leases, are linked to the prices of our products. Accordingly, we adjust the prices of our products to follow fluctuations in the cost of our raw materials and leased land, substantially minimizing the impact of this cost volatility on our results of operations. In addition, another relevant portion of our costs is represented by agricultural and industrial inputs, some of which are imported and which are also subject to price fluctuations primarily as a result of exchange rate variations. As 5% of our net sales are derived from exports, a portion of fluctuations in the costs of these inputs is offset by similar fluctuations in our Brazilian and international prices, minimizing the impact of this cost volatility on our results of operations.

Our cost structure for Comgás is affected by fixed and variable costs. Costs related to our property, plant and equipment incur fixed depreciation charges which increase in line with our capital expenditure. Costs relating to the natural gas resource, costs relating to transportation and other gas services are affected by volumes sold.

Our cost structure for Lubricants is affected by the cost of imported base oil and additives for lubricants blending.

Our cost structure for Cosan Logística is affected by fixed and variable costs. Costs related to our property, plant and equipment incur fixed depreciation charges, which increase in line with our capital expenditure. Costs relating to the transportation of sugar and other commodities are partially dependent on sales volumes.

Other Factors

Other factors that will impact the results of our operations include:

 

   

hedging transactions (as discussed under “—Hedging Transactions and Exposures”);

 

   

trade barriers in U.S., European and other markets that currently limit access to their domestic sugar industry through quotas, subsidies and restrictions on imports;

 

   

the evolving use of ethanol derivatives as an alternative to oil derivatives and as a cleaner burning fuel, derived from renewable sources;

 

   

the use of ethanol as a cleaner burning fuel, derived from renewable sources;

 

   

changes in international prices of oil (denominated in U.S. dollars) and related changes in the domestic prices of oil (denominated in reais);

 

   

the growth rate of the global economy and its resulting corresponding growth in worldwide sugar consumption; and

 

   

the tax policies adopted by the Brazilian government and the governments of the Brazilian states in which we operate (including tax incentives from which we benefit), and our resulting tax obligation.

 

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Hedging Transactions and Exposures

Our management has overall responsibility for the establishment and oversight of our risk management framework. Our board of directors has established the risk management committee, which is responsible for developing and monitoring our risk management policies. The committee reports regularly to our board of directors on its activities.

Our risk management policies are established to identify and analyze the risks that we face, to set appropriate risk limits and controls and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and our activities. Our management, through its training, standards and procedures, aims to maintain a disciplined and constructive control environment in which all employees understand their roles and obligations.

Our hedging strategy primarily seeks to protect our cash flows from risks arising from exchange rates fluctuations. Accordingly, certain of our derivative financial instruments have been designated for hedge accounting, namely: (1) at Cosan S.A., the Senior Notes due 2023 and the associated derivative financial instruments; (2) at Comgás, the third and fifth issuances of debentures due in 2020 and 2023, respectively, and the associated derivative financial instruments; and (3) at Rumo, the Senior Notes due 2024 and the associated derivative financial instruments.

In addition, our joint venture Raízen Energia hedges part of the future price risk of its sugar production, estimated to be exported and exchange rate derivative transactions, using future contracts, options and swaps. Its hedging strategy seeks to protect it from cash flow risks caused by commodities price and exchange rates fluctuations and as most of the derivative instruments have been designated for hedge accounting, Raízen Energia has not experienced material gains or losses in its financial results.

See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” and note 5.9 of our consolidated financial statements for the fiscal year ended December 31, 2018 attached hereto for further information.

 

A.

Operating Results

The following discussion of our results of operations is based on the financial information derived from our audited consolidated financial statements prepared in accordance with IFRS as issued by the IASB, unless otherwise stated. In the following discussion, references to increases or decreases in any year are made by comparison with the corresponding prior year, as applicable, except as the context otherwise indicates. The discussion in this section is based on a comparison of the audited fiscal year ended December 31, 2018 with the audited fiscal year ended December 31, 2017, and a comparison of the audited fiscal year ended December 31, 2017 with the audited fiscal year ended December 31, 2016.

Results of Operations for the Fiscal Year Ended December 31, 2018 Compared to the Fiscal Year Ended December 31, 2017

Consolidated Results

The following table sets forth our consolidated statement of profit or loss for the fiscal years ended December 31, 2018 and 2017:

 

     For the Fiscal Year
Ended December 31,
    %
Variation
 
     2018     2017  
     (in millions of reais, except percentages)  

Consolidated statement of profit or loss

      

Net sales

     16,843.9       13,582.5       24.01

Cost of sales

     (12,119.9     (9,232.2     31.28

Gross profit

     4,724.0       4,350.3       8.59

Selling expenses

     (1,023.5     (1,068.7     (4.23 )% 

General and administrative expenses

     (981.8     (935.3     4.97

Other income (expense), net

     738.2       877.6       (15.88 )% 

Operating expense

     (1,267.1     (1,126.4     12.49

Income before equity in earnings of investees and financial results

     3,456.9       3,223.9       7.23