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Estre Ambiental
20-F 2018-12-31 Annual: 2018-12-31
20-F 2017-12-31 Annual: 2017-12-31
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EST 2018-12-31
Item 17 ☐ Item 18 ☐
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 and Use of Proceeds
Item 15. Controls and Procedures
Item 16. Reserved
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 d719732dex8.htm
EX-12.1 d719732dex121.htm
EX-12.2 d719732dex122.htm
EX-13.1 d719732dex131.htm
EX-13.2 d719732dex132.htm

Estre Ambiental Earnings 2018-12-31

EST 20F Annual Report

Balance SheetIncome StatementCash Flow

20-F 1 d719732d20f.htm 20-F 20-F
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2018

Commission file number: 001-38333

ESTRE AMBIENTAL, INC.

(Exact name of Registrant as specified in its charter)

Cayman Islands

(Jurisdiction of incorporation or organization)

4509, Avenida Brigadeiro Faria Lima, 8th Floor

04538-133 São Paulo, SP, Brazil

(Address of principal executive offices)

Felipe Rodriguez, Interim Chief Financial Officer

4509, Avenida Brigadeiro Faria Lima, 8th Floor

04538-133 São Paulo, SP, Brazil

Telephone No.: +55 11 2124-3265

e-mail: ir@estre.com.br

(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

  

Trading Symbol

  

Name of each exchange on which
registered

Ordinary shares, par value $0.0001 per share    ESTR    NASDAQ Capital Market
Warrants    ESTRW    NASDAQ Capital Market

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.

As of December 31, 2018, the Registrant had:

45,636,732 ordinary shares issued and outstanding, par value $0.0001 per share.

5,550,000 Class B Shares issued and outstanding, par value $0.0001 per share.

27,916,921 outstanding warrants exercisable on a one-for-one basis for ordinary shares.

 

 

 

 

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.

 

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. N/A

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  

CERTAIN DEFINED TERMS

     1  

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

     4  

MARKET DATA

     5  

CURRENCY TRANSLATION

     5  

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

     5  

PART I INTRODUCTION

     7  

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     7  

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     7  

ITEM 3. KEY INFORMATION

     7  

A. Selected Financial Data

     7  

B. Capitalization and Indebtedness

     14  

C. Reasons for the Offer and Use of Proceeds

     14  

D. Risk Factors

     14  

ITEM 4. INFORMATION ON THE COMPANY

     47  

A. History and Development of the Company

     47  

B. Business Overview

     53  

C. Organizational Structure

     70  

D. Property, Plant and Equipment

     71  

ITEM 4A. UNRESOLVED STAFF COMMENTS

     71  

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     72  

A. Operating Results

     72  

B. Liquidity and Capital Resources

     100  

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

     105  

D. Trend Information

     106  

E. Off-Balance Sheet Arrangements

     111  

F. Commitments and Contingencies (Tabular Disclosure of Contractual Obligations)

     111  

G. Safe Harbor

     111  

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     111  

A. Directors and Senior Management

     111  

B. Compensation

     114  

C. Board Practices

     116  

D. Employees

     118  

E. Share Ownership

     119  

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     119  

A. Major Shareholders

     119  

B. Related Party Transactions

     122  

C. Interests of Experts and Counsel

     125  

ITEM 8. FINANCIAL INFORMATION

     125  

A. Consolidated Statements and Other Financial Information

     125  

B. Significant Changes

     135  

ITEM 9. THE OFFER AND LISTING

     135  

A. Offer and Listing Details

     135  

B. Plan of Distribution

     135  

C. Principal Market and Trading Market Price Information

     135  

D. Selling Shareholders

     135  

E. Dilution

     135  

F. Expenses of the Issue

     135  

 

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     Page  

ITEM 10. ADDITIONAL INFORMATION

     135  

A. Share Capital

     135  

B. Memorandum and Articles of Association

     136  

C. Material Contracts

     144  

D. Exchange Controls and other Limitations Affecting Security Holders

     147  

E. Taxation

     148  

F. Dividends and Paying Agents

     153  

G. Statement by Experts

     153  

H. Documents on Display

     153  

I. Subsidiary Information

     154  

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     154  

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     156  

A. Debt Securities

     156  

B. Warrants and Rights

     156  

C. Other Securities

     156  

D. American Depositary Shares

     156  

PART II

     157  

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     157  

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     158  

ITEM 15. CONTROLS AND PROCEDURES

     158  

A. Disclosure Controls and Procedures

     158  

B. Management’s Annual Report on Internal Control Over Financial Reporting

     158  

C. Attestation Report of the Registered Public Accounting Firm

     160  

D. Changes in Internal Control Over Financial Reporting

     160  

ITEM 16. RESERVED

     160  

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     160  

ITEM 16B. CODE OF ETHICS

     160  

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     161  

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     161  

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     161  

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     162  

ITEM 16G. CORPORATE GOVERNANCE

     162  

ITEM 16H. MINE SAFETY DISCLOSURE

     162  

PART III

     163  

ITEM 17. FINANCIAL STATEMENTS

     163  

ITEM 18. FINANCIAL STATEMENTS

     163  

ITEM 19. EXHIBITS

     163  

 

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CERTAIN DEFINED TERMS

In this annual report, except as otherwise indicated or as the context otherwise requires, “Estre,” “we,” “us” and “our” refers to Estre Ambiental, Inc. and its subsidiaries on a consolidated basis, including Estre Ambiental S.A., Estre’s main operating subsidiary, and, unless the context otherwise requires, the predecessor companies that have been merged out of existence with and into it. Except as otherwise indicated or as the context otherwise requires, the “Company” refers to Estre Ambiental S.A. and the “Registrant” refers to Estre Ambiental, Inc. All references to “Brazil” are to the Federative Republic of Brazil. All references to percent ownership interests in the Registrant do not take into account treasury shares.

In addition, in this document, unless otherwise specified or the context otherwise requires:

“$,” “US$” and “U.S. dollar” each refer to the United States dollar.

“R$” and “reais” each refer to the Brazilian real.

“ABRELPE” means the Brazilian Association of Public Cleaning and Waste Management (Associação Brasileira de Empresas de Limpeza Pública e Resíduos Especiais).

“audited financial statements” means our audited consolidated financial statements as of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016, and the related notes thereto.

“Angra” means Angra Infra Multiestratégia Fundo de Investimento em Participações.

“Angra Put Option Agreement” means the put option agreement between Angra and the Company pursuant to which Angra had the right to sell all of its shares to the Company at a specified price. As a result of this agreement, Angra transferred 8,871,895 shares to the Company, which are currently held in treasury. As described elsewhere in this annual report, we were required to pay the exercise price of approximately R$40.3 million by September 6, 2018. No payments in respect of the exercise price have been made as of the date of this annual report.

“BFRS” means the Brazilian Federal Revenue Service.

“BNDES” means the Brazilian National Economic and Social Development Bank (Banco Nacional de Desenvolvimento Econômico e Social).

“C&I” means commercial and industrial, generally referring to our operations and customers not part of the public sector or affiliated with governmental agencies.

“Central Bank” means the Banco Central do Brasil, or Brazilian Central Bank.

“Class B Shares” means the Class B shares, par value US$0.0001 per share, of the Registrant.

“Code” means the Internal Revenue Code of 1986, as amended.

“Companies Law” means the Companies Law of the Cayman Islands (2018 Revision).

“Debt Instruments” means instruments governing the two existing debentures issued by the Company and one debt confession instrument entered into by the Company. All debentures issued pursuant to the Debt Instruments are currently held by Banco BTG Pactual S.A., Banco Santander (Brasil) S.A. and Itaú Unibanco S.A.

“Debt Restructuring” means our debt restructuring carried out on December 26, 2017, pursuant to which we applied US$110.6 million from the total cash investments received by us in the context of the Transaction to partially prepay certain of our existing debentures and related debt acknowledgment instrument, each denominated in Brazilian reais, coupled with a partial debt write-down and the refinancing of the balance of our existing debentures and related debt acknowledgment instrument through the amendment and restatement of the terms of such debt instruments with new terms.

 

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Table of Contents

“Designated Stock Exchange” means any national securities exchange including NASDAQ Capital Market or NASDAQ.

“Employee Compensation Entity” means Estre Ambiental Employee SPV, Inc., a Cayman Islands exempted company.

“Estre USA” refers to Estre USA Inc., a Delaware corporation, formerly known as Boulevard Acquisition Corp. II, which name was changed to Estre USA Inc. on December 21, 2017 in connection with the Transaction. References to Estre USA prior to December 21, 2017 shall be deemed references to its predecessor entity, Boulevard Acquisition Corp. II.

“Exchange Act” means the Securities Exchange Act of 1934, as amended.

“IASB” means the International Accounting Standards Board.

“IBGE” means the Governmental Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística).

“IFRS” means International Financial Reporting Standards, as issued by the IASB.

“Incentive Plan” means our 2017 Incentive Compensation Plan.

“Internal Evaluation Process” means the internal evaluation that we conducted at the direction of a special committee of our board of directors comprised of independent members of our board of directors in the aftermath of the Brazilian Federal Police’s execution of search warrants at our corporate offices and the premises of Soma on March 1, 2018, which was designed for the specific purpose of evaluating our supply relationships and related matters at the Company, including Soma and our joint ventures and which was conducted by external legal counsel working together with external forensic service providers.

“IRS” means the U.S. Internal Revenue Service.

“JOBS Act” means the Jumpstart Our Business Startups Act of 2012, as amended.

“Memorandum and Articles” means the amended and restated memorandum and articles of association of the Registrant.

“Merger” means the merger of Merger Sub with and into Estre USA, with Estre USA surviving such merger as a partially-owned subsidiary of the Registrant.

“Merger Sub” means BII Merger Sub Corp., which entity was merged into Estre USA, with Estre USA surviving such merger as a partially-owned subsidiary of the Registrant.

“MSW” means municipal solid waste.

“NASDAQ” means The NASDAQ Stock Market LLC.

“ordinary shares” means the ordinary shares, par value US$0.0001 per share, of the Registrant.

“PCAOB” means the Public Company Accounting Oversight Board.

“PFIC” means passive foreign investment company.

“PIPE Investment” means the private investment in public equity pursuant to which we issued 15,438,000 of our ordinary shares and 3,748,600 warrants to purchase ordinary shares at US$11.50 per share to certain institutional investors unaffiliated with us.

“PIPE Investors” means the institutional investors unaffiliated with us that purchased our ordinary shares and warrants as part of the PIPE Investment.

 

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“public warrants” means the warrants included in the units sold in Estre USA’s initial public offering, as converted in the Merger such that they represent the right to acquire ordinary shares of the Registrant, with each public warrant being exercisable for one of our ordinary shares, in accordance with its terms.

“Pre-Closing Restructuring” means the restructuring that the Company and the Registrant have completed immediately prior to effecting the Merger, pursuant to which, the holders of Company shares (other than Angra) contributed their shares of the Company to the Registrant in exchange for an aggregate of up to 27,001,886 ordinary shares, and the Company became a subsidiary of the Registrant. In addition, 1,983,000 of our ordinary shares were issued to the Employee Compensation Entity immediately prior to the closing of the Merger.

“private placement warrants” means the warrants to purchase Estre USA Class A Common Stock that were outstanding immediately prior to the closing of the Transaction that were purchased in a private placement in connection with Estre USA’s initial public offering, as converted in the Merger such that they represent the right to acquire ordinary shares of the Registrant, with each public warrant being exercisable for one of the Registrant’s ordinary shares, in accordance with its terms.

“Refinanced Debt” refers to our outstanding debentures issued pursuant to the Debt Instruments, as amended in connection with the Debt Restructuring.

“Registration Rights and Lock-Up Agreement” means the Registration Rights and Lock-Up Agreement to be entered into by and among the Registrant, the Sponsor and certain other persons and entities which will hold ordinary shares upon the Closing pursuant to the terms of the Transaction Agreement in connection with, and as a condition to the consummation of, the Transaction.

“Sarbanes-Oxley Act” means the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder.

“Sponsor” means Boulevard Acquisition Sponsor II, LLC, a Delaware limited liability company.

“SEC” means the U.S. Securities and Exchange Commission.

“Securities Act” means the Securities Act of 1933, as amended.

“Soma” means (i) after September 11, 2017, “SPE Soma – Soluções em Meio Ambiente Ltda.”, our consolidated, majority-owned subsidiary, of which we hold 82.0% as of December 31, 2017, that we operate together with Corpus Saneamento e Obras Ltda. (“Corpus”), our third party partner and (ii) prior to September 11, 2017, Consórcio Soma – Soluções em Meio Ambiente, a joint operation with Corpus, in each case, through which we provide urban cleaning and street sweeping services to the municipality of São Paulo.

“Transaction” refers, collectively, to the Pre-Closing Restructuring, the Merger, the PIPE Investment and the Debt Restructuring, together with the other transactions ancillary thereto.

“warrants” means the public warrants, the private placement warrants and the warrants issued in a private placement to an investor that purchased ordinary shares in the PIPE Investment that have the same terms as the private placement warrants.

 

3


Table of Contents

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

The December 2017 Transaction

On December 21, 2017, we consummated a series of transactions resulting in our current status as a public company in the United States, as described below:

 

   

On December 21, 2017, we completed our (i) Pre-Closing Restructuring, pursuant to which the holders of the Company’s common shares contributed these common shares to the Registrant in exchange for an aggregate of 27,001,886 ordinary shares of the Registrant, and as a result of such contribution became a indirectly-owned subsidiary of the Registrant, and (ii) merger with Estre USA, pursuant to which BII Merger Sub Corp. merged with and into Estre USA Inc., with Estre USA as the surviving entity, and Estre USA became a partially-owned subsidiary of the Registrant, which is referred to herein as the Merger (in addition, 1,983,000 of the Registrant’s ordinary shares were issued to the Employee Compensation Entity immediately prior to the closing of the Merger).

 

   

Also on December 21, 2017, the Registrant issued 15,438,000 of the Registrant’s ordinary shares and 3,748,600 warrants to purchase the Registrant’s ordinary shares at US$11.50 per share to certain institutional investors unaffiliated with us pursuant to a private investment in public equity, which we refer to as the PIPE Investment. For more information on the PIPE Investment, see “Item 10.C. Additional Information—Material Contracts—PIPE Subscription Agreements.”

 

   

As a result of the Merger and the PIPE Investment, we received a total US$139.9 million cash investment (comprising US$11.2 million from existing shareholders of Estre USA that did not redeem their public shares in connection with the Merger, and US$128.7 million from the proceeds of the sale of our ordinary shares to PIPE Investors), of which US$110.6 million was used to reduce certain of our indebtedness pursuant to a simultaneous Debt Restructuring, coupled with a partial debt write-down and the refinancing of the balance of the debentures and related debt acknowledgment instrument through the amendment and restatement of the terms of such instruments with new terms.

We refer to the events described above as the “Transaction” in this annual report. For more information, see “Item 10.C. Additional Information—Material Contracts—the Transaction.”

Prior to the Transaction, the Registrant had limited or no assets, operations or activities. The Registrant was incorporated to become the holding entity of the Company to effect the Transaction. Considering that substantially all of the shareholders of the Company exchanged their shares of the Company for shares of the Registrant, the Transaction was accounted for as a reverse recapitalization transaction. The historical operations of the Registrant are deemed to be those of the Company.

The financial statements included in this report reflect (i) the restated operating results of the Company prior to the Transaction for the year ended December 31, 2016, as described under “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Internal Evaluation Process and Previous Restatement of Financial Statements” below; (ii) the consolidated results of the Registrant and the Company following the Transaction; (iii) the assets and liabilities of the Company at their historical cost; and (iv) the Registrant’s equity and earnings per share for all periods presented, each of which were previously reflected in our annual report on Form 20-F for the year ended December 31, 2017 which was filed with the SEC. The number of ordinary shares issued by the Registrant as a result of the Transaction are reflected retroactively to December 31, 2016 for purposes of calculating earnings per share in all prior periods presented.

The audited financial statements in this annual report have been prepared in accordance with IFRS as issued by IASB.

 

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MARKET DATA

In this annual report, we rely on and refer to information and statistics regarding the waste management services industry and our competitors from market research reports and other publicly available sources, including from ABRELPE, the International Solid Waste Association, Eurostat, Biocycle, the Central Bank and IBGE. We have supplemented such information where necessary with our own internal estimates and information obtained from discussions with our customers, taking into account publicly available information about other industry. Although we have no reason to believe that these sources are not reliable or that any of this information is not accurate or complete in all material respects, we have not independently verified any such information and, therefore, cannot guarantee its accuracy or completeness.

CURRENCY TRANSLATION

We maintain our books and records in reais. However, solely for the convenience of the reader, we have translated certain amounts included in this annual report from reais into U.S. dollars using the selling rate as reported by the Central Bank, as of December 31, 2018 of R$3.8742 to US$1.00 or, where expressly indicated, at an average selling exchange rate prevailing during a certain period. All such currency translations should not be considered representations that any such amounts represent, or could have been, or could be, converted into, U.S. dollars or reais at that or at any other exchange rate. See “Item 3.A. Key Information—Selected Financial Data—Exchange Rate Information” for more detailed information regarding the translation of reais into U.S. dollars.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This annual report contains a number of forward-looking statements, including statements about our financial conditions, results of operations, earnings outlook and prospects and may include statements for the period following the date of this annual report. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Forward-looking statements are typically identified by words such as “plan,” “believe,” “expect,” “anticipate,” “intend,” “outlook,” “estimate,” “forecast,” “project,” “continue,” “could,” “may,” “might,” “possible,” “potential,” “predict,” “should,” “would” and other similar words and expressions, but the absence of these words does not mean that a statement is not forward-looking.

The forward-looking statements are based on the current expectations of our management, as applicable, and are inherently subject to uncertainties and changes in circumstance and their potential effects and speak only as of the date of such statement. There can be no assurance that future developments will be those that have been anticipated. These forward-looking statements involve a number of risks, uncertainties or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors described in “Risk Factors,” those discussed and identified in public filings made with the SEC by us and the following:

 

   

changes in market prices, customer demand and preferences and competitive conditions;

 

   

general economic, political and business conditions in Brazil, particularly in the geographic markets we serve and others in which we intend to serve;

 

   

fluctuations in inflation and interest rates to which our debt is indexed;

 

   

our significant level of indebtedness and fixed obligations;

 

   

the risk that we may lose contracts through competitive bidding or be required to substantially lower prices in order to retain certain contracts, which could negatively impact our revenues, operating margins and operating cash flow generation, including the risk of compromising our capacity to meet financial obligations;

 

   

the outcome of investigations by government authorities under the applicable anti-corruption laws or otherwise, including the currently ongoing Operation Descarte, Operation Quinto Ano and other actions in relation to our former controlling shareholder;

 

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the outcome of alleged tax infringement charges by the Brazilian tax authorities and the possibility of further tax infringement charges relating to other facts and periods, including in relation to ongoing investigations and inquiries of the tax authorities;

 

   

the recruitment, compensation and retention of key personnel;

 

   

our ability to successfully defend ourselves in connection with various ongoing and future judicial, administrative or other third-party proceedings that could interrupt or materially limit our operations, divert our management’s attention and result in adverse judgments, settlements or fines and create negative publicity;

 

   

the strength and security of our information technology infrastructure and internal controls and our ability to successfully implement our remediation plan to address certain weaknesses in our internal controls;

 

   

our ability to retain our customers given that a significant portion of our revenue is derived from a small number of customers;

 

   

our ability to collect for the services we provide, which is dependent on the financial condition of our customers, especially that of our public sector customers;

 

   

our ability to successfully obtain or renew the necessary licenses to operate new landfills or expand existing ones;

 

   

our ability to adequately establish reserves and provisions for landfill site closure and post-closure costs and contamination-related costs;

 

   

existing and future governmental regulation, including in relation to environmental liabilities;

 

   

our ability to detect and prevent money laundering, improper payments and other illegal activities;

 

   

labor disputes, employee strikes and other labor-related disruptions, including in connection with negotiations with unions;

 

   

our ability to successfully implement our strategy, including those initiatives designed to improve our results of operations, including the restructuring of our debt and possibility of extrajudicial reorganization or a judicially-supervised reorganization process; and

 

   

other factors or trends affecting our financial condition or results of operations, including those factors identified or discussed under “Item 3.D.—Key Information—Risk Factors.”

Should one or more of these risks or uncertainties materialize, or should any of the assumptions made by our management prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements.

All subsequent written and oral forward-looking statements contained in this annual report and attributable to us or any person acting on their behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this annual report. Except to the extent required by applicable law or regulation, we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this annual report or to reflect the occurrence of unanticipated events.

 

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PART I

INTRODUCTION

 

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not Applicable.

 

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

Not Applicable.

 

ITEM 3.

KEY INFORMATION

 

A.

Selected Financial Data

The following selected financial information should be read in conjunction with “Presentation of Financial and Other Information,” “Item 5. Operating and Financial Review and Prospects” and our audited financial statements, which are included in this annual report.

The selected financial data as of and for the years ended December 31, 2018 and 2017 and for the three years ended December 31, 2018 have been derived from our audited financial statements, prepared in accordance with IFRS, and included in this annual report.

Statement of Profit and Loss

 

     For the year ended December 31,  
     2018     2018     2017
(restated)(1)
    2016
(restated)(1)
    2015
(restated)(1)
    2014
(restated)(1)
 
     (in millions
of US$)(2)
    (in millions of R$)  

Continuing operations

            

Revenue from services rendered

     325.4       1,260.6       1,345.8       1,380.0       1,328.9       1,282.6  

Cost of services

     (252.7     (979.2     (942.2     (1,003.7     (974.9     (932.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     72.6       281.4       403.6       376.3       354.0       349.6  

Operating income (expenses)

            

General and administrative expenses

     (84.5     (327.3     (256.5     (231.1     (222.5     (248.3

Selling expenses, net

     1.4       5.3       (6.7     10.5       13.3       (56.3

Share of (loss) profit of an associate

     (0.9     (3.3     (1.0     10.2       11.1       40.6  

Other operating expenses, net

     (148.8     (576.5     (31.1     (80.6     (24.7     139.3  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (232.8     (901.8     (295.3     (291.0     (222.9     (124.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before finance income and expenses

     (160.1     (620.4     108.3       85.3       131.1       224.9  

Finance expenses

     (65.0     (251.7     (532.2     (397.1     (384.0     (415.7

Finance income

     30.0       116.3       108.3       51.7       30.1       27.4  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income and social contribution taxes

     (195.1     (755.8     (315.6     (260.1     (222.7     (163.4

Current income and social contribution taxes

     (10.7     (41.6     (17.6     (54.3     (5.4     (48.6

Deferred income and social contribution taxes

     19.7       76.5       371.1       (49.8     12.6       41.6  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) for the year from continuing operations

     (186.1     (720.9     37.9       (364.2     (215.5     (170.4

Discontinued operations(1)

            

Profit after income and social contribution tax from discontinued operations

     7.9       30.5       14.4       3.3       (0.6     (44.8

Profit (loss) for the year

     (178.2     (690.5     52.3       (360.9     (215.0     (215.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Attributable to:

            

Equity holders of the parent

     (168.5     (652.8     43.8       (360.8     (215.0     (195.8

Non-controlling interests

     (9.7     (37.7     8.5       (0.2     (0.0     (19.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (178.2     (690.5     52.3       (360.9     (215.0     (215.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

7


Table of Contents
     For the year ended December 31,  
     2018     2018     2017
(restated)(1)
     2016
(restated)(1)
    2015
(restated)(1)
    2014
(restated)(1)
 
     (in millions
of US$)(2)
    (in millions of R$)  

Earnings (loss) per share(3)

             

- Basic, profit (loss) for the year attributable to equity holders of the parent (in Reais)

     (3.6919     (14.3032     0.9596        (7.9057     (4.7101     (4.2905

- Diluted, profit (loss) for the year attributable to equity holders of the parent (in Reais)

     (3.5382     (13.7076     0.9585        (7.9057     (4.7101     (4.2905

Earnings (loss) per share from continuing operations

             

- Basic, profit (loss) from continuing operations attributable to equity holders of the parent (in Reais)(4)

     (3.8537     (14.9299     0.6453        (7.9777     (4.6110     (3.7469

- Diluted, profit (loss) from continuing operations attributable to equity holders of the parent (in Reais)(4)

     (3.6932     (14.3082     0.6446        (7.9777     (4.6110     (3.7469

 

(1)

In 2018, our energy business, which is part of the Value Recovery segment, was classified as discontinued operations, and as a result of that classification, the statement of profit and loss for the years ended December 31, 2017, 2016, 2015 and 2014 have been restated for comparative purposes. See note 1.5.1 to our audited financial statements included elsewhere in this annual report.

(2)

Solely for the convenience of the reader, the amounts in reais for the year ended December 31, 2018 has been translated into U.S. dollars using the rate of R$3.8742 per U.S. dollar, which was the commercial selling rate for U.S. dollars as of December 31, 2018, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or any other exchange rate. See “—Exchange Rate Information” below.

(3)

Given that the Registrant is a new parent entity established to effect a share for share exchange in connection with the Transaction, and its audited financial statements have been presented as a continuation of the existing group, the number of shares taken as being issued for both the current and preceding periods was the number of shares issued by the new parent entity (Estre Ambiental, Inc.). In the calculation of earnings per share for the year ended December 31, 2016 presented in the audited financial statements, there were no changes in the number of outstanding ordinary shares of Estre Ambiental S.A. for that period that should be reflected in the calculation. Therefore, the weighted average number of shares was the same for all periods.

(4)

The calculation of basic earnings (loss) per share is based on the net income attributable to controlling equity holders of the Registrant and the proportional weighted average number of shares outstanding during the year. Diluted earnings per share is based on the net income attributable to controlling equity holders, as adjusted by the weighted average number of shares outstanding during the year assuming conversion of all potentially dilutive shares. For additional information, see note 34 to our audited financial statements included elsewhere in this annual report.

 

8


Table of Contents

Balance Sheet

 

     As of December 31,  
     2018      2018      2017      2016      2015  
     (in millions
of US$)(1)
     (in millions of R$)  

Assets

              

Current Assets

              

Cash and cash equivalents

     4.9        18.9        84.7        31.1        47.8  

Marketable securities

     0.0        0.0        0.0        —          12.1  

Trade accounts receivable

     129.5        501.8        669.2        716.8        512.7  

Contract asset.

     31.1        120.3        —          —          —    

Inventories

     2.2        8.6        11.4        8.7        8.1  

Taxes recoverable

     25.4        98.4        101.9        117.8        92.1  

Receivables from divestiture

     2.4        9.3        —          —          41.3  

Other receivables

     8.3        32.0        34.9        38.8        34.6  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     203.7        789.3        902.1        913.2        748.7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Assets held for sale

     21.0        81.5        6.6        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total current assets

     224.8        870.8        908.7        913.2        748.7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Noncurrent Assets

              

Marketable securities

     0.0        0.0        —          —          24.2  

Related Parties

     0.6        2.2        14.5        9.8        21.3  

Trade accounts receivable

     31.3        121.1        108.9        5.7        4.8  

Taxes recoverable

     8.1        31.2        52.1        4.5        22.2  

Prepaid expenses

     0.0        0.1        0.2        3.3        4.5  

Deferred taxes

     —          —          0.0        41.1        25.9  

Other receivables

     5.3        20.6        14.5        7.7        12.2  

Fair value of call option

     —          —          —          —          20.9  

Investments

     2.0        7.7        7.2        114.7        104.3  

Property, plant and equipment

     132.2        512.1        689.5        694.5        691.8  

Intangible assets

     15.2        59.0        588.2        553.8        607.1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total noncurrent assets

     194.6        754.0        1,475.1        1,434.9        1,539.6  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

     419.3        1,624.7        2,383.8        2,348.0        2,288.3  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities and Equity

              

Current liabilities

              

Loans and financing

     155.3        601.5        14.1        16.7        64.1  

Debentures

     249.4        966.4        —          1,665.6        1,417.1  

Provision for landfill closure

     1.4        5.6        20.7        15.5        —    

Trade accounts payable

     44.7        173.3        128.1        108.4        96.5  

Labor payable

     25.4        98.5        117.9        106.9        97.6  

Tax liabilities

     39.2        151.7        169.5        295.3        214.8  

Accounts payable from acquisition of investments

     —          —          —          4.9        47.0  

Related parties

     21.2        82.1        82.8        2.6        23.1  

Advances from customers

     3.9        15.0        16.5        0.6        3.5  

Accounts payable for land and intangible asset acquisition

     1.4        5.4        9.0        9.1        10.6  

Other liabilities

     5.1        19.8        33.0        29.5        6.5  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     547.1        2,119.4        591.6        2,255.1        1,980.9  

Liabilities directly associated with the assets held for sale

     10.6        41.2        23.8        24.2        17.9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

9


Table of Contents
     As of December 31,  
     2018     2018     2017     2016     2015  
     (in millions
of US$)(1)
    (in millions of R$)  

Total current liabilities

     557.7       2,160.6       615.4       2,279.4       1,998.8  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noncurrent liabilities

          

Loans and financing

     6.9       26.8       371.4       10       20.2  

Debentures

     —         —         1,069.0       —         —    

Provision for landfill closure

     25.0       96.8       92.9       86.1       83.1  

Provision for legal proceedings

     18.1       70.3       147.8       245.5       185.6  

Accounts payable from acquisition of investments

     —         —         —         4.9       26.7  

Tax liabilities

     93.5       362.3       395.8       236.1       213.1  

Deferred taxes

     13.5       52.3       137.0       175.6       110.6  

Accounts payable for land and intangible asset acquisition

     1.2       4.8       10.4       7.6       13.1  

Other liabilities

     0.1       0.2       0.2       39.9       18.3  

Total noncurrent liabilities

     158.3       613.4       2,224.4       805.7       670.6  

Equity

          

Capital

     0.0       0.0       0.0       108.1       108.1  

Capital reserve

     282.6       1,094.7       1,068.2       748.5       743.7  

Other comprehensive income

     (0.0     (0.0     1.8       1.7       1.5  

Treasury shares

     —         —         —         (37.4     (37.4

Accumulated losses

     (563.6     (2,183.4     (1,520.8     (1,564.5     (1,203.8

Non-controlling interest

     (15.6     (60.5     (5.1     6.6       6.7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity (capital deficiency)

     (296.6     (1,149.2     (455.9     (737.1     (381.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and equity

     419.3       1,624.7       2,383.8       2,348.0       2,288.3  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Solely for the convenience of the reader, the amounts in reais for the year ended December 31, 2018 has been translated into U.S. dollars using the rate of R$3.8742 per U.S. dollar, which was the commercial selling rate for U.S. dollars as of December 31, 2018, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or any other exchange rate. See “—Exchange Rate Information” below.

CONSOLIDATED STATEMENT OF CASH FLOW

 

     For the year ended December 31,  
     2018     2018     2017     2016     2015  
     (in millions of US$)(1)  

Net cash (used in) provided by

          

Operating activities

     5.4       21.0       243.3       213.5       235.2  

Investing activities

     (22.4     (86.9     (200.3     (166.7     (90.1

Financing activities

     0.4       1.7       10.6       (63.5     (210.4

 

(1)

Solely for the convenience of the reader, the amounts in reais for the year ended December 31, 2018 has been translated into U.S. dollars using the rate of R$3.8742 per U.S. dollar, which was the commercial selling rate for U.S. dollars as of December 31, 2018, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or any other exchange rate. See “Exchange Rate Information” below.

 

10


Table of Contents

Segment Information

The table below sets forth our statement of profit or loss by business segment for the periods indicated:

For the year ended December 31, 2018:

 

     Collection &
Cleaning
Services
    O&G     Landfills     Value
Recovery
    Corporate     Eliminations     Consolidated  
     (in thousands of R$)  

Domestic customers

     817,145       12,749       401,140       29,553       —         —         1,260,587  

Inter-segment

     44,831       45       55,427       1,777       —         (102,080     —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue from services

     861,976       12,794       456,567       31,330       —         (102,080     1,260,587  

Cost of services

     (731,424     (13,511     (306,673     (29,119     (2,253     103,797       (979,183
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit (loss)

     130,552       (717     149,894       2,211       (2,253     1,717       281,404  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income/(expenses)

              

General and administrative expenses

     (40,793     (96     (1,761     (187     (284,472     23       (327,286

Selling expenses, net

     (8,433     (189     (26,981     (1,782     42,709       —         5,324  

Share of profit of an associate

     —         —         —         —         (650,080     646,741       (3,339

Other operating income (expenses), net

     1,225       (6     4,949       (122     (580,829     (1,723     (576,506
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (48,001     (291     (23,793     (2,091     (1,472,672     645,041       (901,807
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before finance income and expenses

     82,551       (1,008     126,101       120       (1,474,925     646,758       (620,403

Finance expenses

     14,788       (541     (14,244     (77     (251,619     —         (251,693

Finance income

     8,536       73       6,535       603       100,566       —         116,313  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before income and social contribution taxes

     105,875       (1,476     118,392       646       (1,625,978     646,758       (755,783

(-) Current income and social contribution taxes

     (26,621     —         (479     —         (14,523     —         (41,623

(-) Deferred income and social contribution taxes

     292       —         —         —         76,196       —         76,488  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) for the year

     79,546       (1,476     117,913       646       (1,564,305     646,758       (720,918

Discontinued operations

              

Profit (loss) after tax for the year resulting from continuing operations

     —         —         —         3,285       27,169       —         30,454  

Net income (loss) for the year

     79,546       (1,476     117,913       3,931       (1,537,136     646,758       (690,464
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

11


Table of Contents

For the year ended December 31, 2017:

 

     Collection &
Cleaning
Services
    O&G     Landfills     Value
Recovery
    Corporate     Eliminations     Consolidated  
     (in thousands of R$)  

Domestic customers

     911,652       25,524       371,840       36,833       —         —         1,345,849  

Inter-segment

     17,171       331       83,558       897       —         (101,957     —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue from services

     928,823       25,855       455,398       37,730       —         (101,957     1,345,849  

Cost of services

     (673,024     (21,152     (316,305     (24,428     (9,303     101,957       (942,255
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit (loss)

     255,799       4,703       139,093       13,302       (9,303     —         403,594  

Operating income/(expenses)

              

General and administrative expenses

     (38,309     (42     1,290       (842     (218,629     —         (256,532

Selling expenses, net

     (16,261     —         37,468       280       (28,128     —         (6,641

Share of profit of an associate

     —         —         —         —         83,384       (84,404     (1,020

Other operating income (expenses), net

     (15,335     (4,509     (41,719     76,349       (45,911     —         (31,125
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (69,905     (4,551     (2,961     75,787       (209,284     (84,404     (295,318
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before finance income and expenses

     185,894       152       136,132       89,089       (218,587     (84,404     108,276  

Finance expenses

     (132,234     889       (37,757     (36     (363,037     —         (532,175

Finance income

     8,276       70       948       81       98,906       —         108,281  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before income and social contribution taxes

     61,936       1,111       99,323       89,134       (482,718     (84,404     (315,618

(-) Current income and social contribution taxes

     (8,613     —         (4,030     (62     (4,838     —         (17,543

(-) Deferred income and social contribution taxes

     22,552       —         16,897       —         331,635       —         371,084  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) for the year

     75,875       1,111       112,190       89,072       (155,921     (84,404     37,923  

Discontinued operations

Profit (loss) after tax for the year resulting from continuing operations

     6,506       —         799       7,037       —         —         14,342  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) for the year

     82,381       1,111       112,989       96,109       (155,921     (84,404     52,265  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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For the year ended December 31, 2016, as restated:

 

     Collection &
Cleaning
Services
    O&G     Landfills     Value
Recovery
    Corporate     Eliminations     Consolidated  
     (in thousands of R$)  

Foreign customers

     —         —         —         —         —         —         —    

Domestic customers

     869,333       62,799       420,293       27,606       —         —         1,380,031  

Inter-segment

     52,689       78       29,505       1,632       —         (83,904     —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue from services

     922,022       62,877       449,798       29,238       —         (83,904     1,380,031  

Cost of services

     (678,058     (41,583     (337,335     (22,002     (8,674     83,904       (1,003,748
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit (loss)

     243,964       21,294       112,463       7,236       (8,674     —         376,283  

Operating income/(expenses)

              

General and administrative expenses

     (38,105     (783     (10,206     (343     (163,680     (17,933     (231,050

Selling expenses, net

     268       897       26,293       8,532       (25,495       10,495  

Share of profit of an associate

     —         —         —         —         139,714       (129,562     10,152  

Other operating income (expenses), net

     (12,402     213       962       4       (69,328     —         (80,551
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (50,239     327       17,049       8,193       (118,789     (147,495     (290,954
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before finance income and expenses

     193,725       21,621       129,512       15,429       (127,463     (147,495     85,329  

Finance expenses

     (27,110     (1,326     (732     (11     (367,954     —         (397,133

Finance income

     1,506       1       18       16       50,122       —         51,663  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before income and social contribution taxes

     168,121       20,296       128,798       15,434       (445,295     (147,495     (260,141

(-) Current income and social contribution taxes

     —         —         —         (1     (54,336     —         (54,337

(-) Deferred income and social contribution taxes

     —         —         —         —         (49,755     —         (49,755
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) for the year

     168,121       20,296       128,798       15,433       (549,386     (147,495     (364,233

Discontinued operations

Profit (loss) after tax for the year resulting from continuing operations

     —         —         41       3,247       —         —         3,288  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) for the year

     168,121       20,296       128,839       18,680       (549,386     (147,495     (360,945
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Exchange Rate Information

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 Central Bank has allowed the U.S. dollar-real exchange rate to float freely. Since then, the U.S. dollar-real exchange rate has fluctuated considerably.

The Central Bank has intervened occasionally to control unstable movements in foreign exchange rates. We cannot predict whether the 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. See “—D. Risk Factors—Risks Related to Brazil—The Brazilian economy and we may be negatively impacted by exchange rate instability.”

The real may depreciate or appreciate against the U.S. dollar substantially. See “—D. Risk Factors—Risks Related to Brazil—The Brazilian economy and we may be negatively impacted by exchange rate instability.”

Furthermore, Brazilian law provides that, whenever there is a serious imbalance in Brazil’s balance of payments or there are substantial reasons to foresee a serious imbalance, the Brazilian government may impose temporary restrictions on the remittances of foreign capital abroad and on the conversion of Brazilian currency into foreign currencies. We cannot assure you that such measures will not be taken by the Brazilian government in the future. See “—D. Risk Factors—Risks Related to Brazil—The Brazilian economy and we may be negatively impacted by exchange rate instability.”

 

 

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For convenience purposes only, the amounts in reais for the year ended December 31, 2018 presented throughout this annual report have been translated to U.S. dollars using the rate R$3.8742 per U.S. dollar, which was the commercial selling rate for U.S. dollars as of December 31, 2018, as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or any other exchange rate. The real has fluctuated significantly over the course of 2018 due in part to the general strengthening of the U.S. dollar worldwide and reflecting lower Brazilian interest rates and a high degree of political uncertainty.

The following table shows the period end, average, high and low commercial selling real/U.S. dollar exchange rate reported by the Central Bank on its website for the periods and dates indicated.

 

     R$ per US$1.00
Year Ended December 31,    Low    High    Average(1)    Period End

2013

   1.95    2.45    2.16    2.34

2014

   2.20    2,74    2.35    2.66

2015

   2.58    4.19    3.34    3.90

2016

   3.12    4.16    3.48    3.26

2017

   3.05    3.44    3.19    3.31

2018

   3.14    4.19    3.66    3.87

 

(1)

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

 

B.

Capitalization and Indebtedness

Not applicable.

 

C.

Reasons for the Offer and Use of Proceeds

Not applicable.

 

D.

Risk Factors

An investment in our ordinary shares carries a significant degree of risk. You should carefully consider the following risks and other information in this annual report, including our audited financial statements included elsewhere in this annual report, before you decide to purchase our ordinary shares. Additional risks and uncertainties of which we are not presently aware or that we currently deem immaterial could also affect our business operations and financial condition. If any of these risks actually occur, our business, financial condition, results of operations or prospects could be materially affected. As a result, the trading price of our ordinary shares could decline and you could lose part or all of your investment.

Risks Related to Our Business

We may lose contracts through competitive bidding or be required to substantially lower prices in order to retain certain contracts, which could negatively impact our revenues.

We derive a significant portion of our revenues from markets in which we have exclusive arrangements pursuant to municipal contracts. Our municipal contracts are for a specified term and are, or will be, subject to competitive bidding in the future. Although we intend to bid on additional municipal contracts in our target markets from time to time if and when suitable opportunities arise, we may not, if ever, be successful in winning bids, especially considering the significant increase in competitivity and margin compression in the market during the course of 2018. In addition, municipalities may unilaterally terminate any agreements on grounds of serving the public interest. If we are unable to replace revenue from contracts lost through competitive bidding or early termination or from lowering prices pursuant to the competitive bidding process for existing contracts, our revenues could decline.

Governmental action may also affect our exclusive arrangements. Municipalities may decide to develop their own landfills, on an optional or mandatory basis, which may cause us to lose customers. If we are not able to replace lost revenues within a reasonable time period, our business results of operations and financial condition could be adversely affected. Additionally, the loss of municipal contracts through competitive bidding, early termination or governmental action could cause long lived tangible and intangible assets to be impaired and require a charge against earnings.

 

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In addition, the risks described under “—Risks Related to Compliance and Control” have caused, and may in the future cause, us to be unable to participate in certain competitive bidding processes, which may cause a significant decline in our revenues. For example, Estre was classified as a Compliance High Risk Supplier by Petrobras in the past and, as such, was not permitted to participate in certain of Petrobras’ bidding processes.

A significant portion of our revenue is derived from a small number of customers, and partial or full loss of revenues from any such customer may adversely affect our revenues and results of operations. In particular, the municipality of São Paulo is currently serviced based on a short-term temporary contract which will end on June 1, 2019. The loss of business from the São Paulo contract will have a material adverse impact on us.

Our customer base includes a mix of customers operating in both the private and public sectors. As of December 31, 2018, we had 138 municipal customers and more than 3,000 private sector customers, serving approximately 31 million individual customers daily. Although we have a diversified customer base across our four business segments, our top 13 customers accounted for 72.9% of our total net revenue in the year ended December 31, 2018. In addition, our top 5 costumers represent 38.2% of our revenue from the Landfills segment, totaling 12.1% of our total net revenue and 8 customers accounted for 93.7% or more of our revenue from the Collection & Cleaning segment, totaling 60.7% of total net revenue in the year ended December 31, 2018.

In addition, we rely significantly on certain municipal customers within our Collection & Cleaning segment as a source of revenues, namely the municipalities of São Paulo and Curitiba. Together, our contracts with the municipalities of São Paulo and Curitiba represented 79.0% of the net revenues from services rendered for the Collection & Cleaning segment for the year ended December 31, 2018, and 39.9% of our total net revenues from services that year. Competitive bidding processes are inherently subject to a high degree of uncertainty, and there can be no guarantee that past practices will be indicative of future success. As described below under “—Our contract with the municipality of São Paulo”, we will no longer provide services in São Paulo as of June 1, 2019 when our emergency temporary contract will be terminated. As described below under “Our contract with the municipality of Curitiba”, our contract with Curitiba has been renewed and we signed a five-year contract on January 3, 2019.

Moreover, we cannot assure you that we will be the successful bidder in bidding processes for any other competitive bidding process we participate in. In addition, even if we are successful in the bidding process and enter into new contracts with our most significant customers, the terms of the contracts might differ and might not be as favorable to us as those contracts currently in place, resulting in less revenue from these customers. The loss or adverse modification of any material customer contract could have a material adverse effect on our business, results of operations and financial condition.

While Brazilian law does not allow the term extension of government contracts already expired, public administrators may exercise their right to hire the same contractor on a provisional basis for a temporary period based on a waiver of the bidding process. Provisional service pursuant to a temporary contract may be with any service provider, not just the last serving contractor. These temporary contracts must be limited to a 180-day term, counted as of the occurrence of the exceptional circumstances giving rise to the auction delay, and may be terminated by the municipality at its discretion at any time, including as a result of the conclusion of the formal bidding process. As a general rule, temporary contracts entered into on an emergency basis may not be extended. However, as the collection of MSW is considered an essential service under Brazilian law, once the initial 180-day period expires on a temporary contract, municipalities may continue to extend for subsequent 180-day periods.

Our contract with the municipality of São Paulo

We have been servicing the São Paulo contract through Soma since 2011. Our contract with the municipality of São Paulo for urban cleaning and street sweeping services represented approximately 25.5% of our revenues in 2018 (29.1% of our revenues in 2017). This contract expired in the end of 2017, and we are currently providing urban cleaning services to the city of São Paulo pursuant to a temporary contract. The temporary contract was first entered into on December 15, 2017 and expired in June 2018. On June 12, 2018, we further extended the temporary contract until the end of 2018. In December 2018, we further extended the temporary contract until the end of May 2019 and, on May 2, 2019, we were informed that our emergency contract with the municipality of São Paulo will be terminated on June 1, 2019, at which point we will no longer provide services in São Paulo. The extended temporary contract introduced in June 2018 certain significant changes to the contractual arrangement. Most significantly, under the extended temporary contract, the city of São Paulo has been divided into six separate parcels for urban cleaning, whereas under the previous contract the city had been divided into two parcels only. We, through Soma, were awarded only two parcels under the extended temporary contract, which reflects a significant decrease of our service area, since we previously serviced one of the only two parcels. As a result these changes, monthly revenues under the extended temporary contract decreased approximately 40% starting in June 2018 and as a result our revenues from the contract with the municipality of São Paulo for urban cleaning and street sweeping services decreased to approximately 31.8% of our revenues in 2018.

 

 

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After a series of delays, a new bid for the São Paulo contract was initiated in October 2018, in which the Company participated. In connection with the bidding process, São Paulo has divided the urban cleaning contract into six separate parcels, in line with the extended temporary contracts entered into in June 2018. The Company was not the bidder with the lowest price for any of the six parcels in São Paulo and, on May 2, 2019, we were informed that our emergency contract with the municipality of São Paulo will be terminated on June 1, 2019, at which point we will no longer provide services in São Paulo. The loss of the São Paulo cleaning contract will result in a significant reduction in our revenues, which will have an adverse impact on us.

Considering the significance of the São Paulo contract in terms of revenues, it can be expected that our revenues will materially decrease upon the termination of the contract. According to management estimates, and based on our original revenue expectations for 2019, the impact of losing the São Paulo contract on an annualized basis will result in an estimated decrease in revenues of 25.1%.

A relevant part of our operational structure is designed to serve the São Paulo contract and, upon its termination, we will be required to significantly reallocate resources, including the termination of employees currently servicing this contract and/or closure of certain facilities and projects solely related to our current operations in São Paulo, all of which will have a cash impact in the short-term of approximately R$22 million, which amount is stated after taking account of the cash expected to be generated from the sale of assets previously used in such operation. Furthermore, given the medium and long term nature of the majority of our contracts, we will not have the flexibility to immediately offset a decrease in revenues by increasing prices. Given the staggered timing of attractive competitive bidding opportunities occurring only on an intermittent basis as existing contracts come due, we will likely face challenges to quickly replace the lost revenues with new collections business. Given the size of the city of São Paulo, being the largest city in Brazil in terms of population according to 2017 IBGE data, we would likely have to secure several smaller contracts to replace the revenues lost under the contract. The significant loss of revenues could, in turn, impact our ability to comply with the covenants under any of our indebtedness or make payments as they come due.

Our contract with the municipality of Curitiba

Cavo, which we acquired in 2011, has been servicing the Curitiba contract since 1995. Our contract with the municipality of Curitiba for collections, urban cleaning and street cleaning comprised approximately 12.0% of the Company’s revenues in 2018 (12.5% in 2017). In October 2018, we won the competitive bidding process for the Curitiba collections and cleaning contract. We signed a five-year contract on January 3, 2019 with a maximum value of R$844.8 million (a reduction in price of approximately 14.1% compared with the previous contract) and are currently providing the contractual services to Curitiba. In connection to the new contract, we are required to incur in expenses in order to comply with the terms of the new contract, which could further affect our short-term liquidity and therefore impact our ability to make payments as they become due.

As of December 31, 2018 we recorded significant negative working capital and capital deficiency, we are currently in breach of certain financial covenants and contractual obligations, and our ability to avoid a judicial reorganization is dependent on our ability to successfully complete a debt restructuring and significantly improve our liquidity position

We incurred net losses from continuing operations of R$720.9 million and R$364.2 million in the years ended December 31, 2018, and 2016, respectively, and while we recorded profits from continuing operations of R$37.9 million in 2017, such results were primarily driven by the gains recorded under deferred income and social contribution taxes as a result of our recognition of tax loss carryforwards in connection with our participation in the Brazilian Tax Regularization Program. As of December 31, 2018, we recorded negative working capital (calculated as total current assets minus total current liabilities) of R$1,289.8 million and a capital deficiency (calculated as total assets minus total liabilities) of R$1,149.2 million. As of December 31, 2017, we recorded working capital of R$293.4 million and a capital deficiency of R$455.9 million, and as of December 31, 2016, we recorded negative working capital of R$1,366.2 million and a capital deficiency of R$737.1 million.

 

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As a result of liquidity constraints, the Company was not able to comply with the financial covenants included in its Debt Instruments for the year ended on December 31, 2018 and we are currently in breach of such covenants. In addition, on March 6, 2018, Angra confirmed the exercise of its put option to sell all of its shares of the Company. While we were required to pay the exercise price of approximately R$40.3 million by September 6, 2018, as of the date of this annual report, we have not yet made any payments to Angra due to our liquidity constraints, and the rescheduled payment terms are still being negotiated. See “Major Shareholders and Related Party Transactions—Share Put Option Agreement” and “—We are in default under the Angra Put Option Agreement, and if we are unable to reach an agreement with Angra to resolve the default, Angra can exercise remedies against us” below. Our management has identified several significant obligations arising during 2019 that require funding through liquidity, primarily relating to (a) the payments we are required to make for severance and other demobilization costs related to discontinued operations (for example, the contract with the municipality of São Paulo for cleaning services, which will be terminated on June 1, 2019, at which point we will no longer provide services in São Paulo) and (b) capital expenditures (e.g., new trucks and equipment) required in connection with contract renewals, such as the investment obligations arising under the contract with the municipality of Curitiba for cleaning services, which was renewed on January 3, 2019 for an additional five year period. Furthermore, as of December 31, 2018, the Company had aggregate overdue trade accounts of R$85.9 million, and there can be no assurance that such trade creditors will not demand immediate payment or use a variety of legal remedies to enforce their claims, which may further constrain our liquidity, further jeopardize our ability to continue as a going concern and increase the risk that we become subject to bankruptcy proceedings.

We are engaged in efforts to generate liquidity in order to improve our liquidity position and fund our obligations, including negotiations in respect of the sale of certain assets, which sales will likely require the approval of the holders of our Debt Instruments. In addition, the Company, with the approval of our board of directors, has initiated negotiations with the holders of the Debt Instruments, as well as other relevant creditors including Angra, with the goal of restructuring its financial and such other debt. In that regard, the Company engaged an outside restructuring advisor as well as outside legal counsel to advise in connection with the debt restructuring process. The Company is currently seeking to conclude the debt restructuring process in the course of 2019.

There can be no assurance that the debt restructuring process will be successful or that we will be able to generate sufficient liquidity in order to fully address our liquidity concerns. Our inability to significantly improve our liquidity position and comply with our financial covenants and other payment obligations, including overdue amounts owed to trade creditors, could have a material adverse effect on us and result in an extrajudicial reorganization or a judicially-supervised reorganization process, which may result in our shareholders losing their entire investment.

We have a significant level of indebtedness, including debt issued pursuant to the Debt Instruments, which is secured by a significant amount of our assets and contains financial covenants; we are currently in breach of our financial covenants and such breach and our high level of indebtedness generally may materially adversely affect us and our ability to successfully implement our strategic plan and continue our operations and may result in our bankruptcy.

We have substantial indebtedness. As of December 31, 2018, our total financial indebtedness, consisting primarily of outstanding balances on our debentures and working capital loans and, to a lesser extent, BNDES loans and financings and finance leases, was R$1,594.7 million, as compared to R$1,454.5 million and R$1,692.3 million as of December 31, 2017 and 2016, respectively. Of these total amounts, 97.6% of our total indebtedness was linked to floating rates as of December 31, 2018 as compared to 98.7% and 99.1% as of December 31, 2017 and 2016, respectively.

Furthermore, a significant part of our assets have been pledged as collateral to secure repayment of the Refinanced Debt. The Refinanced Debt is secured by collateral consisting of: (i) a lien on all real estate relating to the operational landfills; (ii) a lien on all material subsidiaries controlled, directly or indirectly, by us; (iii) a fiduciary assignment of the remaining balance originated from the foreclosure of liens described in this paragraph; and (iv) corporate guarantees of all material subsidiaries controlled, directly or indirectly, by us. The debt admission instrument related to our first issuance of debentures is also secured by a fiduciary assignment of certain real estate assets owned by us. In addition, the Refinanced Debt is secured by a fiduciary lien on all (except for 4.38% secured for the benefit of Angra) of the Company’s common shares as security for the payment of all obligations related to the Refinanced Debt. For further information, see “Item 5.B. Operating Financial Review and Prospects —Indebtedness—Debentures—Debt Restructuring and Refinanced Debt.”

 

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The Debt Instruments also contain financial and other covenants. In particular, they require us to maintain certain financial ratios, which are measured semi-annually as of June 30 and December 31 of each year, on a Company consolidated basis, starting on December 31, 2018. As of December 31, 2018, the Company did not comply with its financial covenants, i.e. (i) the Company’s consolidated annual net debt to EBITDA ratio was 7.9x and exceeded the permitted maximum ratio of 4.0x, and (ii) the debt service coverage ratio of the Company was negative 15.6x, below the mimimum ratio of 1.2x. As a consequence of our non-compliance with the financial covenants under the Debt Instruments, lenders are entitled to accelerate the debt obligations. The Company has initiated negotiations with the holders of its Debt Instruments and we currently do not expect that the relevant creditors will accelerate the debt obligations in the near future. However, the lenders have not provided any formal waivers with respect to the non-compliance of the financial covenants.

Our high amount of indebtedness, related collateral and the breach of the financial covenants set forth in our Debt Instruments:

 

   

entitles the holders of our debentures to accelerate the debt obligations and may result in the execution against any collateral securing such indebtedness;

 

   

may result in cross-defaults under our other indebtedness, which in turn could result in the acceleration of our other indebtedness and in the execution against any collateral securing such indebtedness;

 

   

could force us to undergo a judicial reorganization or result in our bankruptcy;

 

   

increases our vulnerability to general adverse economic and industry conditions and an increase in interest rates;

 

   

limits our ability to obtain additional financing or refinancing on acceptable terms or at all;

 

   

may force us to reduce or delay capital expenditures, sell assets, restructure or refinance all or part of our existing debt, or seek additional equity capital, any of which may not be available on terms that are favorable to us or to our shareholders, if at all;

 

   

will, once the grace period for the payment of interest in cash in respect of the Refinanced Debt expires in December 2019 and once our grace period for the payment of principal of the Refinanced Debt expires in December 2020, require the dedication of a substantial portion of our cash flow from operations to the payment of interest on, and principal of, our indebtedness, thereby reducing the availability of such cash flow to fund our operations;

 

   

limits our flexibility in planning for, or reacting to, changes in our business and the industry; and

 

   

places us at a competitive disadvantage relative to our competitors with less debt.

Considering our unsustainably high level of indebtedness and the breach of the financial covenants set forth in our Debt Instruments, we are engaged in efforts to improve our financial position. In that regard, the Company, with the approval of our board of directors, has initiated negotiations with the holders of the Debt Instruments, as well as other relevant creditors such as Angra with the goal of restructuring its financial and such other debt. The Company engaged an outside restructuring advisor as well as outside legal counsel to advise in connection with the debt restructuring process. The Company is currently seeking to conclude the debt restructuring process during the course of 2019. However, there can be no assurance that the debt restructuring process will be successful or that we will be able to otherwise address our high level of indebtedness and distressed financial situation. Our inability to do so may result in our bankruptcy, which may result in our shareholders losing their entire investment.

We are in default under the Angra Put Option Agreement, and if we are unable to reach an agreement with Angra to resolve the default, Angra can exercise remedies against us.

On March 6, 2018, our former shareholder Angra confirmed the exercise of its put option to sell all of its shares of the Company. As a result of such exercise, Angra transferred 8,871,895 shares to the Company, which are currently held in treasury, and we were required to pay the exercise price of approximately R$40.3 million by September 6, 2018. However, as of the date of this annual report, as a result of our liquidity constraints, we have not yet made any payments to Angra with respect to the share transfer, but are negotiating alternative payment terms with Angra.

On September 11, 2018, we received a letter from Angra stating that we are in default under the Angra Put Option Agreement as a result of our failure to pay the put option amount when due and that additional amounts may be due to Angra because of our default, including default interest payments. We are in ongoing negotiations with Angra regarding the payment terms, which are conducted concurrently with our efforts to restructure our Debt Instruments and part of our larger debt restructuring efforts. There are no assurances that our negotiaions with Angra will be successful and Angra has reserved all of its rights, remedies, actions and powers to which it may be legally entitled. As a result, Angra may seek certain remedies afforded to them under the Angra Put Option Agreement and otherwise under Brazilian law, including the enforcement of their security interest of 4.38% of the share capital of the Company.

 

 

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Our default under the Angra Put Option Agreement, if not cured, could also constitute an event of default under the cross-default provisions of our other indebtedness. If a default occurs under the Debt Instruments, in particular, the holders of such debt could accelerate the indebtedness, demand immediate payment and use a variety of legal remedies to enforce their claims. If any of these defaults and the acceleration of any of our debt were to occur, it is unlikely that we would be able to continue as a going concern and we may have to declare, or be forced into bankruptcy.

Our auditors have issued a “going concern” audit opinion, and our ability to continue as a going concern is dependent on our ability to significantly improve our liquidity position

Our management has concluded that substantial doubt exists with respect to our ability to continue as a going concern through one year after the date of issuance of our audited financial statements as of and for the year ended December 31, 2018. In addition, as a result of our material liquidity issues, our independent auditors have indicated, in their report on our audited financial statements that there exists significant uncertainty that could raise doubt about our ability to continue as a going concern. These doubts regarding our ability to continue as a going concern relate to our history of suffering recurring losses from operations, the ongoing process of renegotiating our debt obligations and our net capital deficiency, resulting in substantial doubt as to our ability to continue as a going concern.The audited financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

Our liquidity and our ability to continue as a going concern is dependent on various factors, including our ability to successfully complete a debt restructuring and generate additional liquidity through asset sales, and there are no assurances that we will be successful in our efforts to maintain a sufficient cash balance, report profitable operations in the future or pay our debts as they fall due, any of which could impact our ability to continue as a going concern. Any such inability to continue as a going concern may result in our shareholders losing their entire investment.

Our ability to collect for the services we provide is dependent on the financial condition of our customers, especially that of our public sector customers. The inability of our customers to pay in a timely manner or at all could result in increased working capital requirements and could have a material adverse effect on our business, results of operations and financial condition.

Our ability to collect amounts due pursuant to the terms of the contracts that we have entered into with our customers is largely dependent upon the financial condition of these customers. A significant portion of our customers are municipal entities, which are particularly sensitive to the impact of the macroeconomic and political environment, including election cycles, and, as a result, have historically demonstrated high rates of payment delinquency. As of December 31, 2017, our accounts receivable from customers totaled an aggregate R$969.8 million, 85.8% of which corresponded to accounts receivable from public sector customers, while our provisions for doubtful accounts from customers totaled R$157.2 million as of the same date, 82.9% of which corresponded to provisions for doubtful accounts from public sector customers. As of December 31, 2018, our accounts receivable from customers totaled an aggregate R$765.3 million, 87.0% of which corresponded to accounts receivable from public sector customers, while our provisions for doubtful accounts from customers totaled R$109.9 million as of the same date, 43.5% of which corresponding to provisions for doubtful accounts from public sector customers.

Brazil entered into a recession in 2014 and continues to face macroeconomic challenges (see “—Risks Related to Brazil”). We have observed that challenging macroeconomic circumstances generally impact many of our customers, particularly our municipal customers. Due to negative macroeconomic conditions, many municipalities in Brazil have suffered significant financial difficulties, reduced tax revenues, decreased federal funding and increased cost structures, all of which have imposed material budgetary constraints and cash shortfalls. Governmental entities and municipalities allocate significant portions of their budgets to waste management services costs, according to the Brazilian Ministry of Cities, so their likelihood of material delays in the payment of accounts receivable under existing contracts are exacerbated in an adverse macroeconomic scenario with increased budgetary pressures. As a result of these factors, we continue to experience increased payment delays of our public sector customers in line with delays experienced by the industry as a whole. Overall, the balance of accounts payable by Brazilian municipalities with waste management companies in Brazil has reached approximately R$11.6 billion as of December 31, 2017 according to Selur-SP (Sindicato das Empresas de Limpeza Urbana do Estado de São Paulo).

 

 

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Pursuant to Brazilian law, public services may be suspended in the event the payment for past services is past due for more than 90 days, unless the suspension could result in severe disturbances of the public order. Certain of our public entity customers might argue that the suspension of our services thereunder might result in a severe disturbance of the public order, forcing us to provide such services even in the event of contractual breaches, including failure to honor payment obligations. In addition, although Brazilian law does not permit public entities to declare bankruptcy and forfeit on their obligations, it nevertheless provides them with certain extraordinary rights under distressed circumstances that provides public entities with flexibility in honoring their contractual commitments. Although such rights are subject to certain limitations, some of our public entity customers have in the past resorted to such mechanisms, resulting in payment delays and/or the renegotiation of the schedule of payments of our accounts receivable, and we expect such practices to continue in the future under certain circumstances. See “Item 5.A. Operating Financial Review and Prospects—Key Factors Affecting Our Results of Operations—How We Generate Revenue—Summary of Our Trade Accounts Receivable Policy.”

Our private sector C&I customers are also negatively affected by market forces and adverse financial and economic conditions beyond our or their control, which may result in increased delinquency or cause customers to terminate or not to renew their contracts with us. In particular, our operations serve clients in the Brazilian oil and gas, civil construction and industrial sectors, and these sectors have been acutely impacted by the ongoing Lava Jato corruption investigations in Brazil (see “—Risks Related to Brazil”).

The inability of our customers, both public and private, to pay us in a timely manner or, in the case of C&I customers, to pay the contracted rates, could have a material adverse effect on our business, results of operations, liquidity and financial condition. In addition, we may incur increased litigation expenses in our attempt to recover past-due amounts due to us from our customers, which may materially adversely affect our margins and results of operations.

We may not be successful in obtaining or renewing the necessary licenses to operate new landfills or expand existing ones. Further, the cost of operation and/or future construction of our existing landfills may become economically unfeasible, causing us to abandon or cease such operations.

As of December 31, 2018, we operated 12 active landfills and are in the process of developing another three greenfield landfill projects in Brazil. In Brazil, the operation of landfills is subject to various licensing requirements at the municipal, state and federal level, which specific requirements vary from location to location as well as across the regulatory spectrum, depending in part on the particular characteristics, size, location, and potential environmental impacts of each landfill. The licensing process generally comprises three phases: (i) preliminary licensing, whereby initial discussions with the pertinent environmental agencies are held, the basic conditions and milestones for the project are demonstrated and analyzed, such as its location, concept and environmental feasibility, and the basic requirements to be met during subsequent implementation phases are established; (ii) installation licensing, whereby we demonstrate our compliance with all technical specifications, terms and conditions established for the project during the preliminary licensing phase based on the approved project plans, programs and designs, including environmental control measures, and thus authorizes the implementation of the project and commencement of construction which culminates in a final review by the relevant environmental agency before the project becomes operational, and (iii) operating licensing, whereby, after implementing the project in accordance with all previously established requirements and undergoing a final review, which the operation of the project is authorized in compliance with the technical conditions set forth therein, including any environmental control measures and operating conditions. For more information, see “Item 4.B. Information on the Company—Business Overview—Licensing Regulations for Landfills.” Any delays or denials by the environmental licensing authority in issuing or renewing licenses, as well as the inability to meet the requirements established by the environmental authorities during the environmental licensing process, may delay or even prevent the construction, development and regular maintenance of our landfills, transfer stations and greenfield projects.

Our current strategic focus involves the expansion of our landfill business and, therefore, our ability to meet our business objectives depends significantly on our ability to acquire or renew landfill licenses to expand existing landfills and develop new landfill sites. The process of obtaining or renewing the required licensing to build, operate and expand solid waste management facilities, including landfills and transfer stations, can involve substantial costs over a multi-year period and is subject to a high degree of uncertainty, frequently involving factors outside of our control. Licenses to operate a landfill must be renewed numerous times during the useful life of a landfill (typically, every two to five years) pursuant to a process that requires compliance with zoning, environmental and other requirements, and may be challenged by the Public Prosecutor’s Office, special interest groups and other stakeholders. Such challenges may result in the denial of a license’s issuance or renewal, or its suspension for a shorter duration than we may have originally anticipated, or the imposition of burdensome terms and conditions that may not be favorable to us, each of which could adversely affect our business, results of operations and financial condition. Moreover, the difficulty, time and expense in obtaining and complying with licensing requirements may prevent us from taking advantage of profitable opportunities or reacting to changing market dynamics, which could adversely affect us.

 

 

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After we acquire the land on which we intend to build a landfill, the process of obtaining an operating license is generally expected to take between three and five years, and, in case we are unable to secure the necessary licensing to operate the landfill in accordance with our expectations, we may elect to abandon our development plans and incur a loss in connection with a particular landfill, as has happened in the past in the case of our previous Arapiraca and Cabrália landfill projects. Such occurrence would be highly disruptive to our business plan and, due in part to the upfront costs involved in developing a landfill, could cause a material and adverse effect on our business, results of operations and financial condition.

In addition, our operating licenses must be renewed periodically. Accordingly, as a result of this renewal process, it is possible that the operation or expansion of existing landfills may become economically unfeasible based on management’s assessment of licensing issues, acceptable waste streams, available volumes and operating costs, in which case we may abandon expansion plans or abandon or cease operations entirely at a particular landfill. Any such decision could result in impairment charges as well as ongoing costs for closure and site remediation, which would adversely impact us.

Our reserves and provisions for our landfill site closure and post-closure costs and contamination-related costs may be inadequate.

We are required to pay capping, closure and post-closure maintenance costs for all of our landfill sites. Our obligations to pay closure or post-closure costs or other contamination-related costs may exceed the amount we have accrued and reserved and other amounts available from funds or reserves established to pay such costs. We estimate capping, closure and post-closure maintenance costs and establishes reserves considering the type of landfill, volumetric capacity and the density of the waste to be disposed at a particular site. Any defect or failure in judgment in connection with such assumptions could lead to substantially higher costs than anticipated.

In addition, according to Brazilian regulations, subsequent to the closure of a landfill site, we must continue to monitor and maintain the underground and surface water, leachate treatment, gas collection system, drainages and capping of closed landfills for so long as the closed site is no longer potentially harmful to the environment or the community. In order to satisfy such obligation, we are required to, among other measures, calculate and provision the expected costs associated with such activities, taking into account the particular conditions, the characteristics of each landfill site and the planned future uses of the site, as well as the expected costs of securing the perimeter of such landfill sites and maintaining the necessary on-site structures. We cannot assure you that we will have established sufficient reserves for all potential liabilities in connection with our landfill closure activities, and we may become liable for unforeseen environmental issues that could result in payment of substantial costs that may not have been fully provisioned, such as remediation costs, that could adversely affect our financial condition or operating results. See “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Critical Accounting Policies—Landfill accounting and provision for landfill closure.”

The Brazilian waste management industry is fragmented and characterized by a high degree of competition.

The Brazilian waste management industry is highly fragmented, with no single player accounting for more than 15.0% of market share, and the top five largest players collectively accounting for 42.4% in 2017, according to the most recent ABRELPE data in conjunction with our internal studies. This high degree of fragmentation corresponds to an exceedingly competitive environment requiring substantial labor and capital resources to maintain and capture business. Some of the markets in which we compete or plan to compete are served by one or more large companies, as well as by regional and local companies of varying sizes and resources, some of which may have accumulated substantial goodwill in their markets.

Some of our competitors may be better capitalized in comparison, benefitting, in some cases, from the infrastructure and financial backing of international platforms, while other competitors may have greater name recognition than us, or be able to provide or be willing to bid their services at a lower price than we may be willing or able to offer. We may also face competition from companies that possess more specialized, technical expertise in certain niche services or markets.

We also compete with counties, municipalities and solid waste districts that maintain or could in the future choose to carry out and maintain their own waste collection and disposal operations. These operators may have financial advantages over us because of their access to user fees and similar charges, tax revenues, tax-exempt financing or government subsidies.

An increase in these or other competitive pressures, or our inability to compete effectively, could hinder our growth or adversely impact our business, results of operations and financial condition.

 

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Our business requires a high level of capital expenditures.

Our business is capital-intensive. We must use a substantial portion of our cash flows from operating activities toward capital expenditures, which reduces our flexibility to use such cash flows for other purposes, such as reducing indebtedness. For example, pursuant to certain services contracts we are required to devote significant capital amounts to invest in the renewal of our vehicle fleet, the failure of which could result in the breach of certain obligations under the applicable contract and potentially lead to a suspension, or early termination, of such contracts. We are also required to invest significant capital in the opening and development of new landfill cells, the failure of which could result in damage to our landfill operations and ability to continue to receive hazardous and nonhazardous waste. Our capital expenditures could increase if we make acquisitions or further expand our operations or as a result of factors beyond our control, such as changes in federal, state, local or international requirements. The amount that we spend on capital expenditures may exceed current expectations, which may require us to obtain additional funding for our operations thereby adding additional stress on our liquidity position and adversely affecting us.

The waste management industry is characterized by increasing technological innovation, and our success depends on our capacity to enhance and maximize our existing services and develop new services.

We and others in the industry are increasingly focusing on new technologies that provide alternatives to traditional disposal and maximize the resource value of waste. If we fail to develop or adapt our services on a timely and cost-efficient basis to address customer needs in an evolving technological environment or to respond to regulatory or legislative changes, our competitiveness will be negatively impacted and our customer retention may suffer. We may experience difficulties or delays in the research, development, production or marketing of new services, which may negatively impact or operating results and prevent us from recouping or realizing a return on the investments required to bring new services to market. In particular, if a competitor develops or obtains exclusive rights to a breakthrough technology that provides a revolutionary change in traditional waste management, our financial results may suffer.

The renegotiation of collective bargaining agreements with the labor unions representing our employees may result in increased costs and other disruptions to our business.

Our employees are represented by labor unions with a strong presence in the waste management market. We have entered into collective bargaining and other agreements with each of these unions through a special committee, which agreements define, among other matters, the length of the work day, minimum compensation, vacations and other ancillary benefits for our employees. We renegotiate these agreements on an annual basis and, historically, have significantly adjusted the terms of these agreements upon renegotiation. When we renegotiate wage and salary adjustments, including the establishment of minimum wage thresholds, we typically use the inflation rate as a reference. Our personnel costs may increase significantly as a result of our renegotiation of collective bargaining agreements, which represents a major part of our cost of services. Our business and results of operations may be materially adversely affected if we are not able to pass the increased costs arising from the renegotiation of collective bargaining agreements onto our customers through inflation-based price increases. In addition, we may be negatively impacted if we otherwise fail to maintain harmonious relationships with the labor unions representing our employees, which could lead to strikes, work stoppages or other labor disruptions by its employees. Depending on the type and duration of any labor disruptions, our operating expenses could increase significantly, which could adversely affect our financial condition, results of operations and cash flows.

Increases in labor costs could impact our financial results.

Labor is one of our highest costs and relatively small increases in labor costs per employee could materially affect our cost structure. Our continued success will depend on our ability to attract and retain qualified personnel. A shortage of qualified employees, such as truck drivers or mechanics, would require us to enhance our wage and benefits packages to compete more effectively for employees, to hire more expensive temporary employees or to contract for services with more expensive third-party vendors. If we fail to attract and retain qualified employees, control our labor costs during periods of declining volumes or recover any increased labor costs through increased prices we charge for our services or otherwise offset such increases with cost savings in other areas, our operating margins could suffer.

 

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We depend significantly on the services of the members of our senior, regional and local management teams, including our current CEO and the departure of any of those persons or the inability to adequately replace any such manager could cause our operating results to suffer.

Our success depends significantly on the continued individual and collective contributions of our senior, regional and local management teams including our current CEO. The loss of the services of any member of our senior, regional or local management, in particular our CEO, Mr. Pedreiro, or the inability to hire and retain experienced management personnel could have a material adverse effect on us. Our currently distressed financial situation has further increased the risk of the departure of one or more senior managers and the inability to adequately replace any such manager in the event of a departure.

We may be held legally responsible for the acts and omissions of outsourced personnel.

We rely on outsourced personnel to carry out certain of our non-strategic functions (such as landfill security and gatekeepers) and to ensure the proper functioning of our operations in satisfaction of client needs at a lower cost. If the outsourcing companies engaged by us fail to comply with applicable labor laws in relation to their employees sent to provide services on our behalf, we, as a matter of Brazilian labor law, may be held severally liable for such violations over which we have little to no authority to monitor or prevent. As a result, we may be subject to fines and other penalties imposed by the relevant labor authorities or courts. If we are held liable for labor claims in connection with our outsourced personnel, our business and results of operations may be negatively impacted.

Increases in insurance costs and the amount that we self-insure for various risks could reduce our operating margins and reported earnings.

Our business exposes us to the risk of liabilities arising out of our operations, including environmental and labor-related claims as well as claims for personal injury, death and property damage resulting from the use of the trucks, machinery and equipment used in our operations. We maintain insurance policies at amounts considered by our management to be sufficient to cover possible losses, considering the nature of our activities and our size and operations. Our insurance policies cover: (i) environmental damage, (ii) civil liability, (iii) damage to property, including fleet and equipment, (iv) pain and suffering, (v) fire, lightning and explosion and (vi) directors’ and officers’ insurance. Our coverage limits might not be sufficient to cover all potential losses. We cannot assure you that we will not be exposed to uninsured liability at levels in excess of our historical levels resulting from multiple payouts or otherwise or that liabilities in respect of existing or future claims will not exceed the level of our insurance. Losses that exceed the insured amount or that are not covered by our insurance could result in material additional and unexpected costs. These could affect our results of operations and financial condition. For additional information regarding our insurance coverage, see “Item 4.B. Information on the Company—Business Overview—Insurance.”

We are party to various judicial, administrative, tax or other third-party proceedings that could interrupt or materially limit our operations, result in adverse judgments, settlements or fines and create negative publicity.

We are, and in the future may be, a defendant in various judicial, arbitral and administrative proceedings arising in the ordinary course of our business and also, on an exceptional basis. Such disputes may relate to civil, tax, labor or environmental matters and involve our suppliers, customers, management or environmental and tax authorities, among others. In addition, particularly in relation to our landfill operations, the Public Prosecutor’s Office, as well as individuals, citizens groups, trade associations, community groups or environmental activists, may bring actions against us in connection with our operations that could interrupt or limit the scope of our business. Many of these matters raise difficult and complicated factual and legal issues and are subject to uncertainties and complexities. The timing of the final resolutions to lawsuits, regulatory inquiries, and governmental and other legal proceedings is uncertain. Additionally, the possible outcomes or resolutions to these matters could include materially adverse judgments or settlements, either of which could require substantial payments or other significant financial obligations. We cannot assure you that the outcomes of these proceedings will be favorable to us, or that we will have established sufficient reserves for all potential liabilities in connection with these proceedings.

Unfavorable decisions or settlements in relation to these proceedings that prevent us from conducting our business as initially planned, or that involve substantial amounts that have not been adequately provisioned, may materially adversely affect our business, financial condition and results of operations. For example, based on advice of our external legal counsel, who assessed the risk of a potential loss as possible (and not probable), we have not recorded provisions in the aggregate amount of R$120.9 million and R$212.4 million in relation to recent tax assessments that we received from BFRS at the end of 2018 and 2017, respectively. Therefore, in the event that such possible loss materializes, our provisions would not be sufficient to cover our contingencies in relation to this liability. For more information on the material proceedings to which we are a party, see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.”

 

 

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Changes in the tax regimes to which we and our customers are subject may adversely affect us. Brazilian tax authorities may challenge the tax treatment given to certain of our transactions, potentially resulting in significant tax liabilities that could adversely affect us.

The Brazilian government frequently implements changes to tax regimes that may affect our customers and us. These amendments may include changes in prevailing tax rates and, occasionally, the implementation of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. Some of these changes may result in increases in our tax obligations and payments, which could cause us to increase the prices of our services, restrict our ability to do business in our existing and target markets and adversely affect our financial condition and results of operations. There can be no assurance that we will be able to maintain our projected cash flow and profitability following any increases in Brazilian taxes applicable to us and our operations.

Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid, which requires a significant degree of judgment and estimates. We cannot assure you that Brazilian tax authorities will agree with the assessments made with respect to our tax liability. Under Brazilian law, the tax authorities may challenge the amount of taxes we have paid for a period of up to five years counted from the taxable event or the first day of the following year, based on a variety of factors, including the nature of the tax payable and whether it involves self-reporting by the taxpayer or pre-payment as well as the existence of fraud. Any such challenges may require us to devote additional resources to defend the tax treatment we have ascribed to such transactions and, if adjudicated and decided against us, may result in the incurrence of significant tax liabilities, including fines and other capital commitments, and may have a negative impact on our public image, each of which could adversely affect us.

Moreover, the tax treatment for certain categories of transactions are more vulnerable to challenges by the Brazilian tax authorities. For example, we regularly perform intercompany transactions (such as loans and other financial or operational transactions), the tax treatment of which is especially uncertain under Brazil’s regulatory framework, and is more likely to be questioned by Brazilian tax authorities, particularly with respect to their compliance with IOF or IRRF tax rules.

In addition, our non-compliance with any ancillary obligations could also result in further questioning by the tax authorities and result in additional tax liabilities, including fines and other capital commitments, which could adversely affect us.

We may be liable in connection with discontinued operations over which we currently have no control.

As part of our restructuring effort and with the objective of streamlining our operations and increasing our margins, we have divested of several assets in recent years, including our operations outside of Brazil and a significant portion of our oil and gas activities. For additional information, see “Item 4.A. Information on the Company—History and Development of the Company—Recent Divestments and Acquisitions.” Under Brazilian law, we may be subject to liability, financial losses, and adverse impacts on our image and reputation resulting from past divestitures, particularly in the event that the new owner of our divested assets is found to have insufficient funds to perform on our obligations with respect to those assets.

For example, in January 2016, we entered into an agreement with USA Global MKT (“USA Global”), for the sale of our 51% interest in Doña Juana S.A. ESP (“Doña Juana”), based in Colombia. Pursuant to the terms of the agreement, USA Global, our partner and co-investor in Doña Juana, agreed to seek out a compatible buyer for our interest in Doña Juana and, in the meantime, advanced payments to us for the sale. Following the execution of the agency agreement with USA Global, our results of operations from Doña Juana were recorded as discontinued in 2016, and we ceased to have any participation in the management and affairs of Doña Juana. On November 20, 2018, we fully transferred our shares in Doña Juana to Ecensa Colombia S.A.S. (“Ecensa Colombia”), a subsidiary of USA Global, but continue to have an outstanding balance of receivables in the amount of US$0.8 million (R$2.8 million, calculated using the average FX rate from January 1 to November 30, 2018) as of December 31, 2018 that is payable by USA Global. As a landfill, Doña Juana’s operations are inherently susceptible to various risks, including, among others, in connection with landfill site closure and post-closure costs as well as contamination-related costs. Our potential liability could be significant to the extent these risks materialize, particularly in relation to activities occurring during the period when we still had control. However, despite our sale and transfer, we may continue to be liable for the activities at Doña Juana during times at which we had no authority or control of the entity.

 

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Another example relates to our sale of Estre Óleo e Gás Holding S.A. (“Estre O&G”) in 2014, following which we continued to have contractual obligations to provide certain services to Estre O&G’s business partners through 2017. In addition, we are the subject of, or mentioned in the context of, certain allegations and investigations of misconduct in connection with our discontinued operations. For further information, see “—Risks Related to Compliance and Control” below and “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Discontinued Operations.” Given the current stage of the investigations, we cannot predict whether any such investigations will proceed and, if so, the duration or ultimate outcome of the investigation. In the event we are charged with any violations on the basis of the investigations or other investigations related to discontinued operations or otherwise held responsible in relation thereto, we may be subject to substantial monetary fines and potential ineligibility from contracting with state owned or government entities, which could also have significant impact on our results of operations.

We could also be liable for latent civil, tax, environmental, criminal and labor claims arising out of causes or circumstances existing during the time which we owned the assets we have since divested, the occurrence of which could have an adverse effect on us. For example, in the event that we are deemed responsible for causing an environment damage on a divested asset (irrespective of whether the former operations were supported by environmental licenses or not), we will nevertheless be held liable for the full extent of the damages, including the responsibility for repairing such damage in accordance with applicable legislation, to which statutes of limitations may not apply. Environmental liability may be also be attributed by administrative and criminal courts by imposing administrative and criminal sanctions upon non-compliance with law. Administrative sanction can only be imposed within five years from the violation of the applicable violation and the statute of limitations of criminal liability varies according to the penalty imposed for the committed misconduct. Under Brazilian environmental laws and regulations, companies are subject to strict liability for damages caused to the environment, and no statute of limitations applies.

Any adverse outcome resulting from such risks or liabilities could harm our business, results of operations and financial condition and could create negative publicity that may be damaging to our reputation and competitive position.

Current and future accounting pronouncements and other financial reporting standards, including, but not limited to, those concerning revenue recognition, will impact our financial results.

The IASB, or other regulatory bodies, periodically introduce modifications to financial accounting and reporting standards under which we prepare our audited financial statements. A number of new accounting standards and amendments and interpretations to existing standards have recently been issued, including IFRS 15 regarding revenues from contracts with customers and IFRS 9 regarding financial instruments We have adopted these new accounting standards on the effective date required, which was January 1, 2018 and, therefore, the audited financial statements included in this annual report reflect the application of these new accounting standards.

Upon application of IFRS 9, we recorded a R$3.5 million decrease in the allowance for doubtful accounts on January 1, 2018. The adoption of IFRS 15 resulted in an impact of R$2.3 million, net of deferred income tax and social contribution of 34%, which was recorded in shareholders’ equity as of January 1, 2018.

In addition, on January 1, 2019, we adopted IFRS 16 which establishes principles for the recognition, measurement, presentation and disclosure of leases and requires lessees to account for all leases under a single on-balance sheet model similar to the accounting for finance leases under IAS 17. On January 1, 2019, we recognized a right-of-use asset and a lease liability of R$23.3 million.

For further information regarding the new standards effective as of January 1, 2018 and new accounting requirements, including IFRS 16 – Leases, see “Item 5.A. Operating and Financial Review and Prospects—Operating Results—New Accounting Standards Issued But Not Implemented” and notes 2.22 and 2.23 to our audited financial statements included elsewhere in this annual report.

We rely on a limited number of suppliers for our heavy vehicles, which may materially adversely affect our ability to acquire a waste collection fleet on favorable terms.

In Brazil, the collection and transfer trucks that comprise our fleet are manufactured and sold by only a few suppliers, with Volkswagen, MAN, Mercedes Benz and Ford dominating the market. Accordingly, in the event our suppliers decide to unfavorably modify the purchasing terms for these vehicles, our flexibility to acquire these vehicles elsewhere is limited. As a result, our ability to renew and expand our fleet may be negatively affected and, consequently, our ability to effectively serve customers could suffer.

 

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Risks Related to Compliance and Control

We have been charged, and remain under investigation by, the Brazilian tax authorities, alleging unpaid taxes over the course of several years arising from understated income due to alleged improper payments to certain suppliers. These charges, as well as potential future tax infringement charges, could result in substantial fines, penalties and criminal and regulatory sanctions, among other adverse effects.

Since 2015, the BFRS has periodically filed Notices of Tax Enforcement addressed to us, requiring that we produce information concerning transactions with a number of specified suppliers in relation to payments made from 2010 to 2015. In the majority of cases, these requests for information have resulted in official tax infringement notices charging our failure to pay the full amount of federal taxes due for a specified period on the assumption that we understated our taxable income for such periods due to costs recorded from alleged improper payments to certain suppliers. These tax infringement notices subject us to significant tax liabilities, including fines established by the BFRS and payments of interest. The statute of limitations for these claims is five years.

In 2017, we were able to settle certain tax liabilities resulting from these tax infringement charges on attractive terms through tax amnesty programs offered for a limited time in Brazil. However, after these amnesty programs were closed, (i) on December 15, 2017, Cavo Serviços e Saneamento S.A. (“Cavo”), the entity through which we hold an equity stake in Soma, received an official tax infringement notice from the BFRS in the amount of R$90.6 million concerning transactions with a number of specified suppliers in relation to payments made in 2012, (ii) on December 22 and 27, 2017, the Company received two additional official tax infringement notices from the Brazilian federal tax authorities in the aggregate amount of R$121.8 million concerning transactions with a number of specified suppliers in relation to payments made in 2012, (iii) on December 4, 2018, the Company received a further tax infringement notice from the Brazilian federal tax authorities in the aggregate amount of R$53.5 million concerning transactions with a number of specified suppliers in relation to payments made in 2013, and (iv) on December 11, 2018, Cavo received an additional tax infringement notice from the Brazilian federal tax authorities in the total amount of R$65.6 million relating to transactions entered into with a number of specified suppliers and related payments made in 2013. There is no guarantee that additional tax amnesty programs will be offered by the Brazilian government on favorable terms, or at all. We have not established provisions related to these matters based on the advice of our independent Brazilian counsel. For further information regarding our tax proceedings, see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.”

For the reasons described above, the current tax charges against us, as well as potential additional tax charges that we may receive in the future, may expose us to significant fines, penalties, judgments, damages and/or settlements as a result of non-compliance with applicable legal and regulatory requirements in amounts that exceed the provisions we have established in relation to these tax contingencies (see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations”).

Furthermore, we have reason to believe that the tax authorities have shared their findings with other Brazilian authorities, including the Lava Jato investigators. For example, the Brazilian federal police’s search of our corporate offices and the premises of Soma on March 1, 2018 as part of the so-called Operation Descarte was a collective effort in cooperation with the Brazilian tax authorities within the ambit of the broader Lava Jato task force. Accordingly, any tax charge from the BFRS could potentially result in additional regulatory and criminal inquiries, charges and, eventually, sanctions. Any such consequences emanating from these tax charges could significantly impact our results of operations, cash flows, ability to execute our growth strategy and overall financial health.

Based on our historical experience, we may receive additional tax infringement charges in the future in relation to other suppliers, facts or periods, particularly as the statute of limitations related to such matters approaches expiration. Any of these tax infringement charges may involve additional criminal and regulatory actions and governmental inquiries that could have a material adverse effect on us and otherwise severely limit our business.

Investigations by governmental authorities under the applicable anti-corruption and money laundering laws, including the currently ongoing Operation Descarte, may result in substantial fines, ineligibility from contracting with state-owned or government entities, criminal action against our management team and other adverse effects.

We, the former chairman of the Company’s board of directors as well as businesses formerly owned by us are currently the subject of, or otherwise implicated in, certain allegations and investigations of misconduct in relation to alleged improper payments. For further information regarding the related facts, see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.”

 

 

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On March 1, 2018, the Brazilian Federal Police executed search warrants at a number of companies in the cities of São Paulo, Santos, Paulínia, Belo Horizonte and Lamim, including at the premises of Soma as well as the Company’s corporate offices and at Paulínia landfill. This action was part of the so-called Operation Descarte effort of the Brazilian Federal Police working in conjunction with the Brazilian tax authorities within the ambit of the broader Lava Jato task force, with the stated objective of dismantling a criminal money-laundering network. As part of their search of our corporate offices, the Brazilian Federal Police confiscated numerous hard copy and electronic files related to specified suppliers, among other materials.

Most recently, on January 31, 2019, the Brazilian federal police executed search warrants at various locations in the State of São Paulo, including at the Company’s corporate headquarters, as part of investigations related to contracts entered into in the period between 2008 and 2014 between Estre and some of its former subsidiaries and Petrobras Transporte S.A. – Transpetro (“Transpetro”), a subsidiary of the Brazilian company Petroleo Brasileiro S.A. – Petrobras. We understand that the police investigation was launched within the gambit of the broader Lava Jato investigation and as a result of a plea bargain agreement entered into by Mr. Sergio Machado, the former president of Transpetro. As part of this police operation, temporary arrest warrants were also executed leading to, among others, the arrest of the founder and former chairman of Estre, Mr. Wilson Quintella, and a former senior employee of the Company, Mr. Antonio Kanji Hoshikawa.

On February 1, 2019, Mr. Quintella appeared for a deposition before the Brazilian federal police and confessed both to making payments to Mr. Sergio Machado and to the involvement of Mr. Kanji in executing such payments. On March 1, 2019, the federal prosecutor’s office filed a criminal complaint against Mr. Quintella and other former senior employee of the Company, whereby the prosecutors presented an indicative amount of at least R$79.6 million to be claimed from the individuals in connection with the alleged wrongdoing. In the future, similar claims could be made on civil compensation grounds against the Company.

We cannot predict whether these criminal investigations will move forward and, if so, the duration, scope or ultimate outcome of these investigations. The criminal proceedings are still ongoing and new facts may emerge. In the event we are charged with any violations on the basis of the investigations, these charges may seek to impose various sanctions, including significant monetary fines, potential ineligibility from contracting with state-owned or government entities, injunctions against future conduct, profit disgorgements, disqualifications from directly or indirectly engaging in certain types of businesses, the loss of business permits or other restrictions which could have a material adverse effect on our business, financial condition, results of operations or liquidity. An announcement of a negative outcome of an investigation, or the bringing of any charges against us (or persons or entities affiliated or previously affiliated with us), could also expose us to civil suits or regulatory action, and/or damage our reputation. The materialization of any of these events could have a material adverse effect on us.

Our governance, risk management, compliance, audit and internal controls processes might be unable to prevent, detect or remedy behaviors that are incompatible with relevant legal requirements or our own ethical or compliance standards, which could in turn expose us to sanctions, regulatory penalties, civil claims, tax claims, damage to our reputation, accounting adjustments or other adverse effects.

In 2015, under the leadership and guidance of our current CEO, Mr. Sergio Pedreiro, and in response to Brazil’s new anticorruption law adopted in 2014 and an intensified focus in Brazil on the prevention of corrupt practices, we implemented a new compliance program focused on transparency and ethical conduct. Since 2015, we have invested significantly in our internal controls mechanisms with the objective of auditing, detecting and reporting irregularities, imposing disciplinary measures and taking remedial or punitive measures in the case of violations. We have a focused commitment to continuing to strengthen our compliance policies and internal control systems.

 

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Nevertheless, despite these substantial efforts, we have identified certain shortcomings and defects of our compliance infrastructure as a result of the Internal Evaluation Process (see “Item 15. Controls and Procedures”), particularly in relation to the implementation of our compliance program at Soma. Accordingly, we cannot assure you that our governance, risk management, compliance, audit and internal controls processes will be able to prevent, detect or remedy all behaviors that are incompatible with the applicable legal requirements or our own ethical or compliance standards, and any weakness or breach could expose us to sanctions, regulatory penalties, civil claims, tax claims, monetary losses, accounting errors or adjustments, reputational damages, or other adverse effects.

We are subject to the risk that our employees, counterparties or any person doing business with us may engage in fraudulent activity, corruption or bribery, circumvent or override our internal controls and procedures or misappropriate or manipulate our assets for their personal or business advantage. In the event that we believe or have reason to believe that our employees or agents have or may have violated applicable anti-corruption laws, including the U.S. Foreign Corrupt Practices Act (the “FCPA”), the Brazilian Anti-Corruption Law and similar anti-corruption laws, we may be required to investigate or have outside counsel investigate the relevant facts and circumstances, which can be expensive and require significant time and attention from senior management.

It is difficult for us to ensure that all of our employees and contractors will comply with and uphold our ethical principles, a risk that we believe we are highly susceptible to given the nature of our business in Brazil and substantial commercial dealings with municipal entities. Any weakness or breach in our governance, risk management, compliance, audit and internal controls processes could expose us to sanctions, regulatory penalties, civil claims, tax claims, monetary losses, accounting errors or adjustments, reputational damages, or other adverse effects. The perception or allegations that we, our employees, our affiliates or other persons or entities associated with us have engaged in any such improper conduct, even if unsubstantiated, may cause significant reputational harm and other adverse effects.

We have conducted several internal reviews related to our supply relationships, and additional facts and circumstances could arise requiring further evaluation.

As part of our response to ongoing investigations by the Brazilian authorities into potential misconduct, we have periodically engaged external consultants to review documentation concerning transactions with our suppliers.

Following a review of our transactions with specified suppliers in 2017, forensic consultants determined that certain disbursements made by us to contractors, suppliers and other service providers could not be properly supported by the documentary evidence. As a result of these findings, we terminated our commercial arrangements with a number of suppliers and wrote-off certain items of property, plant and equipment on our balance sheets for which proper support for payments was not available and their existence could not be properly verified. See “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Write-off of Property, Plant and Equipment.”

Following the receipt of tax infringement notices at the conclusion of 2017 (see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations”), we engaged a forensic services firm to review Soma’s relationships with certain suppliers. This investigation was only in the preliminary stages when the Brazilian federal police searched our corporate offices and the premises of Soma on March 1, 2018. In the aftermath of the events of March 1, 2018, we broadened the scope of the internal review process at the direction of a newly constituted special committee of our board of directors comprised of independent members of our board of directors. This expanded internal evaluation process sought to ascertain the nature of the goods and services provided to us for payments made to certain suppliers during the period from 2012 to 2017, including via Soma and our joint ventures. As a result, we identified payments to certain suppliers, particularly through Soma, for which there was insufficient evidence that goods and services were provided. Considering these findings, we restated our financial statements as of January 1 and December 31, 2016 and for the years ended December 31, 2015 and 2016, as presented and restated in the 2017 annual report and recalculated our income tax payable corresponding to our management’s assessment of probable tax losses emanating from these payments, as further described under “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Internal Evaluation Process and Previous Restatement of Financial Statements,” “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations” and Note 1.4 of our audited financial statements included herein.

 

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Internal evaluation processes are costly and disruptive and require significant time, resources and management attention. They are also subject to inherent shortcomings, namely involving (i) the absence of subpoena power to compel production of relevant documents from third parties, and (ii) the inability to compel interviews with important witnesses, such as certain former members of our management team. Accordingly, it is possible that improper conduct may have occurred within the Company that was not captured or considered in the Internal Evaluation Process and other historical investigations. As result, it is possible that facts and circumstances could arise in the future related to alleged improper conduct that we have not considered or adequately prepared for but could nevertheless expose us to significant liability, warrant further investigation, or involve further restatement of our audited financial statements.

Allegations and investigations of impropriety involving Wilson Quintella Filho, our founder, a shareholder and former chairman of our board of directors, have surfaced as part of Brazil’s ongoing Lava Jato and Operation Descarte investigations, which have, and may continue to, adversely affect us, principally by harm to our reputation. Any negative developments in or relating to such allegations and investigations involving Mr. Quintella could further adversely affect us.

There are several allegations of improper payments and other improper conduct against Mr. Quintella, who is our founder, a minority shareholder and former chairman of our board of directors, and certain entities affiliated with him, in connection with the ongoing Lava Jato investigation, including entities that were previously under our control. In 2018, Mr. Quintella’s personal apartment was subject to a police search as part of Operation Descarte, and on February 1, 2019, Mr. Quintella appeared for a deposition before the Brazilian federal police and confessed both to making payments to Mr. Sergio Machado and to the involvement of Mr. Kanji, a former employee of the Company, in executing such payments. On March 1, 2019, the federal prosecutor’s office filed a criminal complaint against Mr. Quintella and other former senior employee of the Company, whereby the prosecutors presented an indicative amount of at least R$79.6 million to be claimed from the individuals in connection with the alleged wrongdoing In the future, similar claims could be made on civil compensation grounds against the Company. For further information regarding the related facts, see “Item 8.A. Financial Information— Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.”

Although Mr. Quintella no longer has management control over us and his share ownership in us (held through Cygnus Asset Holding Ltd) has been significantly reduced to 5.9% as a result of the Transaction, we nonetheless believe that, because of Mr. Quintella’s connections with us as our founder, shareholder and former chairman, these allegations could have adverse impacts on us, principally by way of harm to our reputation and, potentially, as a result of his ongoing influence on our employees resulting from his historical role at the Company. We cannot predict the outcome of the ongoing investigations and the criminal complaint involving Mr. Quintella or whether the authorities will ultimately prosecute us in administrative and civil court, as applicable. The criminal proceedings are still ongoing and new facts may emerge. Both the investigation and the complaint may further negatively impact our reputation or otherwise adversely affect us.

Our commercial relationship with Petrobras has been the subject of inquiry.

We had a commercial relationship with Petrobras and certain of its 2016, 2017 and 2018 generated total revenues of R$52.5 million, R$18.5 million and R$12.8 million, respectively, from such relationship, all of which was allocated to our Oil & Gas (O&G) segment. Petrobras is the primary customer in our Oil & Gas segment, representing 83.6% of the net revenues from services rendered for this segment in 2016, 71.4% in 2017 and 100% in 2018. We engaged independent consultants to review our commercial relationships with Petrobras mainly in response to ongoing investigations by the Brazilian authorities and other allegations related to our historical relationship with Petrobras (see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.”). This review of our dealings with Petrobras was concluded in January 2018 and the consultants identified a number of suppliers that provided goods and services in connection with our Petrobras engagements. These suppliers were then included in the Internal Evaluation Process described above and the respective supply relationships were evaluated across our organization, including Soma and our joint ventures.

We, our affiliates and our shareholders could be materially affected by violations of the FCPA, the Brazilian Anti-Corruption Law and similar anti-corruption laws.

We, our subsidiaries and our joint venture partners are subject to a number of anti-corruption laws, including Law No. 12,846/2013, or the Brazilian Anti-Corruption Law, which became effective on January 28, 2014, the FCPA and various other anti-corruption and anti-bribery laws of other jurisdictions.

 

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The FCPA, the Brazilian Anti-Corruption Law and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to government officials or other persons for the purpose of obtaining or retaining business. If our policies and procedures designed to prevent bribery and other corrupt practices were not in the past or are not in the future capable of preventing voluntary or inadvertent action by our administrators, employees or third parties acting on our behalf that constitutes corruption, applicable regulatory agencies, to which we respond, have the power and authority to impose fines and other penalties.

Violations of these laws, which could arise out of the current allegations and investigations involving Wilson Quintella Filho or otherwise, may result in criminal or civil sanctions (including fines), inability to do business with existing or future business partners, injunctions against future conduct, profit disgorgements, disqualifications from directly or indirectly engaging in certain types of businesses, the loss of business permits or other restrictions which could have a material adverse effect on our business, financial condition, results of operations or liquidity.

Any company that controls, is controlled by, or has a material interest in a company that violates the provisions of the Brazilian Anti-Corruption Law may be held joint and severally liable for the payment of fines and monetary damages arising from such violations. Under Brazilian law, “material interest” means that a given investor either (i) has or exercises the power to participate on decisions involving financial or operational policies of the invested company, without controlling it, or (ii) holds a 20% or higher stake in the voting capital of the invested company, without controlling it.

Personnel from BTG Pactual are the subject of investigations in Brazil, which because of the relationships between BTG Pactual and us may have an adverse impact on our reputation or otherwise.

We have various significant relationships with BTG Pactual, which remains our largest shareholder after the Transaction. Furthermore, certain members of our senior management, including the CEO, are affiliated with BTG Pactual. BTG Pactual is also the holder of 27.0% of our debentures and 52.9% of the Company’s total debt, encompassing the outstanding existing debentures and other obligations arising out of the related debt acknowledgment instrument, as amended and restated pursuant to the Debt Restructuring. In 2015, André Esteves, then the CEO and chairman of BTG Pactual, was temporarily taken into custody in Brazil in connection with allegations of obstruction of justice, which allegations were unrelated to us or BTG Pactual’s and Mr. Esteves’s relationship to us.

On September 1, 2017, the Brazilian Federal Prosecutor’s Office filed its closing arguments requesting the dismissal of all charges against Mr. Esteves. On July 12, 2018, Mr. Esteves was acquitted by the competent court of the charges and the case was officially closed on August 17, 2018. However, as a result of certain statements included in the plea bargain of Delcídio do Amaral Gomez, a former Brazilian senator, Mr. Esteves became subject to additional corruption-related investigations. Other corruption related allegations have been made against Mr. Esteves in connection with an investment by Banco BTG Pactual in assets acquired by Banco BTG Pactual from Petrobras from its PetroAfrica subsidiary as well. None of the foregoing matters have resulted in any criminal charges being brought against Mr. Esteves, BTG Pactual or any other Banco BTG Pactual employees. While a conviction of Mr. Esteves in the ongoing criminal proceedings seems unlikely given the dismissal of all charges as described above on July 12, 2018 by the court of competent jurisdiction and the official closing of the case on August 17, 2018, we cannot predict the ultimate outcome of that criminal proceeding or whether any of the investigations, including new investigations resulting from plea bargains involving third parties or otherwise, will result in criminal charges being brought against Mr. Esteves. Should Mr. Esteves be found liable for any misconduct or should BTG Pactual or any of its affiliates be accused of or found responsible for any wrongdoing, there may be negative impact on our reputation or otherwise, such as administrative or civil liability, as a result of our relationship with BTG Pactual.

We have identified weaknesses in our internal control over financial reporting and our disclosure controls and procedures.

In connection with the audit of our audited financial statements for the year ended December 31, 2018 included in this annual report, we and our independent registered public accounting firm identified material weaknesses in our internal control over financial reporting. In addition, our management has concluded that our disclosure controls and procedures as of December 31, 2018 were not effective due to such weaknesses in internal control over financial reporting. In addition, in connection with the preparation of our annual report for the year ended December 31, 2017, we also identified material weaknesses in our internal control over financial reporting, and consequently, in our disclosure controls and procedures.

 

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Details of the material weaknesses in our internal control over financial reporting are set forth in detail under “Item 15. Controls and Procedures.”

Although our management has put in place a remediation plan aimed at addressing the material weaknesses that we have identified, we cannot at this time estimate how long it will take to fully remediate the weaknesses identified in this annual report and our efforts may not be successful in remediating these material weaknesses. In addition, we will incur additional costs in improving our internal control over financial reporting and our disclosure controls and procedures. If we are unable to remediate these material weaknesses, or if we experience additional weaknesses in the future or otherwise fail to maintain an effective system of internal controls or disclosure controls and procedures, we may not be able to accurately or timely report our financial condition or results of operations, which may adversely affect investor confidence in us and, as a result, the value of our securities.

Our independent registered public accounting firm has not performed an evaluation of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness or significant deficiency in our internal control over financial reporting, as our independent registered public accounting firm will only be required to do once we cease to be an emerging growth company. Had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional weaknesses in our internal control over financial reporting may have been identified.

We have recently implemented new process management software and are increasingly dependent on technology in our operations and, if our technology fails, our business could be adversely affected.

We may experience problems with the operation of our current information technology systems or the technology systems of third parties on which we rely, as well as the development and deployment of new information technology systems, any of which could adversely affect, or temporarily disrupt, all or a portion of our operations until resolved. For example, in 2016, we began implementing new enterprise resource planning (“ERP”), business process management software in order to better manage our business and automate many back office functions with the goal of improving our internal controls over financial reporting on a consolidated basis. The full system migration was expected to be completed by the end of 2018, however, until the system reaches full implementation, distortions may occur. Prior to the adoption of these new systems, certain control functions were managed manually, without the use of technology, including the provisioning for landfill closures and judicial deposits, thus subjecting these processes to a high degree of human error. Accordingly, the process of automating these processes will require constant monitoring and potentially adjustments during the phase-in period. We cannot assure you that technological failures will not occur as a result of the ongoing implementation of this new system that could result in distortions and other problems. Inabilities and delays in implementing new systems, as well as the possibility of human failure when dealing with new systems, could affect our ability to realize projected or expected cost savings and improve our controls as anticipated. Additionally, any systems failures could impede our ability to timely collect and report financial results in accordance with applicable laws.

We rely on computer systems to run our business, and face risks from security breaches that could disrupt or damage our internal operations, information technology systems or reputation, and expose us to litigation risk.

We use computers in substantially all aspects of our business operations. We also uses mobile devices, social networking and other online activities to connect with employees and customers. Such uses give rise to cybersecurity risks, including security breach, espionage, system disruption, hacking, cyber-attack, theft and inadvertent release of information. Our business involves the storage and transmission of numerous classes of sensitive and/or confidential information and intellectual property, including customers’ personal information, private information about employees, and our financial and strategic information. Further, as we pursue our strategy to grow through strategic acquisitions in addition to internal growth, our technological presence and corresponding exposure to cybersecurity risk will increase. If we fail to assess and identify cybersecurity risks associated with acquisitions and new initiatives, we may become increasingly vulnerable to such risks.

Despite the constant monitoring of our technology systems and hiring of specialized third parties to identify and address any vulnerabilities through implementation of multi-tiered network security measures, computer programmers and hackers, or even internal users, may be able to penetrate, create systems disruptions or cause shutdowns of our network security or that of third party companies with which we have contracted. As a result, we could experience significant disruptions of our operations and incur significant expenses addressing problems created by these breaches. Such unauthorized access could disrupt our business and could result in a loss of revenue or assets and any compromise of customer information could subject us to customer or government litigation and harm our reputation, which could adversely affect our business and growth.

 

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We may face difficulty consummating future acquisitions and we may become liable for unknown obligations of acquired companies, which may pose significant risks and could have an adverse effect on our operations.

In the past, we have grown through strategic acquisitions in addition to internal growth and may, in the future, engage in acquisitions in order to acquire or develop additional disposal capacity or businesses that are complementary to our core business strategy. We expect that increased consolidation in the solid waste services industry will continue and may reduce the number of attractive acquisition candidates. Even if we identify suitable acquisition candidates, we may nevertheless be unable to negotiate successfully the acquisition at a price or on acceptable terms and conditions, due to limitations imposed by our debt obligations, amongst others. We may have to borrow money or incur liabilities in order to finance any future obligations and may not be able to do so on favorable terms or at all. In addition, we may be unable to obtain the necessary regulatory approvals to complete potential acquisitions. The integration of acquired businesses and other assets may require significant management time and resources that would otherwise be available for the ongoing management of our existing operations.

In addition, it is possible that the operations or sites we have acquired in the past or that we may acquire in the future, have liabilities or risks with respect to former or existing operations or properties, or otherwise, which we have not been able to identify and assess through our due diligence investigations. For example, employee misconduct or a history of improper payments are not always easy to detect as part of the diligence process pre-acquisition and are frequently concealed by counterparties. Accordingly, it is possible that we could later discover that assets acquired by us have conducted business or engaged in activities that are not aligned with our ethical standards and for which we could be responsible. As a successor owner, we may be generally legally responsible for liabilities that arise from the businesses that we acquire. Even if we obtain legally enforceable representations, warranties and indemnities from the sellers of such businesses, we may not cover the liabilities fully or the sellers may not have sufficient funds to perform their obligations, as was the case in some of our past acquisitions. Some environmental liabilities, even if we do not expressly assume them, may be imposed on us under various regulatory schemes and other applicable laws regardless of whether we caused or contributed to any conditions that resulted in such liabilities. In addition, our insurance program may not cover such sites and will not cover liabilities associated with some environmental issues that may have existed prior to attachment of coverage. A successful uninsured claim against us could harm our financial condition or operating results. Furthermore, risks or liabilities of which we are unaware or judges to be not material or remote at the time of acquisition may develop into more serious risks to our business. Any adverse outcome resulting from such risks or liabilities could harm our business, results of operations and financial condition and create negative publicity, which could damage our reputation and competitive position.

We incur significant expenses and administrative burdens as a public company, which could have an adverse effect on our business, financial condition and results of operations.

We are listed as a public company, which results in increased legal, accounting, administrative and other costs and expenses as a public company that we did not incur until recently as a private company. The Sarbanes-Oxley Act as well as rules and regulations subsequently implemented by the SEC, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations promulgated and to be promulgated thereunder, the PCAOB and the securities exchanges, impose additional reporting and other obligations on public companies. Compliance with public company requirements increases costs and makes certain activities more time-consuming. A number of those requirements require us to carry out activities we have not done as a private company. For example, we have created board committees and are continuing to adopt internal controls and disclosure controls and procedures. In addition, we incur expenses associated with SEC reporting requirements. Furthermore, if any issues in complying with those requirements are identified (for example, the existence of material weaknesses or significant deficiencies in our internal control over financial reporting or our disclosure controls and procedures), we could incur additional costs rectifying those issues, and the existence of those issues could adversely affect our reputation or investor perceptions of us. See also “—We have identified weaknesses in our internal control over financial reporting and our disclosure controls and procedures.” If we are unable to remediate these weaknesses, or if we experience additional weaknesses in the future or otherwise fail to maintain an effective system of internal control over financial reporting and disclosure controls and procedures in the future, we may not be able to accurately or timely report our financial condition or results of operations, which may adversely affect investor confidence in us and, as a result, the value of our securities. It may also be more expensive to obtain director and officer liability insurance. Risks associated with our status as a public company may make it more difficult to attract and retain qualified persons to serve on the board of directors or as executive officers. The additional reporting and other obligations imposed by these rules and regulations increases legal and financial compliance costs and the costs of related legal, accounting and administrative activities. These increased costs require us to divert a significant amount of money that could otherwise be used to fund our business and achieve strategic objectives. Advocacy efforts by shareholders and third parties may also prompt additional changes in governance and reporting requirements, which could further increase costs.

 

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Our management has limited experience in operating a public company.

We became a publicly traded company on December 21, 2017. Our executive officers and directors have limited experience in the management of a publicly traded company. Our management team may not successfully or effectively manage our continued operation as a public company, which subjects us to significant regulatory oversight and reporting obligations under federal securities laws. Their limited experience in dealing with the increasingly complex laws pertaining to public companies could be a significant disadvantage in that it is likely that an increasing amount of their time may be devoted to these activities which will result in less time being devoted to the management of our business and execution of our business strategies. It is possible that we will be required to hire additional employees in order to support our operations as a public company which will increase our operating costs in future periods, including increasing the number of employees in our internal audit team in order to strengthen our ability to continuously evaluate its internal control environment and procedures and seek to remediate the material weaknesses in internal control over financial reporting as described under “Item 15. Controls and Procedures.”

We may lose certain benefits afforded under Brazilian tax repayment programs if we are unable to comply with the program’s terms, and the program may not fully cover our tax liability in connection with past activities.

In 2017 and 2018, we elected to participate in certain tax amnesty programs which allowed us to settle certain of our tax debts under administrative or judicial discussion. While these programs did not provide amnesty for penalties or interest, it did allow us to resolve certain of our federal tax debts in installment payments. The program also allowed the partial settlement of tax debts with the use of tax credits and/or the use of tax loss carryforwards. In order to benefit from this program, we were required to waive in advance any defense or rights in relation to administrative disputes involving the tax indebtedness. For additional information regarding our participation in tax amnesty programs, see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations” and note 17 to our audited financial statements included elsewhere in this annual report.

Despite our participation in these programs, we could be subject to tax audits for subsequent periods, which may lead to additional tax challenges by the relevant authorities on similar claims. In addition, if we are delinquent in our payments under these programs or are otherwise unable to pay as scheduled, we may be barred from participation in these programs.

Risks Related to the Waste Management Regulatory Environment

We are subject to substantial governmental regulation, and failure to comply with these requirements, as well as enforcement actions, could subject us to a shut-down of facilities, fines, penalties and judgments.

We are subject to comprehensive federal, state and, in some cases, municipal laws and regulations in connection with our operations, including environmental and other laws and regulations pertaining to (i) the management (collection, transportation, recycling, storage and disposal) of waste, (ii) atmospheric emissions of pollutants, (iii) water usage and the discharge of effluents into waterways, (iv) licensing requirements, especially relating to our landfill activities, (v) land use requirements, including the protection and preservation of forests, coastlines, caves, watersheds and other features of the ecosystem, (vi) interference into specially protected areas, such as areas of cultural and historical relevance, conservation, preservation and legal reserve areas and their surrounding regions, and (vii) a broad range of occupational health and safety regulations. In addition, under certain circumstances, Brazil’s environmental laws may impose additional costs on licenses for significant impact activities, such as landfills, with proceeds to be destined toward conservation areas.

The Brazilian Constitution grants federal, state and municipal governments the authority to issue environmental protection laws and to publish regulations based on those laws. While the Brazilian federal government has authority to issue environmental regulations setting general standards for environmental protection, state governments have the authority to issue stricter environmental regulations. Municipal governments may only issue regulations regarding matters of local interest or as a supplement to federal or state laws.

With respect to environmental licensing, pursuant to Brazilian law, the projects must be licensed by a single entity, at the federal, state or municipal level. There are certain factors that must be taken into consideration to establish the licensing jurisdiction. Nevertheless, as a general rule, IBAMA (Instituto Brasileiro do Meio Ambiente e dos Recursos Naturais Renováveis) is the competent authority for the environmental licensing of undertakings and activities of national interest or capable of causing significant environmental impact in a regionally or internationally, or for activities located in certain protected areas such as indigenous lands or territorial waters, among others. The local environmental entities, are responsible for the licensing of enterprises with a local impact. The state environmental authorities have jurisdiction to conduct the licensing process of for activities whose impacts are restricted to their territory and whose licensing jurisdiction is not assigned to federal or local agencies.

 

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On the federal level, we are subject to IBAMA, which is part of the Brazilian Ministry for the Environment. In the state of São Paulo, the environmental agency is CETESB (Companhia Ambiental do Estado de São Paulo) and in the state of Paraná, the environmental agency is IAP (Instituto Ambiental do Paraná). In addition, in some of the larger municipalities in which we operate there are local regulators that enforce their own rules and licensing procedures. For example, in the city of São Paulo, we are subject to regulation by the Secretary for the Environment (Secretaria do Verde e Meio Ambiente).

Environmental liability may be attributed under civil, administrative and criminal spheres, with the imposition of administrative civil and criminal sanctions, despite the obligation to readdress all the damages caused. As a result, it is important to bear in mind that lack of conviction in one of these spheres does not necessarily exempt the infractor from liability arising from the remaining other matters.

The civil liability for environmental damage can subject us to environmental remediation or payment of indemnification when the environment cannot be restored. Under Federal Law No. 6,938/1981, companies are subject to strict liability for damages caused to the environment, and no statute of limitations applies. Brazilian law also imposes joint and several liability for anyone who, by virtue of a given activity, regardless of fault (intentional or negligent failure to maintain some standard of conduct, when such failure results in harm to something or someone), facilitates or contributes to environmental damage.

Therefore, we could be civilly liable if our operations cause negative impacts on human health or environmental damage to our properties or to the property of third parties, for example, as a result of the contamination of soil, groundwater or surface water, or drinking water. We may be held liable for any environmental damage that our current or former facilities cause. As part of our restructuring activities, we have recently spun-off or sold various assets (for additional information, see “Item 4.A. Information on the Company—History and Development of the Company—Recent Divestments and Acquisitions”), and our liability exposure would extend to these assets as well despite the fact that they are no longer under our control.

Under current Brazilian law, the owners of real property are jointly and severally liable with the party that has caused damage to the environment for the restoration of the environment and/or the payment of indemnification, i.e. we may be responsible for repairing an asset that was environmentally degraded before our acquisition. We may also be liable for any on-site environmental contamination caused by pollutants or hazardous substances related to our or our predecessors’ activities.

In the event any of the risks described above, or any unforeseen risks in relation to our compliance with applicable regulation, materialize, we may need to shut down or reduce operation of our facilities while expensive and time-consuming remedial actions are undertaken. We may be required to spend substantial capital to bring an operation or an asset into compliance, to temporarily or permanently discontinue activities and/or take corrective actions, possibly including the removal of landfilled materials.

In addition, we may also be subject to administrative and criminal sanctions or penalties, pursuant to Federal Law No. 9,605/98 (Environmental Crimes Law), which regulates certain conduct that is considered criminal conduct. According to such law, both corporations and individuals may be subject to criminal liability. Thus, corporations found to be wrongdoers may be subject to (i) partial or total interruption of operations, (ii) temporary suspension of construction work or activity, and (iii) prohibition of contracting with governmental authorities, and obtaining governmental subsidies, incentives or donations. Executive officers, directors, managers and other individuals from companies found to be polluting may be subject to fines, required to render community service or may be imprisoned for up to five years.

Moreover, administrative penalties may also be imposed whenever there is a breach of environmental laws, according to Federal Decree No. 6,514/2008, and such penalties include: (i) warnings; (ii) restriction of rights; (iii) suspension or prohibition of installation or development of activities; (iv) prohibition to contract with the government; (v) license suspension; (vi) suspension of financing or tax benefits; and (vii) fines. The fines applicable to polluters or those that do not comply with the legal provisions on waste management range from R$50 to R$50 million.

In any of these cases, we may experience negative publicity in addition to liability for environmental remediation. Associated costs with any of these outcomes could be significant to us and impact our results of operations, cash flows and available capital. We may not have sufficient insurance coverage for our environmental liabilities, such coverage may not cover all of the potential liabilities to which we may be subject and we may not be able to obtain insurance coverage in the future at reasonable expense or at all. While we seek to minimize our exposure to such risks through comprehensive training and compliance programs, as well as vehicle and equipment maintenance programs, if we were to incur substantial liabilities in excess of any applicable insurance, our business, results of operations and financial condition could be adversely affected.

 

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In the ordinary course of business, we have in the past, are currently, and may in the future, become involved in legal and administrative proceedings relating to land use and environmental laws and regulations. These include proceedings relating to environmental claims, with noteworthy reference to certain rules established by Brazil’s labor public ministry. The provisions established for the proceedings to which we are party to may be insufficient to cover the total cost resulting from such proceedings, and an adverse outcome of one or more of these proceedings could result in, among other things, material increases in our costs or liabilities as well as material charges for asset impairments.

Future changes in regulations, particularly in relation to our landfill operations, may result in increased liabilities and impose additional compliance costs, which could adversely affect us.

Our operations, particularly our disposal activities, may be adversely affected by changes in governmental laws or regulations, including measures seeking to address global warming or reducing the environmental impact of our operations generally. In particular, legislative changes may result in new or more stringent environmental standards imposed on us which could require additional capital commitments from us, including as a result of the need to modify or replace equipment or facilities. In addition, legislative changes may affect our ability to operate our landfills at full capacity by reclassifying items in the waste stream as hazardous, prohibiting the disposal of certain wastes, impacting the demand for landfill space, or decreasing the tipping fees and prices that we can charge for utilization of landfill space, each of which could increase the costs and decrease the profitability levels associated with the services we provide. Regulatory changes affecting the siting, design and closure of landfills could require us to undertake investigatory or remedial activities, curtail operations or close landfills temporarily or permanently.

With respect to landfill operations, we have significant financial obligations relating to final capping, closure, post-closure and environmental remediation at our existing landfills. We established accruals for these estimated costs, but could underestimate such accruals. Environmental regulatory changes could accelerate or increase capping, closure, post-closure and remediation costs, requiring expenditures to materially exceed our current accruals.

Moreover, our landfill operations produce methane as well as other biogases, which we process at our facilities to emit the greenhouse gases carbon dioxide and carbon monoxide. There are a number of legislative and regulatory efforts at the state, regional and federal levels to curtail the emission of greenhouse gases, among other emissions, to ameliorate the effect of climate change. Legislation and increased regulation regarding climate change could impose significant costs on us and our suppliers, including costs related to increased energy requirements, capital equipment, environmental monitoring and reporting and other costs to comply with such regulations. Given the emotion, moral and political significance and the uncertainty around the impact of climate change and how it should be dealt with, we cannot predict how legislation and regulation will affect our financial condition, operating performance and ability to compete. Even without such regulation, increased awareness and any adverse publicity in the global marketplace about potential impacts on climate change by us or other companies in our industry could harm our reputation. The potential physical impacts of climate change on our operations are highly uncertain, and would be particular to the geographic circumstances in areas in which we operate. These impacts may adversely impact the cost, potential production and financial performance of our operations.

It is also possible that government officials responsible for enforcing environmental laws and regulations may believe an issue is more serious than expected, or that we will fail to identify or fully appreciate an existing liability before we become legally responsible for addressing it. Some of the legal sanctions to which we could become subject could cause the suspension or revocation of a needed permit or license required for our operations, prevent us from, or delay us in, obtaining or renewing permits or licenses to operate or expand our facilities, or harm our reputation.

The implementation and progression of product stewardship policies and take-back requirements, may reduce demand for the services we provide, which could adversely affect us.

Environmental initiatives, such as product stewardship and take-back requirements, which hold manufacturers and other actors responsible for the disposal of manufactured goods and other products throughout such products’ life cycle, may reduce the volume of products that enter the waste stream. In Brazil, Federal Law No. 12,305/2010 established the National Solid Waste Policy, which sets out a framework of shared responsibility among manufacturers, importers, distributors, retailers, consumers and governmental agents for the life cycle of certain products, and places specific obligations on each of these entities across the waste management chain with a view toward reducing the volume of solid residues and mitigating the adverse impact on human health and the environment.

 

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Under the existing regulatory framework, such actors are charged with taking back and managing certain products and packaging at their end of life, and participating in the actions provided for by MSW management plans in relation to those products and packaging not yet subject to the take-back obligation, provided that this participation has been agreed with municipalities. Take-back is currently mandatory for the following products: (i) pesticides and their packaging, as well as other hazardous packaging, (ii) batteries, (iii) tires, (iv) lubricants and lubricant packaging, (v) lamps as well as (vi) electric and electronic equipment. For other products and packaging, take-back may be made mandatory by means of specific agreements entered into by manufacturers, importers, distributors and sellers, on the one hand, and governmental authorities, on the other hand. If further take-back regulations were adopted, they could have a fundamental impact on the waste streams that we manage and how we operate our business, including contract terms and pricing. A significant reduction in the waste, recycling and other streams we manage could have a material adverse effect on our financial condition, results of operations and cash flows.

The waste management industry in Brazil is undergoing fundamental change as traditional waste streams are increasingly viewed as renewable resources, which could cause customers to seek alternatives to landfill disposal which could result in a decline in our revenues and operating results.

As we have continued to develop our landfill capacity, the waste management industry has increasingly recognized the value of the waste stream as a renewable resource and new alternatives to landfills are being developed that seek to maximize the renewable energy and other resource benefits of waste. Although most of these efforts are still in the research or pre-operational phase, and a significant portion of Brazil’s MSW is still being disposed of in more rudimentary open dumps, future technological advances in the waste management industry may result in increasing competition from companies that seek to use parts of the waste stream as feedstock for renewable energy supplies. As a result of such increased competition, our revenues and operating margins could be adversely affected.

In addition, we are increasingly vigilant in monitoring growing worldwide support for “zero landfill” programs, which encourage the redesign of resource life cycles with the ultimate goal of eliminating waste being sent to landfills. Implementation of such programs typically take up to ten years, and the movement in Brazil is still incipient and is just starting to gain momentum. Nevertheless, many important multinational industrial companies operating in Brazil have already indicated a commitment to a “zero landfill” philosophy and are demanding solutions to meet these ambitions. Progression of this industry trend toward a “zero landfill” philosophy could have a fundamental impact on the waste streams we manage and how we operate our business, potentially requiring, among other things, significantly increased investments in value recovery technologies to meet this changing market demand. Increased movement toward a “zero landfill” philosophy could result in higher capital commitments by us into new technologies than currently anticipated, as well as a significant reduction in the role played by our landfills in the Brazilian waste cycle, each of which could have a material adverse effect on our financial condition, results of operations and cash flows.

The provision of environmental and waste management services involves risks, such as truck accidents, equipment defects, malfunctions and failures, abnormal weather conditions and natural disasters, which may not be covered by insurance and could adversely affect our operations and financial condition.

The provision of environmental and waste management services involves inherent risks, such as truck accidents, equipment defects, malfunctions and failures and natural disasters, which could partially interrupt our activities and potentially result in releases of hazardous materials, injury or death of employees, among other negative consequences. These risks include increased rainfall and flooding, fires or explosions, natural disasters, criminal acts, malfunction of equipment and emission of toxic substances, and could expose us to potential liability for pollution and other environmental damages, personal injury, loss of life, business interruption and property damage or destruction. For example, increased rainfall can result in landslides that could threaten our landfills and other infrastructure and limit road transportation, and could also lead to flooding which could restrict our operations and damage our landfills and other facilities, and consequently, result in an increase in operational costs for environmental remediation and treatment of leachate, as well as other cost additions related to landfill operation. In addition, abnormal weather conditions and natural disasters could disrupt our electric power supply, which could affect certain of our activities, such as pumping and shredding, which could adversely affect our waste treatment activities. Finally, the effects of climate change could create impacts and losses in any part of our business operations, for instance, by causing extreme floods.

As a result, our activities could be significantly affected or even paralyzed. These risks could result in property damage, loss of revenue, loss of life, pollution and harm to the environment, among others. If any of these occur, we may be exposed to economic sanctions, damages, fines or penalties in addition to the costs required to repair or remediate the related damage. Moreover, any interruption in production capability may require us to make additional capital expenditures to remedy the problem, which would reduce the amount of cash available for our operations. These costs, fines and penalties may adversely affect our financial condition and results of operations.

 

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Our insurance may not cover losses and liabilities resulting from such incidents. Such incidents could also harm our reputation and result in a loss of customers, which could adversely affect us.

Disagreements with the local communities where we operate can have a negative impact on our business and reputation.

We currently operate, and plan to further expand our operations, in areas considered close to communities and other population centers, including in connection with our landfill operations. Such presence could disproportionately impact certain segments of the population in these areas, or affect vulnerable demographic group (actually or perceived), which could lead to disagreements with surrounding communities, local leaderships, community associations, organized social movements and local government. In order to undertake our activities, we may be required to first consult with such groups and negotiate with them as a condition to obtaining local government approvals and the necessary operating licenses.

Our activities may be subject to opposition, including protests by various communities, even in areas in which we are not required to engage in a consultation process. Disagreements or legal disputes with these local forces could cause delays or disruptions in our operations, result in operational restrictions, adversely affect our reputation or otherwise impair its ability to conduct our operations, thus adversely affecting our business and the viability of planned projects. No assurances can be given that we will successfully reach an agreement with the different community forces opposed to our operations or that such communities will participate in consultation processes.

The provision of environmental and waste management services involves risks, such as truck accidents, equipment defects, malfunctions and failures, abnormal weather conditions and natural disasters, which could adversely affect us.

The provision of environmental and waste management services involves inherent risks, such as truck accidents, equipment defects, malfunctions and failures and natural disasters, which could partially interrupt our activities and potentially result in releases of hazardous materials, injury or death of employees, among other negative consequences. These risks include increased rainfall and flooding, fires or explosions, natural disasters, criminal acts, malfunction of equipment and emission of toxic substances, and could expose us to potential liability for pollution and other environmental damages, personal injury, loss of life, business interruption and property damage or destruction. For example, increased rainfall can result in landslides that could threaten our landfills and other infrastructure and limit road transportation, and could also lead to flooding which could restrict our operations and damage our landfills and other facilities, and consequently, result in an increase in operational costs for environmental remediation and treatment of leachate, as well as other cost additions related to landfill operation. In addition, abnormal weather conditions and natural disasters could disrupt our electric power supply, which could affect certain of our activities, such as pumping and shredding, which could adversely affect our waste treatment activities. Finally, the effects of climate change could create impacts and losses in any part of our business operations, for instance, by causing extreme floods.

As a result, our activities could be significantly affected or even paralyzed. These risks could result in property damage, loss of revenue, loss of life, pollution and harm to the environment, among others. If any of these occur, we may be exposed to economic sanctions, damages, fines or penalties in addition to the costs required to repair or remediate the related damage. Moreover, any interruption in production capability may require us to make additional capital expenditures to remedy the problem, which would reduce the amount of cash available for our operations. These costs, fines and penalties may adversely affect our financial condition and results of operations.

Our insurance may not cover losses and liabilities resulting from such incidents. Such incidents could also harm our reputation and result in a loss of customers, which could adversely affect us.

Risks Related to Brazil

The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. This influence, as well as Brazilian political and economic conditions, could adversely affect us.

The Brazilian government frequently intervenes in the Brazilian economy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions designed to control inflation, stimulate growth and other policies and regulations have often involved, among other measures, increases in interest rates, changes in tax policies, price controls, currency devaluations, capital controls and limits on imported goods and services. We cannot control or predict changes in policy or regulations that the Brazilian government might adopt in the future.

 

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We may be adversely affected by the economic and political conditions in Brazil as well as changes in policy or regulations at the federal, state or municipal levels involving or affecting factors such as:

 

   

economic, social and political instability, including allegations of corruption against political parties, elected officials or other public officials, such as those allegations made in relation to the Lava Jato investigation;

 

   

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

 

   

interest rate fluctuations;

 

   

currency and exchange rate fluctuations;

 

   

inflation;

 

   

volatility and liquidity of domestic capital and lending markets;

 

   

tax policies;

 

   

environmental policy;

 

   

labor regulations;

 

   

energy and water shortages and rationing;

 

   

foreign exchange controls and restrictions on remittances abroad, such as those restrictions that were briefly imposed in 1989 and early 1990; and

 

   

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

Brazil is currently recovering from a recession, and continued weaknesses in the Brazilian macroeconomic environment, including a low savings rate, a high interest rate spread and high public indebtedness, could adversely affect us.

Brazil is currently recovering from a recession, and material weaknesses and imbalances continue to threaten macroeconomic stability and the future prospects of the Brazilian economy, including:

 

   

a notably low savings rate at 6.2% as of December 31, 2018, according to the Brazilian Central Bank;

 

   

one of the highest headline interest rates in the world at 6.4% as of December 31, 2018, according to CETIP;

 

   

a relatively high level public indebtedness, representing 53.8% of Brazil’s gross domestic product (“GDP”) as of December 31, 2018, according to the Brazilian Central Bank; and

 

   

a R$120.3 billion federal budget primary deficit in 2018, according to the Brazilian Central Bank.

For more information, see “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Brazilian Macroeconomic Environment.” We cannot predict what measures the Brazilian government will take in the face of mounting macroeconomic pressures or otherwise or how continued weak macroeconomic conditions may affect us.

Uncertainty over whether the Brazilian government will implement changes in policy or regulation in order to address the current economic challenges affect economic performance and contribute further to economic uncertainty in Brazil and to heightened volatility in the Brazilian financial markets. For more information, see “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Brazilian Macroeconomic Environment.”

The persistence or intensification of the economic crisis in Brazil and the uncertainty over whether the Brazilian government will implement changes in policy or regulation in order to address the current economic challenges could adversely affect us.

Brazil continues to experience political instability, which may adversely affect 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, which have historically resulted in economic deceleration and heightened volatility in the securities issued by Brazilian companies.

 

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Brazil has experienced heightened economic and political instability derived from various currently 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, which have negatively impacted the Brazilian economy and political environment and contributed to a decline in market confidence in Brazil.

As a result of these investigations, a number of senior politicians, including members of Congress, and high-ranking executive officers of major corporations and state-owned companies in Brazil, have been arrested, convicted of various charges relating to corruption, entered into plea agreements with federal prosecutors and/or have resigned or been removed from their positions as a result of these Lava Jato investigations. These individuals are alleged to have accepted bribes by means of kickbacks on contracts granted by the government to several infrastructure, oil and gas and construction companies. The profits of these kickbacks allegedly financed the political campaigns of political parties forming the former government’s coalition that was led by former President Dilma Rousseff, which funds were unaccounted for or not publicly disclosed. These funds were also allegedly destined toward the personal enrichment of certain individuals.

Amidst this background of political and economic uncertainty, President Dilma Rousseff was suspended from office on May 12, 2016, when the Brazilian Senate voted to hold a trial on impeachment charges against her. President Rousseff was replaced by then Vice-President Michel Temer, who served as acting President until Ms. Rousseff was permanently removed from office by the Senate on August 31, 2016. Former President Temer’s term of office ended in December 2018.

In May 2017, several motions for impeachment proceedings against former President Temer were filed in Congress by opposition parties following the surfacing of allegations that Mr. Temer had appeared to endorse the bribing of a jailed politician. On June 26, 2017, Brazil’s chief prosecutor initiated criminal indictment proceedings against former President Temer, which were then referred to Congress for an indictment decision. On August 2, 2017, Congress decided by a majority vote against criminally indicting former President Temer on these charges, and the charges were dismissed for the remainder of his term in office. On an unrelated proceeding, on June 9, 2017, the Brazilian Supreme Court decided that there was insufficient evidence to rule against former President Temer and former President Rousseff on charges relating to illegal campaign financing during former President Temer and former President Rousseff’s 2014 election campaign. On September 14, 2017, Brazil’s chief prosecutor brought additional criminal charges against former President Temer, which were then referred to Congress for an indictment decision. On October 25, 2017, Congress decided by a majority vote against criminally indicting former President Temer on these new charges. On March 21, 2019, former President Temer was arrested for a period of four nights pursuant to an order by a Brazilian federal judge as a precautionary measure in a case involving alleged kickbacks to secure a contract to build a nuclear power plant in Rio de Janeiro state.

Uncertainty regarding the 2018 elections in Brazil also had an adverse effect on the economy and the general public, particularly the incarceration of the former president of Brazil Luiz Inacio Lula da Silva, who was leading polls as a top contender to win the presidential election when he began serving a 12-year prison sentence on corruption and money laundering charges in April 2018. In July 2017, Mr. da Silva was convicted on corruption and money laundering charges and sentenced to almost 10 years in prison, and in January 2018, an appeals court unanimously upheld the conviction and decrease the sentence to 8 years. The warrant for Mr. da Silva’s incarceration was issued after Brazil’s highest court rejected his bid to remain out of prison while appeals of the conviction were considered.

Although Mr. Jair Bolsonaro was elected in November 2018 and took office on January 1, 2019, it remains to be seen whether the proposed economic changes and policies to be adopted will be effective in producing political stability and economic growth. See “—Policies under the new administration of Jair Bolsonaro, Brazil’s recently inaugurated president, may adversely affect the Brazilian economy, our business and the market price of our securities.

We believe that some continued political instability in Brazil and new allegations of wrongdoing involving Brazilian public officials are likely. We have no control over, and cannot predict, whether such investigations or allegations will lead to further political and economic instability or whether new allegations against government officials will arise in the future or will adversely affect us.

Any of the above factors may create additional political uncertainty, which could have a material adverse effect on the Brazilian economy our business, financial condition and results of operations.

 

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Policies under the new administration of Jair Bolsonaro, Brazil’s recently inaugurated president, may adversely affect the Brazilian economy, our business and the market price of our securities.

On October 28, 2018, Jair Bolsonaro, a retired military officer who represented the state of Rio de Janeiro in the lower house of the Brazilian Congress from 1991 through 2018, was elected the next President of Brazil and took office on January 1, 2019. We cannot predict with certainty how Jair Bolsonaro’s administration may impact the overall stability, growth prospects and economic and political health of the country.

During his presidential campaign, Jair Bolsonaro was reported to favor the privatization of state-owned companies, economic liberalization, and social security and tax reforms. However, there is no guarantee that Bolsonaro will be successful in executing his campaign promises or passing certain favored reforms fully or at all, particularly when confronting a fractured congress.

Moreover, Jair Bolsonaro was generally a polarizing figure during his campaign for presidency, particularly in relation to certain of his social views, and we cannot predict the ways in which a divided electorate may continue to impact his presidency and ability to implement policies and reforms, all of which could have a negative impact on our business.

The Brazilian economy and we may be negatively impacted by exchange rate instability.

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.

The Brazilian currency has been historically volatile and has been devalued frequently over the past three decades. Since 1999, the Central Bank has allowed the real/U.S. dollar exchange rate to float freely and during this period, the real/U.S. dollar exchange rate has experienced frequent and substantial variations in relation to the U.S. dollar and other foreign currencies. Throughout this period, the Brazilian government has implemented various economic plans and used various exchange rate policies, including sudden devaluations, periodic mini-devaluations (during which the frequency of adjustments has ranged from daily to monthly), exchange controls, dual exchange rate markets and a floating exchange rate system. Although long-term depreciation of the real is generally linked to the rate of inflation in Brazil, depreciation of the real occurring over shorter periods of time has resulted in significant variations in the exchange rate between the real, the U.S. dollar and other currencies. We cannot predict whether the Central Bank or the Brazilian government will continue to let the real float freely or intervene in the exchange rate market by returning to a currency band system or otherwise. The real may depreciate or appreciate substantially against the U.S. dollar. Furthermore, Brazilian law provides that, whenever there is a serious imbalance, the Brazilian government may impose temporary restrictions on the remittances of foreign capital abroad and on the conversion of Brazilian currency into foreign currencies. We cannot assure you that such measures will not be taken by the Brazilian government in the future.

The real/U.S. dollar exchange rate reported by the Central Bank was R$3.8742 per U.S. dollar on December 31, 2018, reflecting a 17.1% appreciation against the U.S. dollar as compared to R$3.3080 per U.S. dollar on December 31, 2017, which, in turn, reflected a 16.5% appreciation against the U.S. dollar as compared to R$3.9048 per U.S. dollar on December 31, 2015. On September 24, 2015, the real fell to the lowest level since the introduction of the currency, at R$4.195 per US$1.00. As of December 31, 2018, the real/ U.S. dollar exchange rate was R$3.8742 per U.S. dollar, reflecting a 17.1% depreciation against the U.S. dollar as compared to December 31, 2017. The real has fluctuated significantly over the course of 2018 due in part to the general strengthening of the U.S. dollar worldwide and reflecting lower Brazilian interest rates and a high degree of political uncertainty.

Depreciation of the real could create inflationary pressures in Brazil and cause increases in interest rates, which could negatively affect the growth of the Brazilian economy as a whole, harm us, curtail access to financial markets and prompt government intervention, including recessionary governmental policies. Depreciation of the real can also, as in the context of the current global economic recovery, lead to decreased consumer spending, and reduced growth of the economy as a whole.

Because of the degree of volatility and the uncertainty of the factors that impact the Brazilian real’s exchange rate, it is difficult to predict future exchange rate movements. In addition, the Brazilian government may change its foreign currency policy, and any governmental interference in the exchange rate, or the implementation of exchange control mechanisms, could influence the real’s exchange rate.

 

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An increase in inflation, as well as government efforts to combat inflation, may hinder the growth of the Brazilian economy and could adversely affect us.

In the past, Brazil has at times experienced extremely high rates of inflation. Inflation and some of the measures taken by the Brazilian government in an attempt to curb inflation have historically had significant negative effects on the Brazilian economy generally and on Brazil’s capital markets. According to the National Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo) (“IPCA”), Brazilian inflation rates were 3.75%, 2.95%, and 6.29% in 2018, 2017 and 2016, respectively.

If Brazil experiences high inflation again in the future, our operating expenses and borrowing costs may increase while our operating and net margins may decrease. Inflationary pressures may also adversely affect our ability to access foreign capital markets, adversely affecting us. Conversely, more lenient government and Central Bank policies and interest rate decreases have triggered and may continue to trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect us and increase our indebtedness.

Inflationary pressures may also lead the Brazilian government to intervene in the economy and introduce policies that could adversely affect us. In the past, the Brazilian government’s interventions included the maintenance of a restrictive monetary policy with high interest rates. For example, the official interest rate in Brazil increased from 7.25% in 2013 to 14.25% in 2015, as established by the Brazilian Monetary Policy Committee (Comitê de Política Monetária do Banco Central do Brasil). The official interest rate in Brazil was lowered from 14.25% to 14.00% to 13.75% in 2016, and was lowered to 6.75% on February 7, 2018, with further lowering to 6.50% in March 2018. There have been no changes to the official interest rate between then and December 31, 2018.

The government’s high interest rate policies have historically restricted credit availability and reduced economic growth, and may reduce our ability to execute our business and management plans and adversely affect us in the future. In addition, as of December 31, 2017, the interest rates of substantially all of our loans, financing and debentures and related debt acknowledgment instrument were directly tied to the interest rates in Brazil, such as the Brazilian long-term interest rate (Taxa de Juros de Longo Prazo) (“TJLP”) and the interbank deposit rate (Certificados de Depósitos Interbancários) (“CDI”). An increase in such interest rates would increase our borrowing costs and may affect our ability to comply with our financial obligations, which could adversely affect us.

We are exposed to variations in interest rates, which may have adverse effects on us.

We are exposed to the risk of interest rate variations, principally in relation to Brazil’s TJLP, Brazil’s CDI, and Brazil’s consumer price index (Índice de Preço ao Consumidor) (“IPC”). As of December 31, 2018, all of our debt was indexed to Brazilian interest rates, principally the CDI. If these interest rates were to increase, this could adversely affect us by increasing expenses in making the repayments and could restrict our ability to access financing in the future. We may not be able to adjust the prices we charges to our customers to offset increased debt payments, particularly as our contracts with our customers are typically for a term of four years.

As of December 31, 2018, the outstanding balance due on our loans subject to the CDI rate was R$1,552.4 million (R$1,448.2 million as of December 31, 2017).

Significant increases in consumption, inflation or other macroeconomic pressures may lead to an increase in these rates. For further information regarding our exposure to the risk of interest rate variations, see “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Brazilian Macroeconomic Environment.”

The Brazilian government’s inefficiencies or inability to implement critical reforms to improve the Brazilian tax system, labor laws and other areas key to macroeconomic vitality may negatively impact us.

Legislative rigidities, particularly in the goods and labor markets, continue to negatively impact the competitiveness and productivity of the Brazilian economy and hinder the allocation of resources to their most efficient use. Distortionary excise taxes, taxation on investments and a lack of flexibility in the Brazilian labor market are hindrances to continued and robust economic growth in Brazil. In addition, the Brazilian legal and administrative framework within which individuals, firms, and governments interact remains encumbered by bureaucratic constraints. Furthermore, a low confidence level in Brazilian government officials and in the rule of law continues to pose additional challenges. There can be no assurances that the Brazilian government will implement reforms adequately addressing these impediments to greater economic growth and, as a result, we may be adversely affected.

 

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Risks Related to Our Ordinary Shares

We could be adversely affected by any further downgrading of Brazil’s credit rating.

Credit ratings affect investors’ perceptions of risk and, as a result, the yields required on future debt issuances in the capital markets. Rating agencies regularly evaluate Brazil and its sovereign ratings, which are based on a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness metrics and the perspective of changes in any of these factors.

Rating agencies began the classification review of Brazil’s sovereign credit rating in September 2015, and Brazil subsequently lost its investment grade condition by the three main rating agencies. Standard & Poor’s Financial Services LLC initially reduced Brazil’s credit rating from BBB-minus to BB-plus and subsequently reduced it again from BB-plus to BB, and maintained its negative outlook on the rating, citing a worsening credit situation since the first downgrade. In December 2015, Moody’s Investors Service, Inc. placed Brazil’s Baa3 issuer and bond ratings on review for a downgrade, and subsequently downgraded Brazil’s issuer and bond ratings to below investment grade, to Ba2 with a negative outlook, citing the prospect for further deterioration in Brazil’s debt metrics in a low growth environment, in addition to challenging political dynamics. In April 2018 Moody’s placed Brazilian sovereign outlook as stable. Fitch Ratings Inc. downgraded Brazil’s sovereign credit rating to BB-plus with a negative outlook, citing the country’s rapidly expanding budget deficit and worse-than-expected recession. As a result, Brazil lost its investment grade status from all three major rating agencies and consequently the trading prices of securities of the Brazilian debt and equity markets were negatively affected. In January 2018, Standard & Poor’s lowered its long-term rating for Brazil sovereign debt to BB-, citing less timely and effective policymaking, and a risk of greater policy uncertainty after Brazil’s 2018 elections. A continuation of the current Brazilian recession and political uncertainty could lead to further ratings downgrades.

Any further downgrade of Brazil’s sovereign credit ratings could heighten investors’ perception of risk and could, adversely affect us.

Future issuances of any equity securities may dilute your ownership interests and decrease the trading price of our ordinary shares.

Any future issuance of equity securities could dilute the interests of our shareholders and could substantially decrease the trading price of our ordinary shares. We may issue equity or equity-linked securities in the future, including pursuant to a private investment in public equity (“PIPE”) or other offering of equity securities, for a number of reasons, including to finance our operations and business strategy (including in connection with acquisitions and other transactions), to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of then-outstanding options or other equity-linked securities, if any, in connection with the terms of any possible debt restructuring efforts, in connection with any judicial reorganization or for other reasons. We are not required to obtain shareholder approval for the issuance of additional ordinary shares, and investors should note that we are not required to comply with the NASDAQ rule requiring shareholder approval for issuances of additional securities exceeding 20% of our outstanding ordinary shares. See “Item 16. Corporate Governance.”

Future sales of ordinary shares held by significant shareholders, or market expectations as to any such future sales, may increase the volatility in the price of the ordinary shares and negatively impact the trading price of the ordinary shares.

If any significant shareholder sells large amounts of ordinary shares in the open market or in privately negotiated transactions, or if the market has expectations as to any such future sales, this could have the effect of increasing the volatility in the price of the ordinary shares and negatively impact the trading price of the ordinary shares.

The Registrant is a Cayman Islands exempted company and, because judicial precedent regarding the rights of shareholders is different under Cayman Islands law than under U.S. law, you could have less protection of your shareholder rights than you would under U.S. law.

The Registrant’s corporate affairs are governed by our Memorandum and Articles, the Companies Law, as amended, and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by noncontrolling shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are different from under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a different body of securities laws from the United States and may provide significantly less protection to investors. In addition, some U.S. states, such as Delaware, have different bodies of corporate law than the Cayman Islands.

 

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We have been advised by our Cayman Islands legal counsel, Maples and Calder, that the courts of the Cayman Islands are unlikely (i) to recognize or enforce against us judgments of courts of the United States predicated upon the civil liability provisions of the securities laws of the United States or any State and (ii) in original actions brought in the Cayman Islands, to impose liabilities against us predicated upon the civil liability provisions of the securities laws of the United States or any State, so far as the liabilities imposed by those provisions are penal in nature. In those circumstances, although there is no statutory enforcement in the Cayman Islands of judgments obtained in the United States, the courts of the Cayman Islands will recognize and enforce a foreign money judgment of a foreign court of competent jurisdiction without retrial on the merits based on the principle that a judgment of a competent foreign court imposes upon the judgment debtor an obligation to pay the sum for which judgment has been given provided certain conditions are met. For a foreign judgment to be enforced in the Cayman Islands, such judgment must be final and conclusive and for a liquidated sum, and must not be in respect of taxes or a fine or penalty, inconsistent with a Cayman Islands judgment in respect of the same matter, impeachable on the grounds of fraud or obtained in a manner, and or be of a kind the enforcement of which is, contrary to natural justice or the public policy of the Cayman Islands (awards of punitive or multiple damages may well be held to be contrary to public policy). A Cayman Islands Court may stay enforcement proceedings if concurrent proceedings are being brought elsewhere. There is recent Privy Council authority (which is binding on the Cayman Islands Court) in the context of a reorganization plan approved by the New York Bankruptcy Court which suggests that due to the universal nature of bankruptcy/insolvency proceedings, foreign money judgments obtained in foreign bankruptcy/insolvency proceedings may be enforced without applying the principles outlined above. However, a more recent English Supreme Court authority (which is highly persuasive but not binding on the Cayman Islands Court), has expressly rejected that approach in the context of a default judgment obtained in an adversary proceeding brought in the New York Bankruptcy Court by the receivers of the bankruptcy debtor against a third party, and which would not have been enforceable upon the application of the traditional common law principles summarized above and held that foreign money judgments obtained in bankruptcy/insolvency proceedings should be enforced by applying the principles set out above, and not by the simple exercise of the Courts’ discretion. Those cases have now been considered by the Cayman Islands Court. The Cayman Islands Court was not asked to consider the specific question of whether a judgment of a bankruptcy court in an adversary proceeding would be enforceable in the Cayman Islands, but it did endorse the need for active assistance of overseas bankruptcy proceedings. We understand that the Cayman Islands Court’s decision in that case has been appealed and it remains the case that the law regarding the enforcement of bankruptcy/insolvency related judgments is still in a state of uncertainty.

The Registrant may be treated as a U.S. corporation for U.S. federal income tax purposes.

As an exempted company incorporated under the laws of the Cayman Islands, the Registrant is generally classified as a non-U.S. entity (and, therefore, not a U.S. person) under general rules of U.S. federal income taxation. Section 7874 of the Code and the Treasury regulations promulgated thereunder, however, contain rules that may cause a non-U.S. corporation to be treated as a U.S. corporation for U.S. federal income tax purposes in certain cases. Whether the rules of section 7874 apply to cause the Registrant to be treated as U.S. corporation for U.S. federal income tax purposes depends on the application of complex statutory and regulatory rules to the steps of the Pre-Closing Restructuring, the Merger, and certain related transactions. There is limited guidance regarding the application of the rules of section 7874 to the Pre-Closing Restructuring, the Merger, and certain related transactions.

Based on the terms of the Pre-Closing Restructuring, the Merger, and certain related transactions, we do not expect that the Registrant is treated as a U.S. corporation for U.S. federal income tax purposes. Nevertheless, the application of section 7874 is uncertain and depends, in part, on the application of complex rules, the application of which is uncertain. Accordingly, there can be no assurance that the IRS will not assert that the Registrant is treated as a U.S. corporation for U.S. federal income purposes pursuant to section 7874, or that a court would not uphold such an assertion. If the Registrant is treated as a U.S. corporation for U.S. federal income tax purposes, the Registrant could be liable for substantial U.S. federal income tax, dividends paid to non-U.S. shareholders could be subject to U.S. withholding tax and certain other U.S. federal income tax consequences could apply to the Registrant that would adversely affect our tax and financial position. See “Item 10.E. Additional Information—Taxation—U.S. Federal Income Tax Considerations” for a more complete discussion of certain U.S. federal income tax considerations relating to the ownership and disposition of our ordinary shares.

 

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As a “foreign private issuer” under the rules and regulations of the SEC, we are permitted to, and will, file less or different information with the SEC than a company incorporated in the United States or otherwise subject to these rules, and may follow certain home country corporate governance practices in lieu of certain NASDAQ requirements applicable to U.S. issuers.

We are considered a “foreign private issuer” under the Exchange Act and are therefore exempt from certain rules under the Exchange Act, which impose certain disclosure requirements for U.S. and other issuers. Moreover, we are not required to file periodic reports and financial statements with the SEC as frequently or within the same time frames as U.S. companies with securities registered under the Exchange Act. We currently prepare our financial statements in accordance with IFRS. We will not be required to file financial statements prepared in accordance with or reconciled to U.S. GAAP so long as our financial statements are prepared in accordance with IFRS as issued by the IASB. We are not required to comply with Regulation FD, which imposes restrictions on the selective disclosure of material information to shareholders. In addition, our officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions of Section 16 of the Exchange Act and the rules under the Exchange Act with respect to their purchases and sales of our securities.

Furthermore, as a “foreign private issuer” whose ordinary shares are listed on the NASDAQ, we are permitted to follow certain home country corporate governance practices in lieu of certain NASDAQ Global Market requirements. A foreign private issuer must disclose in its Annual Reports filed with the SEC each NASDAQ requirement with which it does not comply followed by a description of its applicable home country practice. With effect from the date of this annual report, we follow home country practice that does not require us to obtain shareholder approval for issuing additional securities exceeding 20% of our outstanding ordinary shares. See “Item 16. Corporate Governance.”

We could lose our status as a “foreign private issuer” under current SEC rules and regulations if more than 50% of our outstanding voting securities become directly or indirectly held of record by U.S. holders and one of the following is true: (i) the majority of our directors or executive officers are U.S. citizens or residents; (ii) more than 50% of our assets are located in the United States; or (iii) our business is administered principally in the United States. If we lose our status as a foreign private issuer in the future, we will no longer be exempt from the rules described above and, among other things, will be required to file periodic reports and annual and quarterly financial statements as if we were a company incorporated in the United States. If this were to happen, we would likely incur substantial costs in fulfilling these additional regulatory requirements and members of our management would likely have to divert time and resources from other responsibilities to ensuring these additional regulatory requirements are fulfilled.

We qualify as an emerging growth company within the meaning of the Securities Act, which could make our securities less attractive to investors and may make it more difficult to compare our performance to the performance of other public companies.

We qualify as an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act, as modified by the JOBS Act. As such, we are be eligible for and intend to take advantage of certain exemptions from various reporting requirements applicable to other public companies that are not emerging growth companies for as long as we continues to be an emerging growth company, including (i) the exemption from the auditor attestation requirements with respect to internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act, (ii) the exemptions from say-on-pay, say-on-frequency and say-on-golden parachute voting requirements and (iii) reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We will remain an emerging growth company until the earliest of (i) the last day of the fiscal year in which the market value of our ordinary shares that are held by non-affiliates exceeds US$700 million as of June 30 of that fiscal year, (ii) the last day of the fiscal year in which we have total annual gross revenue of US$1.07 billion or more during such fiscal year (as indexed for inflation), (iii) the date on which we have issued more than US$1 billion in non-convertible debt in the prior three-year period or (iv) the last day of the fiscal year following the fifth anniversary of the date of the first sale of our ordinary shares in our initial public offering. In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the exemption from complying with new or revised accounting standards provided in Section 7(a)(2)(B) of the Securities Act as long as we are an emerging growth company. An emerging growth company can therefore delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. we may elect not to avail itself of this exemption from new or revised accounting standards and, therefore, we may not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies. Investors may find our ordinary shares less attractive because we will rely on these exemptions, which may result in a less active trading market for the ordinary shares and our stock price may be more volatile.

We have a staggered board of directors, which could impede an attempt to acquire our company or remove our management.

Our Memorandum and Articles provide for a board of directors that is divided into three classes, each of which serves for a staggered term of three years.

 

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A staggered board makes it more difficult for shareholders to change a majority of the directors since only approximately one-third of the existing board of directors may be replaced at any election of directors. This arrangement may have the effect of keeping the current members of our board of directors in control for a longer period of time than shareholders may desire, and may impede any attempts to take over our company or change or remove our management.

An active or liquid trading market for our ordinary shares may not be maintained and the trading price for our ordinary shares may fluctuate significantly.

An active, liquid trading market for our ordinary shares may not be maintained in the long term and we cannot be certain that any trading market for our ordinary shares will be sustained or that the present price will correspond to the future price at which our ordinary shares will trade. Loss of liquidity could increase the price volatility of our ordinary shares.

Any additional issuance of our ordinary shares would dilute the positions of existing investors in our ordinary shares and could adversely affect the market price of our ordinary shares. We cannot assure you that our ordinary shares will not decline below their prevailing market price. You may be unable to sell your ordinary shares at a price that is attractive to you.

We rely principally on dividends and other distributions on equity paid by our operating subsidiaries, and limitations on their ability to pay dividends to us could adversely impact shareholders’ ability to receive dividends on our ordinary shares.

Dividends and other distributions on equity paid by our operating subsidiaries are our principal source for cash in order for us to be able to pay any dividends and other cash distributions to our shareholders. As of the date hereof, we have not paid any cash dividends on our ordinary shares. The instruments governing the debt of the Company, our main operating subsidiary, restrict its ability to pay dividends, with the effect of adversely impacting our shareholders’ ability to receive dividends on our ordinary shares in the foreseeable future.

If securities or industry analysts do not publish or cease publishing research or reports about our company, our business, or our market, or if they change their recommendations regarding our ordinary shares adversely, the price and trading volume of our ordinary shares could decline.

The trading market for our ordinary shares will be influenced by the research and reports that industry or securities analysts may publish about our company, our business, our market, or our competitors. Securities and industry analysts do not currently, and may never, publish research on our company. If no securities or industry analysts commence coverage of our company, our share price and trading volume would likely be negatively impacted. If any of the analysts who may cover our company change their recommendation regarding our shares adversely, or provide more favorable relative recommendations about our competitors, the price of our ordinary shares would likely decline. If any analyst who may cover our company were to cease coverage of our company or fail to regularly publish reports on our company, we could lose visibility in the financial markets, which in turn could cause our share price or trading volume to decline.

The liquidity in our securities may be limited and the market price of our securities may be volatile and decline.

The liquidity in our securities may be limited, negatively affecting the trading price of our securities. Even if an active market for our securities develops and continues, the trading price of our securities could be volatile and subject to wide fluctuations in response to various factors, some of which are beyond our control. Any of the factors listed below could have a material adverse effect on your investment in our securities and our securities may trade at prices significantly below the price you paid for them. In such circumstances, the trading price of our securities may not recover and may experience a further decline.

Factors affecting the trading price of our securities may include:

 

   

actual or anticipated fluctuations in our periodic financial results or the financial results of companies perceived to be similar to ours;

 

   

our liquidity constraints and our restructuring efforts and results;

 

   

our entering into an extrajudicial or a judicially-supervised reorganization;

 

   

expectations with respect to, and the results of, the ongoing investigations of the Brazilian tax and criminal authorities related to the Company and certain former affiliates;

 

   

changes in the market’s expectations about our operating results;

 

   

success of competitors;

 

 

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our operating results failing to meet the expectation of securities analysts or investors in a particular period;

 

   

changes in financial estimates and recommendations by securities analysts concerning our company or our industry in general;

 

   

operating and share price performance of other companies that investors deem comparable to ours;

 

   

changes in laws and regulations affecting our business;

 

   

our ability to meet compliance requirements;

 

   

commencement of, or involvement in, litigation involving us;

 

   

changes in our capital structure, such as future issuances of securities or the incurrence of additional debt;

 

   

the volume of our ordinary shares available for public sale;

 

   

any major change in our board of directors or management;

 

   

sales of substantial amounts of our ordinary shares by our directors, executive officers or significant shareholders or the perception that such sales could occur; and

 

   

general economic and political conditions such as recessions, interest rates, fuel prices, international currency fluctuations and acts of war or terrorism.

Broad market and industry factors may materially harm the market price of our securities irrespective of our operating performance. The stock market in general, and NASDAQ in particular, have experienced price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. The trading prices and valuations of these shares, and of our securities, may not be predictable. A loss of investor confidence in the market for travel-related securities or the shares of other companies which investors perceive to be similar to ours could depress our share price regardless of our business, prospects, financial conditions or results of operations. A decline in the market price of our securities also could adversely affect our ability to issue additional securities and our ability to obtain additional financing in the future.

There is no guarantee that our ordinary shares will continue to qualify for listing on the NASDAQ for any period of time, and the failure to have our ordinary shares listed for any reason may negatively affect the value of our ordinary shares.

Our ordinary shares began trading on the NASDAQ on December 22, 2017. There are no guarantees that our ordinary shares will continue to qualify for listing on the NASDAQ. If our ordinary shares are ever in the future delisted, the holders could face significant consequences, including:

 

   

a limited availability for market quotations for our securities;

 

   

reduced liquidity with respect to our securities;

 

   

a determination that our securities are a “penny stock,” which will require brokers trading in those securities to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market for those securities;

 

   

limited amount of news and analyst coverage for our company in the United States; and

 

   

a decreased ability to issue additional securities or obtain additional financing in the future.

You will have limited ability to bring an action against us or our directors and officers, or to enforce a judgment against us or them, because we are incorporated in the Cayman Islands, because we conduct a majority of our operations in Brazil and because a majority of our directors and officers reside outside the United States.

We are incorporated in the Cayman Islands and conduct our operations in Brazil. All of our assets are located outside the United States. A majority of our officers and directors reside outside the United States and a substantial portion of the assets of those persons are located outside of the United States. As a result, it could be difficult or impossible for you to bring an action against our company or against these individuals in the Cayman Islands or in Brazil in the event that you believe that your rights have been infringed under the applicable securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of Brazil could render you unable to enforce a judgment against our assets or the assets of our directors and officers.

 

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Shareholders of Cayman Islands exempted companies such as our company have no general rights under Cayman Islands law to inspect corporate records and accounts or to obtain copies of lists of shareholders of these companies. Our directors have discretion under Cayman Islands law to determine whether or not, and under what conditions, our corporate records could be inspected by our shareholders, but are not obliged to make them available to our shareholders. This could make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

As a result of all of the above, public shareholders might have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a U.S. company.

 

ITEM 4.

INFORMATION ON THE COMPANY

The Registrant is an exempted company incorporated under the laws of the Cayman Islands on September 11, 2017, and subsequently became a public company upon the consummation of the Transaction. The Registrant’s registered office is located at PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands.

Our principal executive offices are located at Avenida Brigadeiro Faria Lima, 4509, 8th Floor, 04538-133, São Paulo, SP, Brazil, and our telephone number and email are: +55 (11) 2124 3100 and ir@estre.com.br. Our agent for service of process in the United States is Puglisi & Associates located at 850 Library Avenue, Suite 204, Newark, Delaware 19715.

A.    History and Development of the Company

Overview

Our company was founded in 1999 as a company initially focused on the development of landfills for non-hazardous residues in the State of São Paulo. In 2000, we began operating our first landfill, CGR Paulínia, in the city of Paulínia, State of São Paulo, which, at that time, had a daily handling capacity of 500 metric tons of non-hazardous residues. In 2001, we developed our second landfill, CDR Pedreira—Centro de Disposição de Resíduos (“CDR Pedreira”), in the city of São Paulo, which we later sold in 2014, as more fully described below.

In 2005, we established Estação Ecologia and began recycling construction materials, and in 2006, we began the collection of biogas in CGR Paulínia. In 2007 we acquired Oxil, a company focused on the recycling and reassembling of electronics.

In 2008, Estre Petróleo e Gás Ltda. (“Estre Petróleo”) began its operations in renting and supplying oil rigs for the oil and gas industry and providing other services, such as the completion, restoration, deepening and cleaning of, as well as water injection into, oil and gas wells. That same year, we acquired Pollydutos, a company that installs and provides maintenance services for petroleum pipelines and ducts, and transports oil, gas and other fuels. We later transferred these businesses to Mr. Wilson Quintella Filho in 2014, as described below.

In 2009, we acquired, together with Angra, the hazardous and non-hazardous waste treatment and disposal businesses in the states of São Paulo and Paraná of Veolia, a multinational waste management company based in France, which businesses would later be merged into Resicontrol Soluções Ambientais S.A. (“Resicontrol”), one of our wholly-owned subsidiary.

In 2010, we began operating (i) CTR Itaboraí, a landfill in the city of Itaboraí, State of Rio de Janeiro, of which we at the time owned 50%; (ii) CGR Curitiba, a landfill in the city of Curitiba, State of Paraná; and (iii) Doña Juana, a landfill operated as a public concession in the city of Bogotá, Colombia. In addition, in 2010, we established a partnership with Sabesp, a mixed capital, state-controlled company that provides water and sewage services to the 364 municipalities in the State of São Paulo, to implement and operate a non-domestic wastewater treatment plant, which plant started operating in 2014.

In 2011, we acquired Cavo Serviços e Saneamento (“Cavo”), from the Brazilian conglomerate Camargo Correa S.A. As a result of this acquisition, we acquired control of Cavo’s subsidiary Unidade de Tratamento de Resíduos—UTR S.A., a 50% equity interest in Essencis S.A. (“Essencis”) and a 37.6% equity stake in Logística Ambiental de São Paulo (“Loga”), thereby more than doubling our revenues. The transaction was structured and financed by Banco BTG Pactual S.A. as a 100% leveraged buy-out. Through this acquisition, we expanded our operations to include urban waste collection and medical waste management.

 

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In October 2011, BTG Pactual, indirectly through its vehicle BPMB Digama Participações S.A., converted all the convertible debentures issued by us which were then held by BTG Pactual into 16,818,904 of the Company’s common shares, then representing 20.9% of our capital stock. On the same date, Angra indirectly acquired 6,526,378 of the Company’s common shares, then representing 8.11% of our capital stock, in exchange for Angra’s 50% equity stake in Resicontrol. BTG Pactual and Angra introduced enhanced corporate governance and focused on improving operational efficiencies, including through the implementation of several measures with the objective of streamlining our operations.

In December 2011, Wilson Ferro de Lara became a shareholder in our company through the acquisition of 3,477,501 of the Company’s common shares from Wilson Quintella Filho, and 755,391 of the Company’s common shares then held by Gisele Mara de Moraes, then collectively representing 5.26% of our capital stock.

In 2011, our current CEO, Sergio Pedreiro, was appointed a member of our board of directors. Since then, Mr. Pedreiro has become intimately familiar with our day-to-day operations, and has played a leading role in implementing efforts at improving our governance structure, operational efficiencies and streamlining our operations.

In 2012, we acquired: (i) full control of CTR Itaboraí by purchasing the remaining 50% equity interest in that entity that we did not then own; (ii) 100% of the shares of Viva Ambiental e Serviços S.A. and its subsidiaries (“Viva”), which provided landfill and collection services and other urban waste services predominantly in the northeastern region of Brazil; (iii) an additional 43% equity stake in Soma, which provides cleaning services in the eastern and southern regions of the city of São Paulo, thus increasing our ownership interest from 39% to 82%; (iv) 100% of the shares of Geo Vision Soluções Ambientais e Energia S.A. (“Geo Vision”), which provides landfill and collection services and other urban waste services predominantly in the State of São Paulo; (v) a 50% equity stake in our Guatapará and Jardinópolis landfills; (vi) an indirect 10.9% equity stake in Advanced Disposal Services Inc., or ADS, which provides collection, transportation, treatment, recycling and waste disposal services in the United States and which was later sold to an affiliate of BTG in 2013; (vii) a 100% stake in Ambiental Sul Brasil—Central Regional de Tratamento de Resíduos Ltda., which owns a landfill in the municipality of Sarandi, in the State of Paraná; and (viii) a 50% equity interest in Metropolitana Serviços Ambientais Ltda., a pre-operational company that owns property in the State of Goiás, and has an environmental license to build a landfill with an expected daily handling capacity of 1,200 tons.

In September 2014, we executed, together with Wilson Quintella Filho, our founding shareholder, a non-cash share exchange agreement pursuant to which Mr. Quintella exchanged 2,053,983 of his common shares in our company (corresponding to 1.9% of the total common shares he then owned with a book value of R$37.4 million) for 53,701,027 common shares issued by Estre O&G, which we held at the time. Prior to this sale, Estre O&G was a 100%-owned consolidated subsidiary of ours engaged in providing tank cleaning, oil sludge treatment, pipeline construction and maintenance services in various locations under agreements entered into with Petrobras. Upon the closing of the transaction in January 2015, we ceased to hold any equity ownership in Estre O&G or any of its subsidiaries, including Pollydutos, and Mr. Quintella became holder of all the shares of Estre O&G and controller of its subsidiaries. For more information, see “—Sale of Estre Óleo e Gás Holding S.A.” below.

In December 2014, we sold our 50% equity stake in Essencis to Solvi Participações S.A. (“Solvi”), for R$488.0 million thereby increasing Solvi’s ownership to 100%. In connection with Essencis’s sale, we agreed with Solvi to terminate the arbitration proceeding regarding the sale of Essencis’ shares by Camargo Correa S.A. to us.

In October 2014, we sold 65% of our equity interest in CDR Pedreira to BTG Pactual (through BTG Pactual’s vehicle A.Z.P.S.P.E.) for a total purchase price of R$180 million paid in three instalments over the course of 2014. Simultaneously with this sale, we entered into call and put option agreements in connection with a potential repurchase of CDR Pedreira from A.Z.P.S.P.E., originally set to expire in October 2017. On May 19, 2016, we executed a private agreement with A.Z.P.S.P.E. pursuant to which we renounced our rights under the call option and recorded a loss in connection therewith. Following this, BTG Pactual sold CDR Pedreira to an affiliate of Veolia in Brazil. For more information, see “—Sale of CDR Pedreira—Centro de Disposicâo de Resíduo” below.

In March 2015, we sold our 100% interest in Azaleia Empreendimentos e Participações S.A. (“Azaleia”), back to an affiliate of the original seller. The purpose of such transaction was to divest certain of our collections operations in the region of Ribeirão Preto conducted through Geo Vision, which we acquired in 2012. As the buyer was an entity wholly-owned by the original sellers of Geo Vision, at the time of settlement of the earnout provisions for the Azaleia transaction in 2016, we fully offset our accounts receivable from this transaction against our accounts payables in connection with the original acquisition. For more information, see “—Sale of Geo Vision Contracts through Azaleia Empreendimentos e Participacões S.A.” below.

 

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In May 2015, Sergio Pedreiro was appointed as our interim CEO, and was appointed CEO on a permanent basis in September 2015. Under his leadership, we have implemented several concrete measures with the goal of operating at a level of sophistication and efficiency similar to that of major U.S. waste management companies. Chief among these new measures were the reorganization of our upper management team, increased focus on compliance, reduction of corporate headcount, promotion of a new results-oriented culture, and implementation of an objective, results-based compensation system.

In December 2015, we sold our 75% equity stake in Argentina-based Estrans S.A. (“Estrans”), the proceeds of which were used to offset certain existing obligations. For more information, see “—Sale of Interest in Estrans S.A.” below.

In January 2016, we entered into an agency agreement with USA Global MKT (“USA Global”), for the sale of our 51% equity stake in Colombia-based Doña Juana. Pursuant to the terms of the agreement, USA Global, our partner and co-investor in Doña Juana, assumed control of Doña Juana, while at the same time seeking a compatible buyer for our interest in Doña Juana. As per the terms of the agreement, USA Global also agreed to advance us payments for the sale of Doña Juana (irrespective of whether a buyer was found or such sale was completed). For more information, see “—Sale of Interest in CGR Doña Juana S.A. ESP” below.

In an effort to return to profitability and to strengthen our balance sheet, we have been undergoing a comprehensive financial and corporate restructuring over the past several years pursuant to which we have reviewed and rationalized our cost structure, pricing, compliance and controls, planning processes, information technology and use of data. For more information, see “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Key Factors Affecting Our Results of Operations—Restructuring Plan.”

On December 21, 2017, immediately prior to the Merger, we completed our Pre-Closing Restructuring, pursuant to which the holders of the Company’s common shares (other than Angra) contributed their common shares in the Company to us in exchange for an aggregate of 27,001,886 of our ordinary shares. In addition, 1,983,000 of our ordinary shares were issued to the Employee Compensation Entity immediately prior to the closing of the Merger.

As a result of our Pre-Closing Restructuring and the Merger, the Company and Estre USA became the Registrant’s partially-owned subsidiaries, and the former public security holders of Estre USA became our shareholders.

On December 21, 2017, we completed the Merger pursuant to which Merger Sub merged with and into Estre USA.

On December 21, 2017, the Registrant issued 15,438,000 of the Registrant’s ordinary shares and 3,748,600 warrants to purchase the Registrant’s ordinary shares at US$11.50 per share to certain institutional investors unaffiliated with us pursuant to a private investment in public equity, which we refer to as the PIPE Investment.

On December 26, 2017, we completed our Debt Restructuring, pursuant to which we used an amount of US$110.6 million from the total cash investments received by us to partially prepay certain of our existing debentures and related debt acknowledgment instrument, each denominated in Brazilian reais, coupled with a partial debt write-down and the refinancing of the balance of our existing debentures and related debt acknowledgment instrument through the amendment and restatement of such instruments with new terms.

Our ordinary shares and warrants began trading on the NASDAQ on December 22, 2017 under the symbols “ESTR” and “ESTRW,” respectively.

In connection with the Transaction, on December 21, 2017, we entered into three definitive agreements for the transfer of our equity interests in Loga, Attend and Terrestre to a vehicle controlled by the Company’s former shareholders for a nominal fee.

On March 6, 2018, Angra confirmed the exercise of its put option to sell all of its shares to the Company through a formal notification. Consequently, on March 6, 2018, Angra transferred 8,871,895 shares to the Company, with the Company having until September 6, 2018 to complete the payment for such shares. The shares transferred by Angra are currently held by the Company as treasury shares and, thus, in accordance with Brazilian Law No. 6,404/76, will not hold voting or dividend rights for as long as they remain in the treasury of the Company. As of the date of this annual report, as a result of our liquidity constraints, we have not yet made any payments to Angra with respect to the share transfer, but are negotiating alternative payment terms with Angra.

 

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On April 23, 2018, we concluded the sale of our 50% interest in Leccaros Participações S.A. (“Leccaros”) for R$22.1 million to a third party—Lara Central de Tratamento de Resíduos Ltda. Lecarros owned a single asset consisting of land located in the state of São Paulo and did not have any operations. Cash consideration of R$10.0 million was received upon the closing of the transaction, and R$12.1 million are payable in 12 equal monthly installment payments.

On December 14, 2018, we concluded the sale of our 50% interest in CGR Catanduva – Centro de Gerenciamento de Resíduos Ltda. (“CGR Catanduva”) to our business partner for a total consideration of R$7.5 million. CGR Catanduva owned and operated a landfill in Catanduva, São Paulo State. Cash consideration of R$1.0 million was received upon closing of the transaction, a second payment of R$4.0 million was received on December 18, 2018 and R$2.5 million will be received in 5 equal monthly installment payments between January 2019 and May 2019. As a consequence of the sale of our 50% interest in CGR Catanduva its results are no longer consolidated with ours. As of December 31, 2018, the net assets of CGR Catanduva were R$10.2 million, with R$5.1 million attributable to us. The transaction resulted in a gain on sale of R$2.0 million.

Recent Divestments and Acquisitions

As part of our efforts to streamline our operations, we have since 2014 divested of certain assets that negatively impacted our margins and did not align with our strategic vision. A summary of our significant asset sales is set forth below.

Sale of Interest in CGR Doña Juana S.A. ESP

On January 5, 2016, we entered into an agency agreement with USA Global, for the sale of our 51% interest in Doña Juana, based in Colombia. Pursuant to the terms of the agreement, USA Global, our partner and co-investor in Doña Juana, assumed control over Doña Juana while at the same time seeking a compatible buyer for our interest in Doña Juana. As per the terms of the agreement, USA Global also agreed to advance payments to us for the sale of Doña Juana (irrespective of whether a buyer was found or such sale was completed). After USA Global made the first payment to us for Doña Juana, the composition of Doña Juana’s management completely changed such that we relinquished all control over the entity. Accordingly, all of the Estre-appointed board members and executive officers of Doña Juana resigned and were replaced by individuals appointed by USA Global, thus effectively fully conveying control over Doña Juana to USA Global. The initial term of this agency agreement was 18 months, which was subsequently extended by 12 months, during which time we received 59.6% of the purchase price for Doña Juana of US$1.9 million (or R$6.2 million, calculated based on an exchange rate of $1 to R$3.2591 for payments received in 2016 and based on a the actual exchange rate existing on the day of payment for all payments made in 2017) from USA Global in four installments over the course of 2016. In February 2018, we signed an amendment to the agency agreement postponing some of USA Global’s obligations, such as (i) extending the date that the final installment of US$0.6 million (R$2.1 million, calculated as of February 28, 2018) would be paid on May, 26, 2018 and (ii) extending the contract term from 12 to 14 months. As of the date of this annual report, USA Global has remaining payment obligations in an amount of US$0.8 million (R$2.8 million, calculated using the average FX rate from January 1 to November 30, 2018) to be paid in installments until June 2019, as described below.

On November 20, 2018, we fully transferred our shares in Doña Juana to Ecensa Colombia, a subsidiary of USA Global, but continue to have an outstanding balance of receivables in the amount of R$2.8 million as of December 31, 2018 that is payable by USA Global.

Doña Juana operates pursuant to a contract with the municipality of Bogotá and, as such, must have authorization of the Colombian regulatory authority UAESP—AESP—Unidad Administrativa Especial de Servicios Publicos (“UASEP”), in order to operate and also to effect certain changes, including, prior to April 30, 2018, a change in the shareholder composition. On April 30, 2018, UAESP amended the contract with Doña Juana to modify the required procedures to effect a change in shareholder structure such that Doña Juana must only now notify UASEP about shareholder changes rather than obtaining UASEP’s prior approval and such change permitted the transfer of shares to occur.

 

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Following the execution of the original agency agreement with Doña Juana, we classified our investment in Doña Juana as an asset held for sale, recording it at its carrying amount. After the investment in Doña Juana was classified as an asset held for sale, we accounted for the investment under the equity method under IAS 28. In 2017, our share of profit in Doña Juana amounted to approximately R$0.7 million.

On November 20, 2018, we fully transferred our shares in Doña Juana to Ecensa Colombia, a subsidiary of USA Global and agreed that the outstanding amount to be paid to us (as described above) is paid in five installments between December 2018 and June 2019. Such transaction increased our profits by R$31.7 million as a consequence of the reversal of a provision for losses on investments. As of May 5, 2019, the remaining balance of R$1.6 million is scheduled to be paid between May 31 and June 28, 2019.

For additional information, see notes 1.3.1 and 10.2.1. to our audited financial statements included elsewhere in this annual report.

Sale of Geo Vision Contracts through Azaleia Empreendimentos e Participacões S.A.

On May 5, 2015, we entered into a purchase and sale agreement to sell 100% of our interest in Azaleia to Limpus—Soluções Ambientais Ltda. (“Limpus”) for R$30.3 million. The purpose of such transaction was to divest certain of our smaller collections operations in the region of Ribeirao Preto conducted through Geo Vision Soluções Ambientais e Energia S.A. (“Geo Vision”), which we acquired in 2012. These collections operations generated low revenues relative to associated costs, particularly considering the sizeable distance between the collection sites and our landfills. As a result, as part of our restructuring process and with the goal of streamlining our operations in the region, we spun-off these collections operations into Azaleia, a newly-formed entity, which we later sold to Limpus, an entity that was controlled by the original sellers of Geo Vision. Following the execution of our agreement with Limpus in May 2015, we ceased to record results from these contracts. In the first part of 2015 prior to the sale of Azaleia, generated revenues of R$10.9 million and operating costs of R$9.2 million.

There was no cash exchanged as part of the Azaleia transaction. In connection with the original acquisition of Geo Vision, we had a remaining balance of R$39.8 million to be paid to the seller as of December 31, 2016. As Limpus was an entity wholly-owned by the original sellers of Geo Vision, at the time of settlement of the earnout provisions for the Azaleia transaction in 2016, we fully offset our accounts receivable from this transaction, amounting to R$41.3 million as of December 31, 2016, as adjusted by interest, by our accounts payable on the original Geo Vision of transaction of R$39.8 million, as adjusted for interest, with the remaining balance of R$1.4 million written off as a loss from the settlement of accounts.

For additional information, see note 1.3.2 of our audited financial statements included elsewhere in this annual report.

Sale of CDR Pedreira—Centro de Disposicâo de Resíduos

In October 2014, we entered into a purchase and sale agreement with BTG Pactual (through AZPSPE) for the sale of 65% of CDR Pedreira for a total purchase price of R$180 million paid in three installments over the course of 2014.

In addition, simultaneous with this sale, we entered into call and put option agreements in connection with our potential repurchase of CDR Pedreira from AZPSPE, originally set to expire in October 2017. The call and put option amount was R$180 million, plus 25% fixed interest per year from October 2014 and an additional put option premium equivalent to R$1.00 per share. The put option premium would be due on the earlier of (i) the exercise date of the put option or (ii) the last day of the period to exercise the put option. The fair value of the call option was R$20.9 million and R$10.7 million as of December 31, 2016 and 2015, respectively, recorded in noncurrent assets against other operating income. Despite the call option, following our execution of the purchase and sale agreement in October 2014, we ceased all control and influence in the operation and management of CDR Pedreira.

On May 19, 2016, in connection with the sale by BTG Pactual (through AZSPE) of the CDR Pedreira to an independent third party, we agreed to terminate the right corresponding to the call and put options, the fair value of which totaled R$20.8 million at that time and, accordingly, fully wrote it off as a loss under “Other Operating Expense” in 2016.

 

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Transfer of Interests in Loga, Attend and Terrestre

In connection with the Transaction, on December 21, 2017, we entered into three definitive agreements for the transfer of our equity interests in Loga, Attend and Terrestre to Latte Saneamento e Participações S.A. (“Latte”), a vehicle controlled by the Company’s former shareholders for a nominal fee. We also transferred accounts receivable from the spun-off companies to Latte in the amount of R$3.0 thousand. The transfer of Terrestre was completed on August 24, 2018, the transfer of Attend was completed on December 12, 2018 and the transfer of Loga was completed on December 28, 2018.

We recorded the transactions as a distribution to shareholders of equity in the amount of R$103.2 million in the year ended December 31, 2017 corresponding to the carrying amount of these investments and the account receivable.

Sale of Interest in Leccaros Participações S.A.

On April 23, 2018, we concluded the sale of our 50% interest in Leccaros Participações S.A., a non-operational company holding only real estate assets, for R$22.1 million to a third party—Lara Central de Tratamento de Resíduos Ltda. Cash consideration of R$10.0 million was received upon closing of the transaction, and R$12.1 million was payable in 12 equal monthly installment payments. As of December 31, 2017, Leccaros’ net assets were R$6.5 million, with R$3.3 million attributable to us. The transaction resulted in a gain on sale of R$37.6 million, of which R$18.8 million was attributable to us. As of December 31, 2017, we classified our investment in Leccaros as an asset held for sale. For additional information, see note 1.3.5 of our audited financial statements included elsewhere in this annual report.

Sale of Catanduva

On December 14, 2018, we concluded the sale of our 50% interest in CGR Catanduva – Centro de Gerenciamento de Resíduos Ltda., an invested company which owned and operated a landfill in Catanduva, São Paulo State, for R$7.5 million to our business partner – SHZ Participações Ltda. Cash consideration of R$5.0 million was received upon closing of the transaction and R$2.5 million is payable in 5 equal monthly installments (of R$0.5 million each). As of December 31, 2018, the net assets of CGR Catanduva were R$10.2 million, with R$5.1 million attributable to us. The transaction resulted in a gain on sale of R$2.0 million.

Sale of Energy Business

As per our financial statements as of and for the year ended December 31, 2018, our energy business is considered an asset held-for-sale. The sale of the energy business has been approved by our board of directors and we are in ongoing discussions with potential buyers. However, as a significant asset, the energy business is part of the collateral securing our obligations under the Debt Instruments and, therefore, the transaction is subject to the approval of the holders of our Debt Instruments, which approval remains pending. For additional information, see note 1.3.1 of our audited financial statements included elsewhere in this annual report.

Other Pending Divestments

As described elsewhere in this annual report, in light of our severe liquidity constraints, we are analyzing and exploring the potential sale of additional assets to improve our liquidity position in the future. However, as of the date of this annual report, we have not entered into any memoranda of understanding or binding commitments in relation to the sale of any assets not disclosed elsewhere in this annual report.

Capital Expenditures

Historically, we have allocated our capital expenditures by balancing replacement and growth needs and expect to continue to do so.

In 2018, we spent R$122.1 million on capital expenditures, representing 9.7% of our revenue from services rendered, of which R$51.3 million was spent on land and implementation of cells on our landfills, R$25.1 million was spent on turbines for our gas-to-landfill energy business and MRF equipment, and R$47.7 million was spent on the acquisition of new operating equipment.

 

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In 2017, we spent R$145.0 million on capital expenditures, representing 10.8% of our revenue from services rendered, of which R$57.2 million was spent on land and implementation of cells on our landfills, R$35.6 million was spent on turbines for our gas-to-landfill energy business and MRF equipment, and R$13.8 million was spent on the acquisition of new operating equipment.

In 2016, we spent R$136.4 million on capital expenditures, representing 9.8% of our revenue from services rendered, of which R$83.1 million was spent on ongoing construction projects, R$21.9 million was spent on advances to suppliers in connection with the acquisition of electricity generators, R$12.7 million was spent on the acquisition of new operating equipment, and R$6.5 million was spent on the acquisition of vehicles.

B.     Business Overview

Description of Our Operations

We provide collection, transfer, recycling and disposal services to more than 31 million people. We provide municipal, commercial and industrial customers with a full range of waste management solutions, with a focus on leveraging our strategic disposal network to capture compelling growth opportunities in the Brazilian waste management industry. With the goal of creating and maintaining vertically integrated operations, we seek to serve the waste management needs of our customers from the point of collection to the point of disposal, a process we refer to as internalization. By internalizing the waste in the markets in which we operate, we strive to capture higher operating margins while simultaneously attaining a stable revenue stream, with the overall effect of creating significant barriers to entry for competitors.

As of December 31, 2018, we operated the largest landfill portfolio in Brazil, comprised of 12 landfills for non-hazardous residues (Class IIA and IIB) and three landfills also handling hazardous residues (Class I). In 2018, we handled over 17,441 daily tons of waste and, as of December 31, 2018, our landfills had a combined remaining licensed capacity of approximately 129.2 million cubic meters, with a robust pipeline of 24.2 million cubic meters of additional unlicensed capacity. Our waste management infrastructure also includes three autoclaving facilities for the treatment and disposal of medical waste, five transfer stations, two units for blending hazardous waste, one refuse-derived fuel (RDF) facility, one electronic recycling plant (REEE), three landfill gas-to-energy facilities containing a total of 13 electricity generators with an aggregate 18.5 MW of installed capacity, two leachate treatment facilities and a fleet of 1,539 vehicles supporting our collection, O&G, medical waste and landfill businesses.

The graphic below highlights the main features of our fully-integrated waste management operations:

 

LOGO

Our geographic focus is on densely populated urban markets where we can capitalize on upstream and downstream opportunities for vertical integration through a strategically-planned and high-quality landfill-infrastructure. The states in which we operate represent approximately 45.3% of the population and 55.2% of the GDP of Brazil, according to IBGE.

 

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The map of Brazil below demonstrates our geographic footprint and our capabilities in the main markets in which we operate as of December 2018.

 

LOGO

Brazil is geographically similar in size to the continental United States, and we believe the Brazilian waste management market exhibits many of the same characteristics as the U.S. market 30 years ago. There are 2,976 landfills in Brazil as of June 2017, according to the International Solid Waste Association (“ISWA”) and ABRELPE, of which approximately 25% are duly licensed and comply with regulatory and environmental standards and the remaining 75% are open dumps that are considered illegal. By contrast, there are approximately 1,700 landfills in the United States as of December 31, 2018, as compared with 7,924 in 1988 when the enforcement of the Resource Conservation and Recovery Act and other environmental regulations had begun to solidify. In addition, close to one half of all MSW in Brazil, or 29 million tons annually, is not properly disposed of according to ABRELPE.

We are a significant participant in a fragmented industry. In the Brazilian landfills market, we have a 14.7% market share, with the top five players capturing 42.4% of the total market, according to our analysis based on the most recent ABRELPE data available from 2017. Starting in 2018, we began to measure landfills market share on the volume effectively disposed of in the relevant landfills. We understand that participation in the total volume disposed of in landfills is a good indicator of landfills market share. The graph below demonstrates our market share relative to our main competitors as of 2017:

 

LOGO

We have been undergoing a comprehensive financial and corporate restructuring over the past several years pursuant to which we have reviewed and rationalized our cost structure, pricing, compliance and controls, planning processes, information technology and use of data. This restructuring effort has yielded several tangible benefits through focus on the following initiatives, among others; (i) the comprehensive redesign of our management information systems, including migration to SAP and implementation of CRM Oracle solutions and pricing systems, with the effect of improving efficiency of pricing and internal controls; (ii) the sale of certain assets that negatively impacted our margins and did not align with our strategic vision, (iii) collection of overdue accounts and implementation of price adjustments on certain large contracts with our municipal customers and (iv) the reduction of corporate headcount by approximately 13% in December 2018.

 

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We have been facing liquidity issues as further described in this annual report and are focused on executing a number of initiatives to allow us to improve our liquidity position and return to profitability and growth, including, among others: (i) the sale of our energy business (which, prior to its classification as a discontinued operation, was part of the Value Recovery segment), (ii) the development of new landfills, with three greenfield landfill projects in Brazil in the pipeline, (iii) commercial efforts to attract new C&I customers to our existing landfills, and (iv) the development of new transfer stations to expand the coverage area of our existing waste disposal infrastructure.

Business Segments

We offer our customers a full range of waste-related and environmental services that comprise every step of the waste management cycle, from waste collection to disposal and, ultimately, value recovery. Our operations are grouped into four distinct business segments (i) Collection & Cleaning Services; (ii) Landfills; (iii) Oil & Gas; and (iv) Value Recovery.

The following table sets forth the breakdown of our net sales revenue by segment for the periods indicated:

 

     Year ended December 31,  
     2018     2017
(restated)
    2016
(restated)
 
     (in millions of R$)  

Collection & Cleaning Services

     862.0       928.8       922.0  

Landfills

     456.6       455.4       449.8  

O&G

     12.8       25.9       62.9  

Value Recovery(1)

     31.3       37.7       29.2  

Elimination and adjustments(2)

     (102.1     (102.0     (83.9
  

 

 

   

 

 

   

 

 

 

Total

     1,260.6       1,345.8       1,380.0  
  

 

 

   

 

 

   

 

 

 

 

(1)

In 2018, our energy business, which is part of the Value Recovery segment, was classified as discontinued operations, and as a result of that classification, the statement of profit and loss for the years ended December 31, 2017 and 2016 have been restated for comparative purposes. See note 1.5.1 to our audited financial statements included elsewhere in this annual report.

(2)

Reflects the elimination of intersegment transactions entered into in the ordinary course of business.

The following table sets forth the breakdown of our net revenue from services rendered by segment as a percentage of our net sales revenue for the periods indicated, without giving effect to any adjustments for intersegment transactions:

 

     Year ended December 31,  
     2018     2017
(restated)
    2016
(restated)
 
     (percentage of total net revenue
from services rendered)(1)
 

Collection & Cleaning Services

     68.4     69.0     66.8

Landfills

     36.2     33.8     32.6

O&G

     1.0     1.9     4.5

Value Recovery(1)

     2.5     2.8     2.1
  

 

 

   

 

 

   

 

 

 

Total(2)

     108.1     107.6     106.0

 

(1)

In 2018, our energy business, which is part of the Value Recovery segment, was classified as discontinued operations, and as a result of that classification, the statement of profit and loss for the years ended December 31, 2017 and 2016 have been restated for comparative purposes. See note 1.5.1 to our audited financial statements included elsewhere in this annual report.

(2)

Does not reflect the elimination of intersegment transactions entered into in the ordinary course of business and, therefore, the sum of each business segment as a percentage of total net revenues from services rendered will be greater than 100.

Collection & Cleaning Services

Our Collection & Cleaning Services segment is our largest in terms of revenues, comprising 69.0% of our total net revenues from services rendered in 2017 and 68.4% in 2018. This segment includes, primarily, household collection, pursuant to exclusive contracts with municipalities across six Brazilian states. Our collection services are supported by a fleet of 864 vehicles (845 for municipal services and 19 for C&I services) as of December 31, 2018 (of which 569 were owned by us, and 295 were leased), consisting mostly of collection and transfer trucks. According to census data compiled by the IBGE, we estimate that we currently serve approximately 31 million residential clients through our collection and cleaning and landfill activities and 580 private clients through our collection and cleaning activities.

 

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A significant portion of our revenues in this segment is derived from urban cleaning services, including street sweeping and the maintenance of public spaces and monuments. Through Soma, we operate (together with other providers) the largest urban cleaning operation in Brazil for the city of São Paulo. As described elsewhere in this annual report, following a recent bid process or the city of São Paulo, the Company was not the bidder with the lowest price for any of the six parcels in São Paulo and, on May 2, 2019, we were informed that our emergency contract with the municipality of São Paulo will be terminated on June 1, 2019, at which point we will no longer provide services in São Paulo.

This segment involves focused logistical planning in terms of routing based on the profiles and conditions of each municipality, with the objective of optimizing efficiency and minimizing risks and environmental impact in transporting waste to the final destination. In 2018, approximately 56.0% of the MSW we collected through this segment was subsequently disposed in our own landfills, as compared to 55.0% in 2017.

Public Sector Collections and Cleaning Operations

Our residential collection operations consist of curbside collection of residential solid waste from trash bins, small carts or containers for transport to a transfer station/disposal site or landfill. These services are typically performed pursuant to exclusive contracts with municipal entities that are usually entered into for an initial term of three to five years. Our municipal contracts typically set forth fees based on the weight of the waste collected or, less commonly, a fixed monthly collection fee, as is the case for our Salvador contract. The pricing of these contracts is established at the time of execution as part of the competitive bidding process based on factors such as anticipated collection frequency, type of collection equipment furnished, number of employees needed to provide service, anticipated type and volume or weight of the waste collected, distance to the transfer station or disposal facilities and our disposal costs. The majority of contracts with our customers have annual price escalation clauses that are tied to inflation. Contracts with municipalities in the Collection & Cleaning segment may be renewed or extended at the end of the scheduled term.

Our urban cleaning services are typically bundled with our collections operations. Services consist mainly of street sweeping services operations comprised of manual or mechanized sweeping to maintain public roads and streets cleaned on a day-to-day basis, including the washing and disinfection of streets and public places following the conclusion of certain activities, such as outdoor public markets. In addition, we also provide public cleaning services that entail the washing of public equipment and monuments, mechanized scraping of land and sand from the gutters of public roads, weeding and scrubbing of streets and roadways, collecting and transporting bulky debris such as rubble. We also have specialized teams dedicated toward cleaning and sweeping after special events and for temporary operations. Finally, we provide manual and mechanized cleaning of beaches, coastlines, streams and channels as part of our municipal cleaning activities.

We operate exclusive waste collection services in some of the largest and most densely-populated urban areas in Brazil such as the cities of São Paulo and Curitiba, which had a combined metropolitan population of approximately 24 million inhabitants in 2018 according to IBGE. For additional information regarding our contracts with the city of São Paulo and Curitiba, see “—Our contract with the municipality of São Paulo” and “—Our contract with the municipality of Curitiba”. In the state of São Paulo, we provide collection services to the cities of Ribeirão Preto, Taboão da Serra, Araraquara, Jaú, Américo Brasiliense and Sertãozinho and elsewhere in Brazil, in the cities of Maceió in the state Alagoas, Aracaju in the state of Sergipe and Salvador in the state of Bahia. For additional information regarding our main customers in the Collection & Cleaning Services segment, see “—Collection & Cleaning Services.”

The table set forth below summarizes the main features of our municipal collections operations as of December 31, 2018:

 

#   

Municipality

  

Services Provided

   Area Covered
(km2)
     Tons of Waste
Handled per
Day (2018)
     Year
Established
1    São Paulo-SP    Cleaning      993        1,789      2011
2    Curitiba-PR    Collection & Cleaning      435        1,561      1995
3    Ribeirão Preto-SP    Collection & Cleaning and MSW Disposal      651        648      1999
4    Salvador-BA    Collection & Cleaning (100% of consortium)      90        333      2010
5    Aracaju-SE    MSW and Selective Collection      182        637      2016
6    Taboão da Serra-SP    MSW and Medical Waste Collection & Cleaning      20        290      2005
7    Sertãozinho-SP    Collection & Cleaning and MSW Disposal      403        91      2017
8    Araraquara-SP    Transfer Station and MSW Disposal      1,004        194      2009
9    Américo Brasiliense-SP    Collection and MSW Disposal      123        24      2009
10    Campo Largo-PR    Collection and Transfer Station      1,244        69      2017
11    Altinópolis-SP    Collection and MSW Disposal      929        11      2018
12    Rio Claro-SP    Collection & Cleaning      498        149      2018
        

 

 

    

 

 

    

 

13    Morro Agudo    Collection and MSW Disposal      1,388        20      2018
        

 

 

    

 

 

    

 

   Total         7,589        5,680     

 

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We generally secure our contracts with municipalities through a competitive bidding process pursuant to which we receive exclusive rights to service all or a portion of the homes in the respective municipalities.

The process of public procurement in Brazil is regulated by a series of federal laws, primarily: Law No. 8,666/1993 (Competition, Price Taking, Invitation, etc.); Law No. 10,520/2002 (Trading); Law No. 8,987/1995 (Public Concession), Law No. 11,079/2004 (Contracting of Public-Private Partnership) and Law No. 13,303/2016 (State-Owned Companies). This legislation stipulates the criteria for the competitive bidding process, which involves analysis of legal, tax, technical and financial qualifications and, most critically, pricing, with municipalities typically favoring price competitiveness above other factors. In Brazil, it is generally the responsibility of the municipality to render collection services and, therefore, the municipality is obliged to adhere to a competitive bidding process in contracting these services to private entities as per Articles 37 and 175 of the Federal Constitution of 1988, item XXI.

Revenue from our municipal collections operations consists of the fees we receive from our customers, with pricing of these contracts established based on factors such as anticipated collection frequency, type of collection equipment furnished, anticipated type, distance to the transfer station or disposal facilities and, occasionally, also include disposal costs. In 2018, our revenues from collections services from municipal contracts represented 97.8% of our total net revenues from services in our Collection & Cleaning segment and 56.3% of our total net revenues from services on a company-wide basis (compared to 89.5% and 60.9%, respectively, in 2017).

Commercial and Industrial Collections Business

While the Brazilian constitution establishes that municipalities are responsible for providing waste collection services to its citizens, each municipality has discretion to establish maximum per capita waste volumes entitled to collection, with any excess amount falling outside the purview of the constitutional protections. In the City of São Paulo, for example, individuals that generate more than 200 liters (equivalent to approximately 50 kilograms) of waste daily are not eligible for the collection services rendered by the concessionaires Loga and Ecourbis and have to hire private collection companies. In this context, C&I collection businesses have developed significantly in Brazil to fill the gap for large waste generators.

We offer comprehensive waste management solutions to our C&I customers that encompass the entire waste management chain, including strategic planning for our customers’ waste management needs with the goal of optimizing operational and economic efficiency. We provide diagnostic and waste classification services to our C&I customers based on the types and quantities of waste generated, which is then used in order to map out the disposal strategies available. We also offer waste handling services to our C&I customers, whereby we supply waste containers suitable for our customers’ needs and transports the waste from where it is generated to the central collection areas within the customer’s premises where the waste containers and compactors are located. Our C&I collection and transportation services involve planning the best routes and vehicles suitable for waste collection and disposal, and collecting the waste from the customers’ premises and transporting it to its final destination.

Standard service agreements with C&I customers are typically one year in duration with pricing based on estimated weight and time required to service the account. In 2018, revenues from collections and cleaning services from C&I customers represented 7.5% of our total net revenues from services on a company-wide basis (compared to 7.2%, respectively, in 2017).

We have observed a growth in demand for our C&I services in recent years as part of companies’ efforts to comply with the requirements of Brazil’s National Solid Waste Policy legislation of 2010, particularly in relation to treatment services. In order to meet such demand, we have established a dedicated subdivision specifically focused on capturing and servicing C&I business opportunities. We intend to focus our marketing efforts in the short-term on capturing new customers in the manufacturing, food & beverage, vehicle assembly, metallurgy and steelmaking sectors.

 

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Principal Customers in Collections and Cleaning Segment

We rely significantly on municipal customers within our Collection & Cleaning segment as a source of revenues. Contracts with municipal customers and subject to competitive bidding processes, as such are inherently subject to a high degree of uncertainty, and there can be no guarantee that past practices will be indicative of future success. Accordingly, we cannot predict with certainty when the competitive bidding processes for municipal contracts occur and, likewise, there can be no assurances that we will prevail in securing municipal contracts on favorable terms or at all. Our most significant contracts in the Collection & Cleaning segment are our contracts with the municipalities of São Paulo and Curitiba. Together, our contracts with the municipalities of São Paulo and Curitiba represented 79.0% of the net revenues from services rendered for the Collection & Cleaning segment for the year ended December 31, 2018, and 39.9% of our total net revenues from services during the same period. The contract with the municipality of São Paulo is currently serviced on an emergency basis and on May 2, 2019, we were informed that our emergency contract with the municipality of São Paulo will be terminated on June 1, 2019, at which point we will no longer provide services in São Paulo. The contract with the municipality of Curitiba was renewed in January 2019 for an additional 5-year period.

Our contract with the municipality of São Paulo

We have been servicing the São Paulo contract through Soma since 2011. Our contract with the municipality of São Paulo for urban cleaning and street sweeping services comprised approximately 25.5% of our revenues in 2018 (29.1% of our revenues in 2017). This contract expired, and we are currently providing urban cleaning services to the city of São Paulo pursuant to a temporary contract. The temporary contract was first entered into on December 15, 2017 and expired in June 2018. On June 12, 2018, we further extended the temporary contract until the end of 2018. In December 2018, we signed a new extension of the contract which was set to expire in June 2019, subject to earlier termination by the municipality. However, the extended temporary contract executed in June 2018 introduced certain significant changes to the contractual arrangement. Most significantly, under the extended temporary contract, the city of São Paulo has been divided into six separate parcels for urban cleaning, whereas under the prior contract the city had been divided into two parcels only. We, through Soma, were awarded only two parcels under the extended temporary contract, which reflects a significant decrease of our service area, since we previously serviced one of the only two parcels. As a result of these changes, the monthly revenue under the extended temporary contract decreased by 37.7%.

After a series of delays, a new bid for the São Paulo contract was initiated in October 2018, in which the Company participated. In connection with the bidding process, São Paulo has divided the urban cleaning contract into six separate parcels, in line with the extended temporary contracts entered into in June 2018. The Company was not the bidder with the lowest price for any of the six parcels in São Paulo and, on May 2, 2019, we were informed that our emergency contract with the municipality of São Paulo will be terminated on June 1, 2019, at which point we will no longer provide services in São Paulo. For additional information regarding the risks of losing the contract with the municipality of São Paulo, see “Item 3. Key Information—D. Risk Factors—A significant portion of our revenue is derived from a small number of customers, and partial or full loss of revenues from any such customer may adversely affect our revenues and results of operations. In particular, the municipality of São Paulo is currently serviced based on a short-term temporary contract which will end on June 1, 2019. The loss of business from the São Paulo contract will have a material adverse impact on us—Our contract with the municipality of São Paulo.”

Our contract with the municipality of Curitiba

Cavo, which we acquired in 2011, has been servicing the Curitiba contract since 1995. Our contract with the municipality of Curitiba for collections, urban cleaning and street cleaning comprised approximately 12.0% of the Company’s revenues in 2018 (12.5% in 2017). In October 2018, we won the competitive bidding process for the Curitiba collections and cleaning contract. We signed a five-year contract on January 3, 2019 with a maximum value of R$844.8 million (a reduction in price of approximately 14.1% compared with the previous contract) and are currently providing the contractual services to Curitiba.

For additional information regarding the competitive bidding processes in Curitiba and São Paulo, see “Item 5.A. Operating and Financial Review and Prospects—Operating Results—How We Generate Revenue—Competitive Bidding Processes and Revenue Impact.”

Other relevant Customer in the Collection and Cleaning Segment

In addition, our other significant customers in this segment include the municipalities of Ribeirão Preto, Taboão da Serra, Araraquara, Jaú, Américo Brasiliense, Sertãozinho Altinópolis and Rio Claro, all located in the State of São Paulo, Campo Largo in the state of Paraná, and the cities of Maceió in the state Alagoas, Aracaju in the state of Sergipe, and Salvador in the state of Bahia.

Our principal C&I customers in this segment are GPA, Vale, Kimberly Clark, Bosch and Votorantim.

 

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Our Transfer Stations

As part of our vertically integrated solid waste disposal services, we operate five transfer stations. Transfer stations receive, consolidate and transfer solid waste to landfills and recycling facilities. Transfer stations enable us to:

 

   

increase the operational reach of our landfill operations;

 

   

increase the volume of revenue-generating disposal at our landfills; and

 

   

improve efficiency of collection, personnel and equipment.

Transfer stations provide our collection operations with a cost-effective means to consolidate waste and reduce transportation costs while providing our landfill sites with an additional point of access to extend the geographic reach of a particular landfill site with the goal of increasing market share. Our transfer stations thus provide important economies of scale, permitting us to offer more competitive pricing to municipalities even when a municipality generates a low amount of waste or is far from the ultimate landfill.

Our transfer stations are used exclusively for the temporary storage of waste we collected prior to final disposal at a landfill and, accordingly, are not used by other private and municipal haulers. Therefore, while our transfer stations serve as an integral part of our disposal network, they do not independently generate revenues through a fee-based system.

Landfills

We own and operate the largest portfolio of landfills in Brazil, with 12 landfills for the final disposal of both hazardous (Class I) and non-hazardous (Classes IIA and IIB) waste. In addition, as of December 31, 2018, we were developing three additional landfill sites, which we expect will become operational on dates ranging from late 2019 through 2020. Our landfills received approximately 6.3 million tons of waste in 2018, with a remaining licensed disposal capacity of more than 129.2 million cubic meters of waste as of December 31, 2018. In 2018, 17.0% of the total volume of waste disposed in our landfills was internalized from our municipal collection operations and transfer stations.

Landfills remain the most cost-effective waste disposal technology and the primary way of disposing of waste in Brazil, receiving approximately 59.1% of MSW collected in 2017, according to the ABRELPE. To the extent alternative treatments for industrial waste develop in Brazil (such as biological treatments, for example), this treated waste would still need to be disposed somewhere, which we believe bodes well for the longevity of a landfill-focused disposal model in Brazil. In addition, we perceive recycling as an attractive alternative to waste disposal that has the potential of adding value to the waste stream. According to ABRELPE and the EPA, less than 2% of waste collected in Brazil is recycled compared to 34.6% recycled in the United States as of December 31, 2017. As Brazil continues to develop its regulatory framework with an increased focus on recycling and other environmental sustainability strategies, we believe that higher recycling rates could have the effect of increasing the longevity of our landfills.

We believe our landfills are operated in an efficient manner, adhering to a series of requirements designed to protect the soil, groundwater, atmosphere and surrounding communities. All leachate naturally generated in our landfills is collected and treated into reclaimed water for reuse, and greenhouse gases are captured and treated so as to minimize the impact of greenhouse gases on the atmosphere. Our landfills are compliant with international environmental policies and standards, and we have never experienced a material operational disruption as a result of any environmental violation on any of our properties. We are the first company in Brazil to use drones to control and monitor the geotechnical parameters concerning the stability of each landfill. In addition, it is our policy to use an extra layer in the impermeability and drainage layer at the bottom of each installation for purposes of environmental protection. We have implemented an internal quality control and benchmarking system so as to promote consistency, as well as a high standard of quality and environmental compliance, across our operations. In fact, our landfills have been regularly rated highly by CETESB, the State of São Paulo’s environmental agency, which frequently monitors and grades the operations of landfills in that state, having most recently rated our operations between 8.3 and 10.0 on a scale of 0 to 10 (Paulínia 8.3; Itapevi 8.5; Piratininga 9.1; Guatapará 10.0; Tremembé 10.0; and Jardinópolis 10.0).

 

 

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CETESB, the state environmental agency of São Paulo, developed the landfill quality index (IQR) in 1997 as a tool to evaluate the general conditions of MSW disposal in the state of São Paulo through assigning a score from 0 to 10 to all disposal sites. The scores intend to reflect the adequacy of the disposal processes at such sites from a sustainability standpoint. The rating takes into account a variety of factors, primarily, among others: (i) the site support structure, including the sufficiency of the entry and discharge points and the draining and collection systems for percolated liquid, (ii) compacting rates, (iii) soil protection systems to help reduce odor, control litter, insects, and rodents, and protect public health, (iv) rainwater drainage systems, (v) leachate collection and removal systems, (vi) groundwater monitoring to determine whether waste materials have escaped from the landfill and (vii) monitoring of landfill gas emissions. CETESB assigns a rating largely based on data compiled through reports prepared by CETESB technicians during site visits. In 2016, the average landfill score in the state of São Paulo was 8.5, according to CETESB’s 2016 Inventory of Urban Solid Waste Report (Inventário Estadual de Resíduos Sólidos Urbanos). In 2017, the average landfill score in the state of São Paulo was 8.7 according to CETESB’s State Survey of Urban Waste for the year 2017.

We focus on the operation of mid- and large-scale landfills (i.e., landfills with greater than 100 tons per day and total area over 100 thousand square meters). Our landfills received approximately 6.3 million tons of waste in 2018 and, over the past three years, have averaged approximately six million tons of waste per year. As of December 31, 2018, our operating landfills had a remaining licensed disposal capacity of more than 129.2 million cubic meters of waste. Of the total volume of waste disposed in our landfills in 2018, 47% originated from our municipal collection operations and transfer stations. Our landfills are located in some of the largest markets in Brazil, including the state of São Paulo, which is the most populous Brazilian state. Furthermore, the landfills that we operate outside of São Paulo serve some of the fastest-growing markets in the Northeastern region of Brazil, where we believe we are well-positioned to capture an increased portion of market share in the coming years.

The map below shows the location and remaining life span of our 12 landfills and the inset shows the landfills we operate in the state of São Paulo:

 

LOGO

Several of our landfill sites have the potential for expanded disposal capacity beyond the currently permitted acreage. We monitor the availability of permitted disposal capacity at each of our landfills and evaluate whether to pursue an expansion at a given landfill based on estimated future waste volumes and prices, market needs, remaining capacity and the likelihood of obtaining licensing. The in-place capacity of our landfills is subject to change based on engineering factors, requirements of regulatory authorities and our ability to continue to operate our landfills in compliance with applicable regulations and licensing restrictions.

We have observed that our landfills follow approximately the same patterns as those in the United States, insofar as it relates to the landfills’ base waterproofing system, which exhibit a clay K10-7 compacted layer, HDPE membrane and drainage system. The sizes of our landfills vary as in the same way as typical landfills in the United States. We believe that the main difference between our landfills and landfills typically found in the United States is that our landfills are designed and operated in two-to-one (two horizontal, one vertical) slopes, while typical landfills in the United States exhibit slopes that are less steep. This characteristic results in our landfills having a higher number of waste layers, and consequently higher volume capacity, as well as significantly greater stability.

 

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The table below sets forth key operating data with respect to each of our landfill sites, including their respective area, processing capacity and remaining licensed capacity as of December 31, 2018.

 

#   

Landfill Site(1)

   Area (m2)     

Residues(2)

   Tons
per day
(2018)
     Remaining
Licensed
capacity (m3)
    

Remaining
life span
(years)(3)

   Year
Established
1    Paulínia      1,962,307      Class II      5,301        13,618,678      10+    1999
2    Curitiba      2,703,643      Class II      2,801        2,535,402      5+    2010
3    Maceió      1,040,000      Class II      1,595        5,969,409      5+    2010
4    Aracaju      1,305,143      Class I and II      1,652        13,557,790      20+    2012
5    Guatapará      1,000,000      Class II      1,400        5,265,277      10+    2007
6    Itapevi      215,832      Class II      1,079        283,611      3+    2003
7    Tremembé      2,329,001      Class I and II      886        3,508,350      5+    1996
8    Itaboraí      4,200,000      Class II      654        66,736,128      20+    2010
9    Piratininga      759,297      Class II      827        4,494,497      15+    2012
10    Feira de Santana      299,335      Class II      477        2,521,081      20+    2014
11    Sarandi      350,275      Class II      169        3,083,479      10+    2010
12    Jardinópolis      182,716      Class I and II      225        273,908      5+    2005
     

 

 

       

 

 

    

 

 

       
   Total      16,347,549           17,066        121,847,615        
     

 

 

       

 

 

    

 

 

       

 

(1)

The landfill sites listed do not include the greenfield projects currently being developed. For more information regarding the greenfield projects, see “—Landfills—Greenfield Projects.”

(2)

Class I residues are considered to be hazardous and Class II residues are non-hazardous.

(3)

Data presented corresponds exclusively to remaining capacity for which we have already obtained a license for expansion from the relevant governmental authorities, and the figures presented do not consider disposal capacity beyond this licensed amount. In addition to these amounts, as of December 31, 2018, we had an additional capacity of 23.0 million cubic meters for which licenses had not been obtained (13.3 million corresponding to unlicensed capacity at our Paulínia landfill, 9.6 million corresponding to unlicensed capacity at our Curitiba landfill and 76,000 corresponding to unlicensed capacity at our Jardinópolis landfill).

Our landfills generate revenue from disposal and tipping fees based on the type and weight of waste being disposed, which are paid by private and public collection companies, municipalities and large C&I waste generators. Our standard disposal agreement is a one- to three-year renewable agreement with annual price adjustment based on inflation indexes and charged on a monthly basis. While, as a result of the competitive bidding process, our landfill contracts with our municipal customers typically stipulate a fixed amount per ton of waste disposed, the amount invoiced to municipal customers on a monthly basis varies based on actual volume of waste disposed. For certain municipalities for which we provide waste collection services, such as Curitiba and Aracaju, we also provide landfill services; however, such landfill services are governed by separate contracts apart from our waste collection services.

With the exception of the landfill in Maceió, which is a concession established in a leased area, all of our landfills are established in duly-licensed proprietary or leased areas. All of our landfills include soil protection systems, draining and collection systems for percolated liquids and greenhouse gases, rainwater drainage systems and geotechnical monitoring systems, with regular reports controlled by environmental authorities.

Principal Customers in Landfills Segment

Our principal customers in our Landfills business segment are similar to those in our Collection and Cleaning Services segment. Principally as a result of our relatively high rate of internalization, there is a significant degree of overlap between our customers in the Collection & Cleaning Services segment and Landfills segment (47.2%). Collections and disposal services are generally provided pursuant to separate agreements with different pricing models. For more information, see “—Collection & Cleaning Services” above. Our main customers in this segment are municipalities, including public collection companies (accounting for 69.7% of our net revenues from this segment in 2018) and private customers, including large C&I waste generators (accounting for 30.3% of our net revenues from this segment in 2018). Our principal customers in our Landfills business segment include the municipalities of Curitiba, Maceió and Aracaju. In addition, other significant customers in this segment include the municipalities of Campinas and Paulínia and private customers such as Arcelor Mittal and Renova.

Licensing Regulations for Landfills

We work carefully to select the location of our landfills, transfer stations and greenfield projects, which are subject to strict environmental licensing due to the nature of our activities.

 

 

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Under Brazilian law (Federal Law No. 6,938/1981), the construction, installation, expansion and operation of effectively or potentially polluting activities, such as landfills, transfer stations and power plants, are subject to environmental licensing by the relevant governmental authorities. Specifically, an environmental license is needed for approval of the feasibility of landfills, transfer stations and greenfield projects, initial construction and start of our operations, as well as for any future expansions.

The Brazilian Constitution grants federal, state and municipal governments the authority to issue environmental protection laws and to publish regulations based on those laws. While the Brazilian federal government has authority to issue environmental regulations setting general standards for environmental protection, state governments have the authority to issue stricter environmental regulations. Municipal governments may only issue regulations regarding matters of local interest or as a supplement to federal or state laws.

With respect to environmental licensing, as a general rule, IBAMA (Instituto Brasileiro do Meio Ambiente e dos Recursos Naturais Renováveis) is the competent authority for the environmental licensing of undertakings and activities of national interest or capable of causing significant environmental impact regionally or internationally, or for activities located in certain protected areas such as indigenous lands or territorial waters, among others. The local environmental entities are responsible for the licensing of enterprises with a local impact. The state environmental authorities have jurisdiction to conduct the licensing process for activities whose impacts are restricted to their territory and whose licensing jurisdiction is not assigned to federal or local agencies.

In the state of São Paulo, the environmental agency is CETESB (Companhia Ambiental do Estado de São Paulo) and in the state of Paraná, the environmental agency is IAP (Instituto Ambiental do Paraná). Also, in some of the larger municipalities in which we operate there are local regulators that enforce their own rules and licensing procedures. For example, in the city of São Paulo, we are subject to licensing by the Secretary for the Environment (Secretaria do Verde e Meio Ambiente).

The specific requirements to operate a landfill in Brazil vary from location to location, depending in part on the particular characteristics, size, location, and potential environmental impacts of each landfill. The environmental licensing process in Brazil, as a general rule, consists of a three-step system, in which each license is contingent upon the issuance of its preceding license, as follows:

 

   

Preliminary License (“LP”): granted during the preliminary stage of planning of the enterprise or activity approving its location, conception and environmental feasibility, and sets forth the basic requirements to be met during the subsequent stages of its implementation. Generally, LPs will only be issued upon the successful completion of an environmental impact study (such as the Environmental Impact Assessment and the Environmental Impact Report – Estudo de Impacto Ambiental e Relatório de Impacto Ambiental);

 

   

Installation License (“LI”): authorizes the implementation of the project and commencement of construction which culminates in a final review by the relevant environmental agency before the facilities begin operating. Applications for the LI must be made through the applicable environmental authority accompanied by an environmental report ensuring compliance with the requirements of the LP, and a certificate issued by the municipal government regarding land use; and

 

   

Operational License (“LO”): after implementing the project in accordance with all previously established requirements and undergoing a final review, the operation of the project is authorized in compliance with the technical conditions set forth therein, including any environmental control measures and operating conditions. Applications for the LO must be made through the applicable state-level environmental authority accompanied by an environmental report ensuring compliance with the requirements of both the LP and the LI.

Environmental licenses are issued on a conditional basis, meaning that they set forth technical requirements and obligations that must be complied with in order to maintain the validity of the respective licenses. The accomplishment of technical conditions may involve the adoption of specific pollution control measures and other actions that may result in high costs to us.

In addition to the general guidelines set by the Brazilian federal government, each state has the power to issue specific regulations governing environmental licensing procedures under its jurisdiction. In addition, depending on the level of environmental impact caused by the exploratory activity, the procedures for obtaining an environmental license may require assessment of the environmental impact and public hearings, which can considerably increase the complexity and duration of the licensing process and expose the relevant operations to potential legal claims.

Once granted, licenses must be renewed periodically to ensure continuous compliance with the previous technical requirements. The maximum term for environmental licenses is five years for LPs, six years for LIs and 10 years for LOs. Every environmental license must have its renewal request to be presented to the competent agency on a timely basis (generally, at least 120 days prior to expiration), and the validity of licenses will be extended automatically until the environmental body has rendered a decision on the renewal request.

 

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Failing to secure licenses or authorizations from the environmental agencies for the construction, implementation, modification, expansion and/or operation of potentially pollutant activities and/or enterprises will subject the violator to criminal and administrative sanctions, including the imposition of penalties of fines, suspension of activities, deactivation and demolition, among others. These penalties are also applicable if a project developer fails to fulfill the conditions established in its environmental license.

In addition to the above technical requirements, the installation, expansion and operation of our landfill operations in areas considered close to communities and other population centers may require us to consult with representatives of potentially affected communities, social movements and local government organizations. We may be required to negotiate with such groups as a condition to obtaining local government approvals and the necessary environmental licenses for our landfills.

Greenfield Projects

The landfill business is characterized by high barriers to entry resulting from the significant capital costs of landfill development, increasingly stringent environmental legislation and the lengthy and uncertain permitting process for new landfills.

Through our many years of experience in the landfill business, we have become one of the leading experts in landfill siting, development and operation in the Brazilian waste management industry. We have assembled a team of specialized professionals that monitors various locations for potential landfill site acquisitions, taking into account environmental, demographic, economic as well as other aspects. We compile this information into a continuously updated database that we use in making landfill site acquisition decisions. Once a decision has been made to acquire a landfill site, our specialized team of regulatory and licensing experts play a critical role in obtaining the necessary licenses and approvals to develop and operate the contemplated landfill. We have developed specialized knowledge and experience in managing the regulatory process at the federal, state and municipal levels, and our technical teams are capable of carrying out complex analyses on proposed landfill sites, including sophisticated geotechnical and topographical surveys. These analyses are then used to prepare detailed reports that are submitted to the licensing authorities, which can help expedite the licensing process. We also possess an experienced landfill project development team, which conceives all landfill projects with the appropriate safety features while seeking to maximize the utility to be derived from the landfill site. In addition, we possess an active M&A team that is dedicated toward identifying and evaluating potential acquisition targets as well as new landfill project developments, with specialized knowledge in integrating these new projects into our operations. After a landfill has been developed or acquired, our landfill operations team comes into play with its several years’ experience in managing landfill operations.

To satisfy future disposal demand, we are currently developing three greenfield landfill projects in strategic locations that we believe are located in underserved regions of Brazil. These three greenfield projects have a combined potential processing capacity of over 2,700 tons of waste daily, adding significant value to our existing landfill infrastructure and will help to replenish our landfills’ capacity in the future. The greenfield project related to CGR Ceará (Caucaia) was discontinued as after a detailed analysis we determined that the project was not economically interesting. However, we are continuously seeking opportunities and analyzing potential new projects.

We cannot assure you that all proposed or future expansions of our greenfield projects will be successfully realized as intended or at all.

Oil & Gas (O&G)

Our Oil & Gas segment provides on-site and off-site biological remediation of soil that has been contaminated with oil or other pollutants as well as cleaning of storage tanks. We provide remediation and cleaning services in several sites and transfer the contaminated soil to our biopile facilities located in the Paulínia and Curitiba landfills. In these facilities, the soil goes through a bioventing process whereby contaminated soil is stacked into engineered piles or cells with the aim of enhancing conditions required for biodegradation by controlling oxygen and nutrients such as phosphorus, nitrogen and water. Bacteria or microorganisms are added to the waste and the soil, in order to degrade hydrocarbon contaminants such as diesel that are affixed to the soil particles. Our Oil & Gas segment accounted for only 1.9% of our total net revenues from services rendered in 2017 and 1.2% in 2018.

This segment’s soil remediation is provided primarily to one main customer, Petrobras, which accounted for 71.4% of the Oil & Gas segment’s net revenues from services rendered in 2017 and 100% in 2018. Petrobras contracts with us to clean contaminated sites on an as needed, per-engagement basis, rather than on a fixed or term basis. Accordingly, revenues derived from our Oil & Gas segment are highly dependent on demand from Petrobras, and are therefore subject to volatility in direct correlation to increases or decreases in Petrobras’ need for soil remediation services.

 

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Value Recovery

Through the Value Recovery segment, we develop processes to convert and recycle collected waste into usable and efficient forms of energy and/or recyclables which can be sold to third parties. We also have the capabilities to carry out traditional recycling activities, including the recycling of complex electronic devices. This segment is driven by public and private markets that view environmental stewardship as a top priority.

Our activities in our Value Recovery segment can be divided into four sub-segments: (i) landfill gas-to-energy, (ii) co-processing and blending, (iii) reverse manufacturing and waste recycling and (iv) carbon credit trading, each described in greater detail as follows.

We are currently in the process of selling our landfill gas-to-energy business. The sale has been approved by our board of directors and negotiations are ongoing. However, the sale transaction is subject to the approval of the holders of our debentures, which approval remains pending. As of December 31, 2018, the energy business was classified as a disposal group held for sale and as a discontinued operation. As such, the results of operations our energy business are no longer presented within our Value Recovery segment.

Landfill Gas-to-Energy

Energy generated from landfill gas is considered a renewable resource, since this fuel source is derived from household waste and other materials that have been deposited in landfills, and, therefore, because it is considered sustainable, it is eligible to tax benefits.

Our landfill operations naturally produce methane as well as other biogases from the decomposition of organic compounds. These biogases are readily available, renewable energy sources that can be gathered and used beneficially as an alternative to fossil fuels or to generate electricity. We capture these biogases at our landfills using drains installed throughout our landfills, channeling them to processing plants through a gas network interconnecting the drains. At our power plants, these biogases go through a process of filtration and cooling to fuel the turbines that burn biogas and generate electricity.

We have been generating electricity from our landfill gases since 2014. We currently operate three landfill gas-to-energy generation facilities at our Curitiba, Tremembé and Guatapará landfills, with a total installed capacity of approximately 18.5 MW and energy generation and sale of 111.4 MWh in 2018 and 82.0 MWh and 49,1 MWh in the years 2017 and 2016, respectively. In addition, we have received approval for the required permits to develop new gas-to-energy generation facilities at our Paulínia, Maceió, Piratininga, Aracaju and Jardinópolis landfills, which together comprise a total potential capacity of additional 40.6 MW.

We sell approximately 80% of the energy we generate from our biogas generation operations to private customers in the free market pursuant to power purchase agreements usually on three-year terms with annual inflation-based price adjustments, and the remaining approximately 20% in the spot market to benefit from the more volatile Brazilian energy market. In 2018, we generated and sold 111,414 MWh of energy generated from our landfill gas-to-energy operations (82,005 MWh and 49,081 MWh for the years 2017 and 2016, respectively).

Co-Processing

Co-processing is the use of waste materials as substitutes for primary fuel and raw materials in industrial processes, such as cement production. A wide range of waste materials may be used in co-processing, ranging from papers, plastics and wood to industrial byproducts, such as used oil, tires, solvents or paint sludge, or even obsolete pesticides and other organic waste materials. Co-processing offers a significant potential for the reduction of greenhouse gas emissions from fossil fuels, primarily by increasing the energy recovery factor from industrial waste streams that would have otherwise been destined to landfills and incinerators.

We maintain commercial agreements with some of the largest industrial companies in Brazil for collection and treatment of certain types of industrial waste for co-processing into a form of fuel commonly referred to as a RDF (refuse-derived fuel). RDF is a combustible “blend” with high energy output value that can be used in a variety of contexts, including, most commonly, in cement kilns, boilers and biomass plants.

We operate two co-processing facilities, one in Sorocaba, São Paulo and another in Balsa Nova, Paraná. Co-processing employees use equipment such as backhoe loaders, wheel loaders or lifts to move and mix the waste, and use grinders and screeners to create a homogeneous blend. Then, employees use machines to handle the material and to pack the blend into large containers, bulks or barrels, which are then transported to the cement plants by contracted third parties. Co-processing is not a capital-intensive process. As of December 31, 2018, our co-processing and blending facilities have a daily processing capacity of 700 to 900 tons of waste.

 

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We supply RDF free of charge primarily to cement plants for use as an energy input in their industrial ovens. While we do not currently generate additional revenues from the supply of RDF to cement plants, we do receive collection and disposal fees from the industrial companies producing the waste that is used as an input in the co-processing to produce RDF. We may, however, opportunistically pursue opportunities to monetize our co-processing activities in the future through the sale of RDF should market conditions so permit.

Waste Recycling

We operate one waste recycling facility at our Paulínia landfill with capacity to process approximately 40 thousand tons of waste per year, the primary function of which is to segregate inorganic from organic waste and have contracted the construction of a materials recovery facility (“MRF”) in the Paulínia landfill with capacity to handle 500 tons of MSW per day. This new MRF facility started its operations in October 2018. Organic waste with high energy output value is converted into RDF by means of the co-processing described above and supplied to cement plants, while metals and plastic waste products are sold as commodities, with the remaining waste being disposed at our Paulínia landfill.

We also operate one reverse manufacturing facility that breaks down complex electronic devices and products with diverse components into simple and easily disposable materials. Our reverse manufacturing services are offered pursuant to medium-term contracts with large electronic-producing companies that seek our specialized services to limit the environmental impact of the disposal of their electronic waste output. The component parts of the electronics that we collect, primarily metals, electronic parts and plastic waste products, are sold as commodities. We recycle such electronic devices in an efficient manner, ensuring that at least 85% of the original parts are effectively recycled and reused. In 2018, our subsidiary Oxil recycled 101 thousand tons of toners and 249 thousand tons of other electronics.

We also operate a mechanized recycling system that has the capacity to process various types of construction materials. The materials are converted into raw materials with physical properties similar to unused products, however, with more competitive costs. Recycled materials produced as part of this process include sand, gravel, stones, mortar, concrete, crushed ceramic material and other materials that can be used in various aspects of the construction industry.

Contracts in connection with our recycling operations generally provide for the payment of a collection fee and set forth the terms pursuant to which the recycling byproduct may be sold.

In 2017, Brazilians generated about 78.4 million tons of municipal solid waste and recycled and composted about 1.5 million tons of this material, equivalent to a 1.9% recycling rate, according to ABRELPE data. As Brazil continues to develop its regulatory framework with an increasing focus on environmental sustainability, we believe that there may be attractive opportunities to capitalize on recycling-related activities. In addition, we believe that higher recycling rates would bode well for the longevity of a landfill-focused disposal model in Brazil by making use of waste that would otherwise have been disposed in landfills. We also perceive the expected environmental benefits of increased recycling as an important social benefit that is consistent with our philosophy of environmental sustainability, by, for example, decreasing the use of primary resources and energy, and reducing water and air pollution (including greenhouse gas emissions).

Carbon Credit

Under the Kyoto Protocol, signatories are required to abide by certain caps, or quotas, on the amounts of greenhouse gases emitted, and, to meet such quotas, participants are allowed to trade carbon credits to offset their carbon emissions. Carbon credit revenue consists of a tradable certificate or permit representing the right to emit carbon dioxide, which we sell to carbon emitters. Our landfill operations produce methane as well as other biogases as a result of the biological decomposition of organic waste in our landfills, some of which we process by burning such gases in our Paulínia landfill to convert them into carbon dioxide and carbon monoxide. As methane is a greenhouse gas that has approximately 21 times the heat-trapping capacity of carbon dioxide, our process of reducing methane into carbon dioxide and carbon monoxide generates carbon credits.

We have been selling carbon credits generated from our landfill operations since 2006, at prices of approximately EUR1.98 per Certified Emission Reduction (one Certified Emission Reduction is equivalent to one ton of carbon dioxide avoided in the atmosphere). We sell the carbon credits we generate to the NEFCO (Nordic Environment Finance Corporation) pursuant to a procurement contract that expires in 2020, which it uses in order to meet Norway’s requirements under the second commitment period of the Kyoto Protocol.

Our stock of carbon credits is measured by United Nations and recognized companies, through approved methodologies, to quantify the amount of carbon credits that we can sell. From 2015 to 2018, we had sold a total of 1,870,440 Certified Emission Reductions carbon credits resulting in total revenues of R$13.8 million.

 

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We anticipate that a continued focus by regulatory authorities on environmental issues could increase the demand for carbon credits we generate, and could present an attractive opportunity to generate ancillary revenues in the future.

Principal Customers Value Recovery

Our principal customers in our Value Recovery business segment are Apple, Votorantim Cimentos, HP, Goodyear, ABB, Dow Chemicals, CPFL and Camil.

Competition

The Brazilian waste management industry is highly fragmented and, accordingly, we face competition in all aspects of our operations. According to internal studies based on ABRELPE data and other public information related to landfills locations and size, in 2017, no one player in the Brazilian waste management sector had greater than a 15% market share, and the top five players collectively had an approximately 42.4% market share in terms of volume. Based on our internal studies based on 2017 data, we were a significant participant in the waste management company, in 2017 in terms of waste disposal market share, with 14.7% market share.

The graph below demonstrates our market share in the Brazilian landfills market relative to our main competitors in 2017 according to internal studies based on 2017 ABRELPE data, which is the most recent data available:

 

LOGO

Competition in the waste management industry is mainly driven by a few large companies and several smaller and regionally-based companies. We believe that most of our competitors are typically family-owned companies that lack the scale, technology and skilled management that we possess. Nevertheless, in any given market, certain competitors may have larger operations and greater resources available than us. Municipal landfills, in most part, are used exclusively to dispose the waste generated by its own municipality, therefore the competition that we face with our landfills is not significant.

Our principal competitors in each of our business segments include:

 

   

Collection and Cleaning Services: Solvi, Vital, Marquise, Ambipar, Sustentare, Constroeste, Seleta

 

   

Landfills: Solvi, Vital, Haztec and Proactiva (Veolia), JSL, Marquise

 

   

Oil & Gas (O&G): Essencis, Ambiental do Brasil, Geoclock, Arcadis

 

   

Value Recovery: Essencis, Haztec, Serquip, Renova, Ecoprimos, Revalore

We compete for municipal contracts and private sector accounts primarily on the basis of price and the quality of our services. Operating costs, disposal costs and collection fees vary throughout the areas in which we operate. The prices that we charge are determined locally, and typically vary by volume and weight, type of waste collected, treatment requirements (especially the availability to treat the leachate generated in the landfill), risk of handling or disposal, frequency of collections, distance to final disposal sites, the availability of airspace within the geographic region, labor costs and amount and type of equipment furnished to the customer. From time to time, our competitors reduce the price of their services in an effort to expand market share or to win a competitive bid municipal contract. Our ability to maintain and increase prices in certain markets may be impacted by our competitors’ pricing policies. This may have an impact on our future revenue and profitability.

 

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Marketing and Sales

Our marketing and sales efforts are conducted on a company-wide basis, rather than individually for each of our business segments. For our municipal customers, we enter into competitive bidding processes to win long-term contracts to provide municipal collection services. Due to the strength of our localized operations and highly experienced regional management teams operating through our four main regional hubs, we maintain close relationships with key decision-makers throughout our markets, which we believe positions us well to capitalize on new municipal contracts and renew existing ones. For our private sector customers, our marketing and procurement efforts are mainly focused on the segmentation of the target market (principally the manufacturing industry) and the customization of marketing proposals.

Seasonality

We experience moderate revenue seasonality in our business segments due to the location of certain landfills in regions that depend heavily on tourism, therefore leading to an increase in the volume of waste processed at these landfills in the summer months. Moreover, periods of heavy rain will generate a higher volume of leachate at our landfills leading to an increase in costs.

On a cash basis, we experience a higher rate of payments on our accounts receivable from municipalities during the first three months of each year, as Brazilian municipalities receive an annual transfer of federal funds at the beginning of the year. The rate of payments on accounts receivable progressively decreases as the year progresses, with the fourth quarter of each year exhibiting the longest collection periods.

In addition, we also experience a lower overall rate of payments on our accounts receivable from municipalities during election years and during the first quarter of the years following elections. Municipal elections were last held in Brazil in 2016 and the next municipal elections in the regions in which we operate are expected to be held in 2020.

Raw Materials and Suppliers

Our principal raw materials are in relation to the purchase and leasing of the light vehicles, trucks and heavy machinery that comprise our fleet together with the diesel fuel needed to operate our collection and transfer vehicles. In Brazil, the collection and transfer trucks that comprise our fleet are manufactured and sold primarily by Volkswagen, MAN, Mercedes Benz and Ford. As of December 31, 2018, we owned approximately 56% of our fleet, while 44% was leased or rented. Our leasing contracts for our fleet are typically for a term of four years, with the option to buy the leased equipment at the end of the leasing period at a set price. As of December 31, 2018, the aggregate amount of the minimum lease payments under our leasing contracts was R$36.5 million. In addition, on January 1, 2019 we adopted IFRS 16 – Leases, for which we recognized a right-of-use asset and a lease liability at the present value of R$23.3 million. For further details, see “Item 5. Operating And Financial Review And Prospects—New Accounting Standards Not Yet Adopted”.

We purchase fuel from a number of distributors in Brazil, principally from Ipiranga Produtos de Petróleo S.A., pursuant to long-term contracts providing us with generally more attractive pricing than we could otherwise obtain in the open market. Our diesel fuel contract with Ipiranga provides for the purchase and delivery of a minimum of 33.6 million liters of diesel fuel per year at a fixed price, with prices being adjusted on a yearly basis. Fuel delivery takes place upon request. Prices are set by Ipiranga and are charged uniformly to all companies in a similar industry at a set rate. The contract does not have a fixed term but may be cancelled by either party with at least 30 days’ advanced notice.

We also contract with third parties that provide leachate treatment and disposal, which consist of costs associated with the physical, chemical and biological treatment of leachate as well as costs associated with the transportation of this residue from our landfills to treatment plants, which in the majority of cases are offsite and operated by third-parties. We and our subsidiaries have entered into ten service contracts with various suppliers for the collection, treatment and transportation of leachate. The price of the service contract is calculated based on the price per cubic meter of leachate, and the aggregate value of our service contracts for leachate collection, treatment and transportation is R$50.7 million as of December 31, 2018. All agreements are set to expire on September 1, 2019, and we currently expect that the ongoing renewal process will be completed before that time. The duration of our service contracts typically vary in duration from six months to eight years, depending on the amount of services provided.

Insurance

We have insurance policies covering (i) environmental damage; (ii) civil responsibility; (iii) our fleet, equipment and properties; and (iv) directors’ and officers’ insurance, among others. We believe that the insured amounts are sufficient, considering our business activities and exposure to risk.

 

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Regulation

There have been significant developments in the regulatory environment of the waste management industry in Brazil at the federal, state and municipal levels. These new regulations have significantly benefited the waste management operators, and have created opportunities for the remediation business as well as for services in the collection, treatment and destination of all waste types. Recently, Brazilian environmental regulatory agencies have been increasing their enforcement activities aimed at reducing environmental damages and enforcing current regulations.

The Brazilian waste management industry is heavily regulated at the federal, state and municipal levels. At the federal level, the main regulatory bodies are: IBAMA (Instituto Brasileiro de Meio Ambiente) and National Council of the Environment (CONAMA), which are part of the Ministry for the Environment, and ANVISA (Agência Nacional de Vigilância Sanitária). The federal authorities work with the state authorities. For example, in the State of São Paulo, the environmental authorities are CETESB (Companhia Ambiental do Estado de São Paulo) and SMA (Secretaria de Meio Ambiente), while in the State of Paraná, the environmental authorities are IAP (Instituto Ambiental do Paraná) and SEMA (Secretaria de Estado do Meio Ambiente e Recursos Hídricos). In addition, in some of the larger municipalities there are local regulators that enforce their own rules. For example, in the city of São Paulo, the environmental authority is the Secretary for the Environment (Secretaria do Verde e Meio Ambiente) and, regarding health issues, COVISA (Coordenação de Vigilância e Saúde).

The Brazilian Constitution grants federal, state and municipal governments the authority to issue environmental protection laws and to pass regulations based on those laws. While the Brazilian federal government has jurisdiction to issue environmental regulations setting minimum general standards for environmental protection, state governments have the jurisdiction to issue stricter environmental regulations. Municipal governments may only issue regulations regarding matters of local interest or aiming at supplementing federal or state laws.

Environmental Regulations

Environmental Liability

Environmental liability may be attributed under civil, administrative and criminal spheres, with the imposition of administrative and criminal sanctions, in addition to the obligation to redress the damages caused.

The Brazilian National Environmental Policy sets forth strict civil liability for environmental damages. The fact that the offender’s operations are licensed does not waive such liability. Under Brazilian law, legal entities and individuals directly or indirectly involved in the damaging or polluting activities are subject to joint and several liabilities.

Criminal liability also applies to both individuals and legal entities that violate environmental laws. As a result, a legal entity’s officer, administrator, director, manager, agent or proxy may also be subject to criminal liability if he is negligent or commits environmental crimes. Settlement of civil and administrative proceedings does not prevent criminal prosecution. Freedom-restricting-penalties (confinement or imprisonment) are often reduced to right-restricting penalties, such as community services.

Administrative penalties include single fines of up to up to R$50 million, or daily fines, full or partial suspension of activities, right-restricting penalties and orders to redress damages, among others. In addition to criminal and administrative sanctions, Brazilian environmental laws require the offender to repair or indemnify for damages caused to the environment and to third parties. Enforcement of fines may be suspended upon settlement with environmental authorities for damage redress. In the event of failure to redress damages or to pay fines, the corporate veil piercing doctrine may apply.

In addition, according to Brazilian legislation, after the closure of a landfill, we must continue to monitor the underground and surface water and maintain the leachate treatment, the gas collection system, the drainages and the capping of closed landfills for a long period, until the closed site is no longer potentially harming to the environment or the community.

Management of Waste

The Solid Residues National Policy, which is outlined by the Federal Law No. 12,305/2010, determines that the management and final disposal of residues must not cause any damage to the environment, nor any inconvenience to the public health and welfare. As a result, Brazilian legislation regulates the sorting, collection, storage, transportation, treatment and final disposal of residues, and states that parties outsourcing such activities are jointly liable with the contracted third parties in the event of environmental damages.

 

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Inappropriate disposal as well as potential accidents resulting from the transportation of waste can be a factor of environmental contamination and trigger the imposition of penalties at the administrative (which could include warnings, fines, embargoes, and suspension of financing and tax benefits) and criminal levels, despite the obligation to redress the damages caused.

The Solid Residues National Policy also created a new legal regime intended to produce a positive impact on the waste management industry. The creation of this new regime established relevant waste management sustainability goals through the following measures:

 

   

shared responsibility among manufacturers, importers, distributors, retailers, consumers and governmental agents for the life cycle of certain products, which places specific obligations on each of these entities across the waste management chain;

 

   

regulation of the regional and local waste management authorities, in order to guide such authorities on the management of waste and allocate resources to those entities for promoting cost reduction programs;

 

   

requires the private sector to develop waste management plans, which includes segments such as mining, industrials, hospitals, drugs manufacturers, water and sewage companies, construction companies, ports, airports, roads, railways and companies within the agribusiness, among others. Those that do not comply with the Solid Residues National Policy would not be entitled to eventual environmental licenses that would be required to their businesses;

 

   

prohibits the disposal of solid waste into dumps, which shall be gradually eliminated or cleaned up (decontaminated);

 

   

establishes the mandatory reverse logistics, which consists in returning products post consumption from the final consumer to the manufacturer or importer independently from the public waste collection; and

 

   

tax incentives for energy generated from waste.

Finally, as the waste-to-energy technology becomes more efficient and cost effective, new opportunities are being presented to Brazilian waste management companies to enter into the power generation business, notably through landfill gas and the development of new businesses to supply the international demand of carbon credits. As waste-to-energy technology—such as in our value recovery segment—becomes more efficient and cost effective, new opportunities might arise for waste management players in Brazil to enter into the power generation business through landfill gas and clean waste incineration, among other methods.

The National Solid Waste Policy also sets forth specific obligations with a view to reduce the volume of solid residues and mitigate the adverse impact on human health and on the environment, such as the take-back obligations imposed to manufacturers or other actors in the product life cycle of certain products.

Pursuant to the National Solid Waste Policy Act, outlined by the Federal Law No. 12,305/2010, administrative penalties applicable to the inadequate provision of solid waste, liquids and gases, whether or not causing effective pollution, include, among others, the embargo of the activity and fines up to R$50 million. According to our experience, the maximum penalty is only imposed in cases of severe damage to the environment.

Contaminated Areas

The existence of contamination may be confirmed by investigatory evaluations carried out by specialized technical consultants, through the assessment of past and current conditions of the area, occupancy history, natural characteristics, sampling of soil and groundwater, among other aspects. An area may be deemed as contaminated when the concentration of polluting substances is higher than the quality standards set forth by the applicable legislation. Contamination events may arise from planned, accidental or even natural pollution due to the disposal, accumulation, storage or infiltration of substances or wastes, resulting in adverse impacts to the soil and water.

In the civil sphere (strict liability, irrespective of fault), the remediation of environmental damages involves joint and several liability, which means that the detection of contamination requires that actions be taken by the causer of the damage (even if it does not have the possession or ownership of the area), by the owners and occupants of the property, as well as by whomever benefits itself from the existing environmental damage. The environmental agency may require from any of the aforementioned agents that corrective steps be taken to establish quality levels compatible with the present and future use of the area.

 

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It is also important to bear in mind that claims seeking the restitution of environmental damages are not subject to cap values. Likewise, liabilities for environmental damages are not subject to statute of limitations and, therefore, shall not be extinguished by the course of time.

Licenses

For a description of licensing requirements, see “—Landfills” above.

 

C.

Organizational Structure

The chart below sets forth our simplified corporate structure as of the date of this annual report:

 

LOGO

The Company currently holds in treasury 8,871,895 common shares previously held by Angra. In accordance with Brazilian Law No. 6,404/76, such shares will not hold voting or dividend rights for as long as they remain in the treasury of the Company. Therefore, such shares were not considered for the purposes of the calculation of the percentage of equity interest held by each of the shareholders of the Company as described above. In the event the Company transfers any of the treasury shares, the percentages provided above may be altered.

 

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In addition, the chart below sets forth details of the subsidiaries of the Company as of the date of this annual report:

UPDATED ORGANIZATION CHART

 

LOGO

 

D.

Property, Plant and Equipment

Our principal property and equipment consists of land, landfills, buildings, vehicles and equipment. We own or operate 12 landfills, five transfer stations, three facilities for the treatment of medical waste, two units for blending hazardous waste, one recycling and RDF unit, one reverse manufacturing facility, two biogas power generation plants and three effluent treatment facilities. In addition, we own the land on which we intend to develop three additional landfills. As of December 31, 2018, we also owned or leased a fleet of 1,539 vehicles consisting mostly of collection and transfer trucks.

We also are responsible for a closed cell on the Paulínia landfill, which landfill is composed of a total of two cells. The total amount provisioned as a contingency for landfill closure and post-closure obligations was R$92.8 million as of December 31, 2018. The post-closure period generally runs for 20 years after final landfill’s site closure.

For more information, see “Item 3.A. Key Information—Selected Financial Data” and note 2.11. to our audited financial statements included elsewhere in this annual report.

 

ITEM 4A.

UNRESOLVED STAFF COMMENTS

Not applicable.

 

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ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

A.

Operating Results

Introduction

The following management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our audited financial statements included elsewhere in this annual report on Form 20-F. This annual report 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, without limitation, those set forth in “Item 3.D. Key Information—Risk Factors” and the matters set forth in this annual report generally.

Liquidity Constraints and Breach of Financial Covenants

As a result of liquidity constraints, we were unable to comply with the financial and other covenants included in our Debt Instruments and, as a result, are currently in default under our Debt Instruments. Since we were unable to obtain a waiver from the banks that hold the Debt Instruments by December 31, 2018 in relation to such defaults, pursuant to IFRS accounting rules, we were required to reclassify the total outstanding amount under the Debt Instruments (consisting of R$1,548.3 million) as short-term obligations in our financial statements as of and for the year ended December 31, 2018 included in this annual report.

The terms of the Debt Instruments required, among other things, that as of December 31, 2018, our consolidated net debt to EBITDA ratio must be 4.0x or less. In addition, the Debt Instruments also contain a covenant that required our debt service coverage ratio to be at least 1.2x. As of December 31. 2018, our consolidated net debt to EBITDA was 7.9x, and our debt service coverage ratio was negative 15.6x. In addition, the terms of the Debt Instruments required that by December 31, 2018 we register certain liens on certain real estate relating to operational landfills with the appropriate governmental agencies and to provide certain documents listed in the annexes to the Debentures, which we were also unable to comply with by December 31, 2018.

Therefore, as a result of the breach of the consolidated net debt to EBITDA ratio and the debt service coverage ratio, the failure to register the relevant liens and to provide certain of the documents required to be provided, we are in default of our obligations under our Debt Instruments. These defaults entitle the banks that hold the Debt Instruments to accelerate the debt obligations and declare that all amounts owing under the Debt Instruments are immediately due and payable.

The Debt Instruments are secured by collateral consisting of a lien on all real estate relating to our operational landfills, a lien on all material subsidiaries controlled, directly or indirectly, by us and a fiduciary assignment of the remaining balance originated from the foreclosure of liens granted in relation to the Debt Instruments. In addition, the Debt Instruments are secured by a fiduciary assignment of certain real estate owned by us and a fiduciary assignment lien on all of the common shares of the Company (except for 4.38% secured for the benefit of Angra). In addition, the Debt Instruments are also guaranteed by all material subsidiaries controlled, directly or indirectly, by us. The breach of the obligations under the Debt Instruments entitles the holders of the Debt Instruments to enforce against any collateral securing the Debt Instruments.

In addition, on March 6, 2018, Angra confirmed the exercise of its put option to sell all of its shares of the Company. While we were required to pay the exercise price of approximately R$40.3 million by September 6, 2018, as of the date of this annual report, we have not yet made any payments to Angra due to our liquidity constraints, which constitutes a default under the share put option agreement entered into with Angra. As a result, Angra may seek certain remedies afforded to them under the share put option agreement and otherwise under Brazilian law, including the enforcement of their security interest of 4.38% of the share capital of the Company.

Furthermore, as of December 31, 2018, the Company had aggregate overdue trade accounts of R$85.9 million, and there can be no assurance that such trade creditors will not demand immediate payment or use a variety of legal remedies to enforce their claims, which may further constrain our liquidity, further jeopardize our ability to continue as a going concern and increase the risk that we become subject to bankruptcy proceedings. For further information, please see note 15 of our consolidated audited financial statements included elsewhere in this annual report.

 

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We have identified several significant other obligations arising during 2019 that require funding through liquidity, primarily relating to (1) the payments we are required to make for severance and other demobilization costs related to discontinued operations (for example, the contract with the municipality of São Paulo for cleaning services, which will terminate on June 1, 2019) and (2) capital expenditures (e.g., new trucks and equipment) required in connection with contract renewals, such as the investment obligations arising under the contract with the municipality of Curitiba for cleaning services, which was renewed on January 3, 2019 for an additional five year period.

Our management has concluded that substantial doubt exists with respect to our ability to continue as a going concern through one year after the date of issuance of our audited financial statements as of and for the year ended December 31, 2018. In addition, as a result of our material liquidity issues, our independent auditors have indicated, in their report on our audited financial statements that there exists significant uncertainty that could raise doubt about our ability to continue as a going concern. These doubts regarding our ability to continue as a going concern relate to our history of suffering recurring losses from operations, the ongoing process of renegotiating our debt obligations and our net capital deficiency, resulting in substantial doubt as to our ability to continue as a going concern. The audited financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

For further information, see “Item 3.D. Key Information—Risk Factors—Risks Related to Our Business—As of December 31, 2018 we recorded significant negative working capital and capital deficiency, we are currently in breach of certain financial covenants and contractual obligations, and our ability to avoid a judicial reorganization is dependent on our ability to successfully complete a debt restructuring and significantly improve our liquidity position” and “—Our auditors have issued a “going concern” audit opinion, and our ability to continue as a going concern is dependent on our ability to significantly improve our liquidity position.”

The December 2017 Transaction

Prior to the Transaction, the Registrant had limited or no assets, operations or activities. The Registrant was incorporated to become the holding entity of the Company to effect the Transaction. Considering that substantially all of the shareholders of the Company exchanged their shares of the Company for shares of the Registrant, the Transaction was accounted for as a reverse recapitalization transaction. The historical operations of the Registrant are deemed to be those of the Company. Thus, the financial statements included in this annual report reflect (i) the historical operating results of the Company prior to the Transaction, as restated as of and for the years ended December 31, 2016, as described under “—Internal Evaluation Process and Previous Restatement of Financial Statements”; (ii) the consolidated results of the Registrant and the Company following the Transaction; (iii) the assets and liabilities of the Company at their historical cost; and (iv) the Registrant’s equity and earnings per share for all periods presented, each of which were previously reflected in our annual report on Form 20-F for the year ended December 31, 2017 which was filed with the SEC.

As of December 31, 2017, Estre USA had assets of R$1.2 million reflecting its cash position and did not generate revenues from operations.

The main financial statement effects of the Transaction were as follows:

 

   

the receipt by the Registrant of R$37.1 million (US$11.2 million) from existing shareholders of Estre USA that did not redeem their public shares in connection with the Merger;

 

   

the receipt by the Registrant of R$425.6 million (US$128.7 million) from the gross proceeds of the sale of 15,438,000 of our ordinary shares and 3,748,600 warrants to purchase ordinary shares to certain institutional investors unaffiliated with us pursuant to the PIPE Investment;

 

   

the payment of R$366.0 million (US$110.6 million) used to partially repay certain of our indebtedness pursuant to the Debt Restructuring, which was repaid using the net proceeds from the transactions referred to above;

 

   

a discount of an amount corresponding to 25% of the prepaid amount of our debentures and related debt acknowledgment instrument as of such date, totaling R$91.5 million (US$27.7 million), and reclassification of the remaining balance of debentures and related debt as non-current; and

 

   

payment of R$96.7 million (US$29.2 million) in fees and expenses in connection with the Transaction.

 

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Internal Evaluation Process and Previous Restatement of Financial Statements

In response to the findings of the Internal Evaluation Process, the Company’s audited financial statements included in this annual report as of December 31, 2016 and January 1, 2016 and for the year ended December 31, 2016 (as well as the audited financial statements for the year ended December 31, 2015 which are not included in this annual report) were restated to reflect certain adjustments, as described below. Such restatement was previously reflected in our annual report on Form 20-F for the year ended December 31, 2017 which was filed with the SEC.

Overview

On March 1, 2018, the Brazilian Federal Police executed search warrants at a number of companies in the cities of São Paulo, Santos, Paulínia, Belo Horizonte and Lamim, including the premises of Soma, as well as our corporate offices. This action formed part of the so-called Operation Descarte effort of the Brazilian Federal Police working in conjunction with the Brazilian tax authorities within the ambit of the broader Lava Jato task force. The stated objective of Operation Descarte is dismantling a criminal money laundering scheme focused on payments made by companies operating in the Brazilian waste management industry.

In the aftermath of the events of March 1, 2018, we instituted a special committee of our board of directors comprised of independent members of our board of directors for the specific purpose of evaluating our supply relationships and related matters at the Company, including Soma and our joint ventures, which we refer to herein as the “Internal Evaluation Process.” This Internal Evaluation Process was conducted by external legal counsel working together with external forensic service providers with a focus on the integrity of our supply relationships. For additional information, see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.”

In response to the findings of the Internal Evaluation Process, the Company’s audited financial statements as of December 31, 2016 were restated and such restatements were reflected in our annual report on Form 20-F for the year ended December 31, 2017 which was filed with the SEC.

Tax Adjustments

Following our Internal Evaluation Process, we recalculated our taxes to reflect probable amounts due, including fines and interest, applying an income tax rate of 34% (principal), plus application of a 150% fine and an average 14.9% interest payment (fines and penalties). On this basis, we recorded provisions for Corporate Income Tax (Imposto de Renda de Pessoa Jurídica – “IRPJ”) and Social Contribution of Net Profits (Contribuição Social sobre o Lucro Líquido – “CSLL”) in an aggregate amount of R$25.6 million and R$26.0 million in the years ended December 31, 2017 and 2016, respectively, corresponding to impermissible deductions in the past in relation to the alleged unsupported payments made to specific suppliers and alleged impermissible amortization (as applicable) recorded from these transactions that may be challenged by the BFRS. In the case of taxes payable arising from unsupported payments made through Soma, our recalculated income taxes reflect only our proportional interest in this entity.

In connection with the adjustments described above, based on the advice of our external legal counsel, who assessed the risk of a potential loss as possible (and not probable), we did not establish provisions in the aggregate amount of R$212.4 million (as of December 31, 2017) corresponding to IRPJ, CSLL and IRRF taxes levied by the BFRS in relation to the tax assessments received by the Company and Cavo at the conclusion of 2017 alleging impermissible deductions with respect to certain allegedly unsupported payments made to specific suppliers and alleged impermissible deductions with respect to amortization derived from these transactions. For additional information, including information in connection with tax assessments received in the year ended December 31, 2018 (i.e. subsequent to the adjustments described in this section), see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.”

While no additional provisions were recorded in 2018, we partially reversed the loss recorded for the year ended December 31, 2017 in an amount of R$66.6 million, which corresponds to a reduction in the probable amounts due in respect of taxes as a result of a reduction in the amount of penalties applied in calculating the probable amount due, which we decreased from a penalty rate of 150% to a penalty rate of 20% after we self-reported certain outstanding tax payments as part of the tax regularization programs.

 

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Key Factors Affecting Our Results of Operations

Brazilian Macroeconomic Environment

As a company with all of its operations and activities conducted in Brazil, our results of operations and financial condition are affected by Brazilian economic conditions. Most notably, we are impacted by Brazilian economic growth and its consequences on our customers’ ability to pay in a timely manner, particularly our municipal customers that may confront fiscal challenges and cash shortages in an adverse macroeconomic scenario. In addition, the Brazilian interest rate environment and inflation materially impact our financing costs, as 97.6% of our indebtedness was linked to floating rates as of December 31, 2018, with the majority linked to the Brazilian CDI rate as well as the Brazilian TJLP rate. Inflation in Brazil also impacts our revenue from services rendered, cost of services and other operating expenses as a result of our inflation-adjusted contracts with both our customers and suppliers as well as annual inflation adjustments that we are required to make pursuant to the collective bargaining agreements that we maintain with employees.

The Brazilian macroeconomic environment has historically been characterized by significant variations in economic growth, inflation and interest rates. Our results of operations and financial conditions are affected by these factors. The table below sets forth Brazilian GDP, inflation rates, interest rates, exchange rates and other key macroeconomic data as of and for the years ended December 31, 2018, 2017 and 2016:

 

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

GDP growth (contraction)(1)

     1.1%        1.0%        (3.6)  

IGP-M(2)

     7.5%        (0.5%)        7.2%  

IPCA(3)

     3.7%        3.0%        6.3%  

CDI(4)

     6.4$        9.9%        14.0%  

TJLP(5)

     7.0%        7.0%        7.5%  

Exchange rate at the end of the period per US$1.00

     R$3.87        R$3.31        R$3.26  

Average exchange rate per US$1.00(6)

     R$3.65        R$3.34        R$3.49  

Appreciation (depreciation) of the real against the U.S. dollar(7)

     14.5%        22.1%        (16.5%)  

 

(1)

As measured by the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística) (“IBGE”).

(2)

Demonstrating variation of the Brazilian General Index of Market Prices (Índice Geral de Preços do Mercado) (“IGP-M”), accumulated during the period.

(3)

Demonstrating variation of the National Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo) (“IPCA”), accumulated during the period.

(4)

CDI accumulated during the period.

(5)

The TJLP is the interest applicable to long-term BNDES financing agreements, as of the end of the period.

(6)

Represents the average daily U.S. dollar closing selling exchange rate during the period.

(7)

Comparing the U.S. dollar closing selling exchange rate as reported 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.

Brazil experienced a 3.8% contraction in 2015 followed by an additional contraction of 3.6% in 2016. After contracting two consecutive years, GDP grew 1.0% in 2017 and 1.1% in 2018 according to IBGE.

Recently, the Brazilian political and economic scenario has been characterized by high levels of volatility and instability, including meager GDP, sharp fluctuations of the real against the U.S. dollar and increased levels of unemployment. Such scenario is in part due to economic and political uncertainties resulting from a global decrease in commodities prices as well as to corruption investigations of Brazilian state-owned and private sector companies, politicians and business executives. In particular, the ongoing Lava Jato launched by the Office of the Brazilian Federal Prosecutor at the end of 2014 has probed members of the Brazilian federal government and other members of the legislative branch, as well as senior officers and directors of large state-owned as well as other companies in connection with allegations of political corruption including, more recently, individuals related to Company (for additional information, see “Item 3.D. Risk Factors—Risks Related to Compliance and Control” and “Item 8.A. Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations”). The resulting fallout from the Lava Jato investigation contributed to, among other factors, the destabilization of the Brazilian economy and the ouster and the arrest of several prominent politicians, including the impeachment of former President Dilma Rousseff in August 2016, incarceration of former Brazilian President Luiz Inacio Lula da Silva in April 2018 and arrest of previous president, Michel Temer, in March 2019.

 

 

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On October 28, 2018, Jair Bolsonaro, a retired military officer who represented the state of Rio de Janeiro in the lower house of the Brazilian Congress from 1991 through 2018, was elected the next President of Brazil and took office on January 1, 2019. During his presidential campaign, Bolsonaro was reported to favor the privatization of state-owned companies, economic liberalization, and social security and tax reforms. However, there is no guarantee that Bolsonaro will be successful in executing his campaign promises or passing certain favored economic and other reforms fully or at all, particularly when confronting a fractured congress. Adverse macroeconomic conditions in Brazil may persist to the extent Bolsonaro is unsuccessful in implementing these reforms and other adjustments.

For more information, see “Item 3.D. Key Information—Risk Factors—Risks Related to Brazil—Brazil continues to experience political instability, which may adversely affect us”.

Effects of Inflation and Interest Rates

Inflation rates in Brazil have been volatile in the past. According to the IPCA, Brazilian inflation rates were 3.75%, 2.95% and 6.29% in 2018, 2017 and 2016, respectively.

Inflation affects our performance primarily by affecting our revenues from services rendered, which is supported, in almost all cases, by contracts with annual inflation-adjustment clauses. Inflation also affects our results by increasing costs from inflation-indexed supply contracts, increasing expenditures primarily for diesel fuel, electricity, and leachate treatment and disposal as well as wage expenses through our collective bargaining agreements. In addition, some of our indebtedness is generally adjusted with reference to inflation indexes; for example, a significant portion of our debt bears interest based at the Brazilian CDI rate, which is partially adjusted for inflation.

The Brazilian government’s measures to control inflation frequently have included maintaining a tight monetary policy with high interest rates, thus limiting the availability of credit and reducing economic growth. Consequently, the official interest rates in Brazil at the end of 2017 and 2016 were 7.0% and 13.75%, respectively, as established by the Brazilian Central Bank’s Monetary Policy Committee (Comitê de Política Monetária) (“Copom”). In March 2018, Copom established a 6.5% interest rate, reflecting a historical low, which has been maintained until the day of this annual report. Despite the recent downward trend in interest rates, any potential future increase could negatively affect our profits and operating results, by increasing the cost associated with financing our activities.

Variations in Brazilian interest rates affect our financial liquidity and capital resources primarily by exposing us to the variations in our floating-rate lending. Substantially all of our debt accrues interest at floating rates, with 97.6% of our loans and financings indexed to Brazilian variable interest rates as of December 31, 2018, with particular exposure to the CDI rate (to which all of our debentures and related debt acknowledgment instrument are indexed), and, to a lesser extent, the Brazilian TJLP interest rate. Accordingly, rising interest rates significantly impact the costs of our indebtedness, increasing our finance expenses. Such an increase could in turn adversely affect our ability to pay our obligations to the extent it reduces cash on hand. Mismatches between rates contracted in assets versus liabilities and/or high volatility in interest rates may result in financial losses for us. The high interest rate environment in Brazil in recent years, impacted in part by high inflation environment, led to the suspension of interest payments and amortization of principal on our debentures since 2014 (for additional information, see “Item 3.D. Key Information—Risk Factors—Risks Related to Brazil”. An increase in inflation, as well as government efforts to combat inflation, may hinder the growth of the Brazilian economy and could adversely affect us”).

Write-off of Property, Plant and Equipment

We are the subject of certain allegations and investigations of misconduct. For further information regarding the related facts, see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations.” As part of our historical response to the allegations and investigations of misconduct, we engaged independent consultants in November 2016 to review documentation regarding our transactions with certain identified suppliers during the 2010 to 2017 period. These consultants concluded in March 2017 that certain disbursements made by us were not properly supported by documentary evidence. On the basis of this historical investigation, our management made an accounting adjustment reflected in our financial statements as of and for the year ended December 31, 2017 resulting in the write-off of property, plant and equipment items totaling R$44.0 million relating to payments by us for goods and services that could not be properly documented during the 2010 to 2014 period. We also made an additional write-off of property, plant and equipment of R$9.4 million reflected in our financial statements as of and for the year ended December 31, 2017 as a result of the related review of our inventory based on our improved controls and management systems. This earlier investigation did not capture payments made by Soma, which was the focus of our more recent Internal Evaluation Process. For additional information, see “Item 3.D. Key Information—Risk Factors— Risks Related to Compliance and Control.”

 

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Participation in Tax Regularization Programs

In 2017, we entered into the Brazilian Tax Regularization Programs which allowed us to settle certain of our tax debts under administrative or judicial discussion. For additional information, see “Item 8.A. Financial Information—Consolidated Statements and Other Financial Information—Legal and Administrative Proceedings and Investigations—Tax Proceedings.” While these programs did not provide for amnesty of penalties or interest, it did allow us to resolve certain of our federal tax debts, including some of which were the subject of ongoing disputes, in installment payments. The programs also allowed the partial settlement of tax debts with the use of tax credits and/or the use of tax loss carryforwards. In order to benefit from this program, we were required to waive in advance any defense or rights in relation to administrative disputes involving the tax indebtedness.

The main impacts on the statement of profit or loss in relation to entering into this program in 2017 were (i) recognition of a gain of R$373.2 million recorded under “Income and Social Contribution Taxes” reflecting the recognition of tax loss carryforwards (previously not recognized as a deferred tax assets) that were applied in partial settlement of the tax debts under the Tax Regularization Program, (ii) a R$120.4 million increase in interest expenses recorded under “Finance Costs” reflecting interest accrued on the balance of taxes settled through the Brazilian Tax Regularization Program and (iii) a R$53.6 million loss recorded under “General and administrative expenses” reflecting a provision established corresponding to disputed amounts for which our management had not previously recorded provisions based on their determination that the risk of loss for such liabilities was not probable, and (iv) R$3.0 million in September 2017 reflecting the inclusion of tax liabilities from our CGR Catanduva landfill under this program, which was previously being settled through another tax amnesty program.

The main impacts on the statement of profit or loss in relation to entering into this program in 2018 were: (i) inclusion of additional R$46.6 million into the Brazilian Tax Regularization Program as a result of the internal investigation process; (ii) reversal of R$7.7 million deferred tax assets million not used to settle “Income and Social Contribution Taxes” in one of the programs; (iii) accrual of R$11.4 million in interest expenses recorded under “Finance Expenses” reflecting interest accrued on the balance of taxes through the Brazilian Tax Regularization Programs; (iv) the usage of R$89.9 million in tax losses carryforward and other tax credits that were applied in partial settlement of the tax debts under the Tax Regularization Program; and (v) R$54.0 million of taxes excluded from the Brazilian Tax Regularization Program as they were not due or not eligible to be included (which resulted in a R$6 million positive impact on our statement of profit and loss for the year ended December 31, 2018).

2018 Cost Cutting Initiatives

As described elsewhere in this annual report, during the course of 2018, the revenue we generated from our collection business significantly decreased and our liquidity position deteriorated. We are currently focused on executing a number of initiatives aimed at allowing us to improve our liquidity position. In the second half of 2018, the Company implemented certain cost-cutting initiatives, of which the most significant from a cost perspective was a headcount reduction in approximately 13%. We estimate that on an annual basis, such measures resulted in a reduction of employee compensation costs of R$2.5 million. As a result of the headcount reduction, in the year ended December 31, 2018, we incurred in severance costs of R$15.7 million, which were paid in December 2018.

Divestments and Asset Sales

As part of our efforts to streamline our operations, we have since 2014 divested of certain assets that negatively impacted our margins and did not align with our strategic vision, together with the sale of other assets to generate additional liquidity. These divestments and other transactions have had a significant impact on our results of operations, serving as a salient factor driving variations between periods. A summary of our significant asset sales is set forth in “Item 4.A. Information About the Company—History and Development of the Company—Recent Divestments and Acquisitions.” It is possible that we may have to sell additional assets in the future to improve our liquidity position.

In addition, as discussed below under “—Principal Components of Our Statement of Profit or Loss—Discontinued Operations,” during the periods included in this annual report, we classified certain of our operations as discontinued operations. Our results for the years ended December 31, 2018, 2017 and 2018 included in this annual report have been restated to reflect the reclassification of the relevant operations as discontinued operations.

 

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How We Generate Revenue

We generate revenue primarily by providing cleaning, collection, disposal and treatment services to municipal, residential, waste collection companies and C&I customers. Our remaining revenue is generated from soil treatment and site clean-up for oil and gas clients, co-processing, landfill biogas energy generation operations, recycling, reverse manufacturing and the sale of carbon credits.

Revenue from our collection and urban cleaning operations consists of fees we receive from municipal and C&I customers pursuant to short and medium-term contracts through which we collect based on the weight collected or, less commonly, a fixed monthly fee, as is the case for our Salvador contract. The pricing of our municipal contracts is established at the time of execution as part of the competitive bidding process based on factors such as anticipated collection frequency, type of collection equipment needed, number of employees needed to provide service, anticipated type and weight of the waste collected, distance to the transfer station or disposal facilities and disposal costs. The pricing model for our C&I customers differs from the process for public clients, since it does not involve public bidding processes. Instead, contracts are negotiated privately between us and our prospective customers. Once an initial inquiry is made, our pricing team analyzes several factors based on the scope and type of services to be provided, as well as margin and other financial requirements, in order to arrive at the specific pricing terms to be negotiated with the prospective C&I client. Our municipal customer relationships are generally supported by exclusive contracts ranging from three to five years in initial duration with subsequent renewal periods when permitted by the contract agreement. Our contracts with our C&I customers are typically from one to three years in initial duration with subsequent renewal periods. The majority of our contracts with our customers have annual price escalation clauses that are tied to inflation.

Our landfills generate revenue from disposal and tipping fees. Revenue from our landfill operations consist of fees which are generally based on the type and weight of waste being disposed. While, as a result of the competitive bidding process, our landfill contracts with our municipal customers typically stipulate a fixed amount per ton of waste disposed, the amount invoiced to municipal customers on a monthly basis varies based on actual volume of waste disposed. Due to our high rate of internalization pursuant to which we currently dispose of approximately 55% of the total waste collected for municipal clients in our own landfills, there is a significant degree of overlap between our customers in the Collection & Cleaning Services segment and Landfills segment. Collections and disposal services are generally provided pursuant to separate agreements with different pricing models.

Revenue from our Oil & Gas operations was derived from the fees we receive for site cleanup of oil and gas projects and, specifically, remediation of areas contaminated by hydrocarbons. Our main customer in this segment was Petrobras with whom we no longer have active contracts.

Revenue derived from our co-processing operations consists primarily of treatment fees that we receive from industrial customers based on the type and weight of the hazardous waste being treated. While we receive fees by the waste generators for the treatment of materials used for co-processing, we do not generate additional revenues in selling the fuel byproduct, which we give, without charge, to private industrial companies to use as fuel for industrial ovens.

Revenue derived from our energy-generation activities consists of the proceeds we receive from the sale of energy we produce from biogas. Our landfill operations naturally produce methane as well as other biogases from the decomposition of organic compounds. We capture these biogases using drains installed throughout our landfills, channeling them to processing plants through a gas network interconnecting the drains. At our power plants, these biogases go through a process of filtration and cooling to fuel the turbines that burn biogas and generate electricity. Of the energy produced as a result of this process, approximately 80% is sold pursuant to power purchase agreements (“PPAs”), which are structured as take or pay contracts with long-standing customers pursuant to which we are required to deliver a certain amount of electricity at set intervals, while the remaining approximately 20% is sold on the spot market.

Revenue from our recycling operations consists of treatment fees as well as the sale of products produced from construction and demolition waste to participants in the construction industry.

Revenue from our reverse manufacturing operations consists of treatment fees as well as the sale of the component parts of complex electronic products, such as steel, plastics and electronic parts, that are the byproduct of our disassembly of such products.

Carbon credit revenue consists of our sale of a tradable certificate or permit representing the right to emit carbon dioxide to carbon emitters. Our landfill operations produce biogas, which we burn in high-temperature flares at our facilities to convert into carbon dioxide. As methane is a greenhouse gas that has approximately 21 times the heat-trapping capacity of carbon dioxide, our process of reducing methane into carbon dioxide generates carbon credits. We sell the carbon credits to the NEFCO Nordic Environment Finance Corporation (“NEFCO”), pursuant to a procurement contract that expires in 2020, which NEFCO uses in order to meet Norway’s requirements under the second commitment period of the Kyoto Protocol.

 

 

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Until December 31, 2017, we used to recognize revenue to the extent economic benefits are likely to be generated and when such amount can be reliably measured and, accordingly, revenue recognition did not necessarily correspond to cash flow. Revenue was measured at fair value of payments received or receivable and were recorded in our statement of profit and loss net of certain sales taxes and other discounts.

On January 1, 2018, IFRS 15 – Revenue from Contracts with Customers came into effect, which establishes a five-step model to account for revenue arising from contracts with customers and requires that revenue be recognized at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring good or services to a customer. The five steps are as follows: (i) identification of the contract with the client; (ii) identification of performance obligations; (iii) determination of transaction price; (iv) allocation of transaction price; and (v) income recognition upon satisfaction of performance obligation. Considering the above-mentioned aspects, revenues shall be recorded at the amount that reflects the Company’s expectation of receiving in consideration of the products and financial services offered to customers.

Revenue from services

 

   

Collection & Cleaning Services: Revenue from Collection & Cleaning Services is recognized when the service is provided. The Company measures the provided service by the transaction price the Company expected to be entitled to.

 

   

Landfills: Waste that cannot be reused is sent for the most appropriate final disposal, in sanitary landfills. The Company operates 12 landfills across Brazil, serving public and private entities. Revenue is recognized when the disposals are received in the Company’s landfills. The Company measures the waste disposed in the landfills by the transaction price the Company expected to be entitled to.

 

   

Value Recovery: Value Recovery services are related to a series of solutions that ensure the maximum use of the waste, with its reuse or search for new technology to recycle the materials. Revenue is recognized when the service is provided. The Company measures the provided service by the transaction price the Company expected to be entitled to.

 

   

O&G: Revenue from services contracts provided to the Oil & Gas industry is recognized when the service is provided. The Company measures the provided service by the transaction price the Company expected to be entitled to.

Revenue from the sale of products

Revenue from the sale of products refers to the sale of scrap, fuel gas, carbon credits and electric power. For the sale of products, revenue is recognized when the performance obligations is satisfied at the time the control of the product sold is transferred to the customer, usually at the time of receipt and acceptance.

The gross income is less rebates and discounts and eliminations of income between related parties and adjustment to present value. For further information, see “Adoption of New IFRS Accounting Standards” below.

Summary of Our Trade Accounts Receivable Policy

Accounts Receivable Policy for C&I Customers

Our trade accounts receivable collection policy with respect to our C&I customers is as follows:

 

   

Trade accounts receivable that are three days overdue result in a notification informing the customer of the balance and requesting payment;

 

   

Trade accounts receivable that are seven days overdue result in a second notification informing the customer of the overdue balance and requesting payment, subject to suspension of the services being provided;

 

   

Trade accounts receivable that are ten days overdue result in suspension of the services being provided, as well as a third notification to the client;

 

   

Trade accounts receivable that are more than 15 days overdue are result in a fourth notification informing the customer of the overdue balance and requesting payment, subject to being reported to the local credit bureaus;

 

   

Trade accounts receivable that are 30 days overdue are reported to the local credit bureaus and result in a notification informing the customer of the balance, requesting payment and reiterating the suspension of the services; and

 

   

Trade accounts receivable that are 45 or more days overdue are forwarded to our legal department to consider legal action, which may involve a collection demand in court.

 

 

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Our contracts with our C&I customers typically provide for payment within 30 days from the date of the invoice, although invoicing arrangements can vary on a case-by-case basis based on the profile of the municipality. Our experience is that our C&I customers typically pay for current invoices between 30 to 45 days from the date of the invoice, but significant variation exists across the spectrum of our customers. As of December 31, 2018, accounts receivable from C&I customers represented approximately 14.0% of our total accounts receivable balance (14.2% as of December 31, 2017).

Accounts Receivable Policy for Public Entity Customers

Our trade accounts receivable collection policy with respect to our municipal and other public entity customers is as follows:

 

   

Trade accounts receivable that are 45 days overdue result in a notification informing the customer of the balance and requesting payment;

 

   

Trade accounts receivable that are 60 days overdue result in a second notification informing the customer of the overdue balance and requesting payment;

 

   

Trade accounts receivable that are 90 days overdue result in a third notification requesting payment within 72 hours, subject to suspension of the services being provided (to the extent permitted under Brazilian law); and

 

   

Trade accounts receivable that are more than 90 days overdue are forwarded to our legal department to consider legal action, which may involve a collection demand in court. We typically attempt to simultaneously negotiate alternative payment arrangements with our defaulting public entity customers to incentivize payment, which arrangements can vary on a case by case basis, but do not involve forgiveness of any portion of the principal amount due to us. Generally, we will renegotiate the payment schedule, allowing delinquent customers to pay the full principal amount due in installments over a period of 24 to 60 months, sometimes with interest or inflation adjustments. Failure to reach agreement with the customer to settle the debt could result in suspension of the services being provided (to the extent permitted under Brazilian law).

Our contracts with our public sector customers typically provide for payment within 30 days from the date of the invoice, although invoicing arrangements can vary on a case-by-case basis based on the profile of the municipality. Our experience is that our customers typically pay for current invoices between 30 to 45 days from the date of the invoice, but significant variation exists across the spectrum of our customers. As of December 31, 2018, accounts receivable from public sector customers represented approximately 87.0% of our total accounts receivable balance (85.8% as of December 31, 2017).

Significantly late payments by public entity customers, such as municipalities, are a frequent occurrence in the Brazilian waste management industry. Pursuant to Brazilian Law No. 8,987/95 and Law No. 8,666/93, public services may be suspended in the event the payment for past services is past due for more than 90 days, unless the suspension could result in severe disturbances of the public order. In addition, under the Brazilian Constitution, as well as Law No. 11,101/05, municipalities are unable to declare bankruptcy and forfeit on their obligations. As a result of this, we do not typically write off accounts receivable from our public entity clients, as there is an expectation that accounts will eventually be settled following renegotiation and, if necessary, court intervention, even if such payment may be delayed for years. In addition, in extreme circumstances, the Brazilian Constitution allows the intervention of the state to settle unpaid obligations at the municipal level.

In addition, Brazilian Complimentary Law No. 101/00 and Law No. 4,320/64, which regulate public budgets, permit a governmental entity to transfer unpaid amounts in any given year to the subsequent year’s budget. Such practice underlies our policy of not writing off municipal accounts, as any overdue amounts will be presumably budgeted for the subsequent period until settled. In addition, as an additional form of protection, creditors owed amounts by governmental entities can claim such unpaid amounts through legal actions by obtaining a government-backed credit document called a “precatório” through which the petitioning creditor can guarantee that the claimed amounts will be included in the relevant governmental entity’s budget until these amounts are settled. Governmental entities must consider in their annual budgets the payment of claims for which an official precatório has been issued, with actual payments typically made in the order that precatórios are received. Default of the obligation to pay a precatório may trigger the intervention of the state to pay on behalf of the municipality.

In our experience, the general macroeconomic environment has a significant impact on the financial condition of municipalities, with the rate of payments on trade accounts receivable decreasing significantly during periods of economic downturn as municipalities face decreasing revenues. For example, the extended recession that Brazil experienced starting in 2014 and from which it is still recovering, has increased budgetary pressures on Brazilian municipalities and significantly increased payment delays by our public entity customers.

 

 

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In addition, we experience a higher rate of payments on our trade accounts receivable from municipalities during the first three months of each year, as Brazilian municipalities receive an annual transfer of federal funds at the beginning of the year. In the first quarter of the year, municipalities typically pay on time and, in addition, often make payments on past due amounts, if any. The rate of payments on trade accounts receivable progressively decreases as the year progresses, with the fourth quarter of each year exhibiting the lowest rate of payments on trade accounts receivable. We also experience a lower overall rate of payments on our trade accounts receivable from municipalities during election years and during the first quarter of the years following elections due to shifting budgetary priorities. Municipal elections are held country-wide at the same time every four years, and the last such elections were held at the end of 2016. In line with past experience, our collections were negatively impacted in the last quarter of 2016 and the first quarter of 2017.

Our strategy of engaging public entity clients in an attempt to renegotiate the payment schedule of overdue balances has helped to incentivize payments on trade accounts receivable and allowed us to increase our rate of collections from delinquent customers. By permitting certain delinquent municipal customers to pay their full overdue principal amounts in installments, we believe we are able to recover such amounts while at the same time enabling our customers to continue meeting their obligations under current invoices. The renegotiation process for payment of accounts receivable that are overdue by 360 days or more is time-intensive and can take years to be concluded.Trade accounts receivable are recorded net of allowances for doubtful accounts. For more information on our policy relating to allowances for doubtful accounts, see “—A. Operating Results—How We Generate Revenue—Allowance for doubtful accounts” above.

Competitive Bidding Processes and Revenue Impact

Our contract with the municipality of São Paulo

We have been servicing the São Paulo contract through Soma since 2011. Our contract with the municipality of São Paulo for urban cleaning and street sweeping services represented approximately 25.5% of our revenues in 2018 (29.1% of our revenues in 2017). This contract expired in the end of 2017, and we are currently providing urban cleaning services to the city of São Paulo pursuant to a temporary contract. The temporary contract was first entered into on December 15, 2017 and expired in June 2018. On June 12, 2018, we further extended the temporary contract until the end of 2018. In December 2018, we further extended the contract which is now set to expire in June 2019, subject to earlier termination by the municipality. However, the extended temporary contract introduced in June 2018 certain significant changes to the contractual arrangement. Most significantly, under the extended temporary contract, the city of São Paulo has been divided into six separate parcels for urban cleaning, whereas under the previous contract the city had been divided into two parcels only. We, through Soma, were awarded only two parcels under the extended temporary contract, which reflects a significant decrease of our service area, since we previously serviced one of the only two parcels. As a result these changes, monthly revenues under the extended temporary contract decreased approximately 40% starting in June 2018 and as a result our revenues from the contract with the municipality of São Paulo for urban cleaning and street sweeping services decreased to approximately 31.8% of our revenues in 2018.

After a series of delays, a new bid for the São Paulo contract was initiated in October 2018, in which the Company participated, and is expected to be finalized in June 2019. In connection with the bidding process, São Paulo has divided the urban cleaning contract into six separate parcels, in line with the extended temporary contracts entered into in June 2018. The Company was not the bidder with the lowest price for any of the six parcels and has been informed that its temporary emergency contract will terminate on June 1, 2019. Therefore, we expect to provide services under the terms of the temporary emergency contract until its expiration. The loss of the São Paulo cleaning contract will result in a significant reduction in our revenues, which will have an adverse impact on us.

Considering the significance of the São Paulo contract in terms of revenues, it can be expected that our revenues will materially decrease upon the termination of the contract. According to management estimates, and based on our original revenue expectations for 2019, the impact of losing the São Paulo contract on an annualized basis will result in an estimated decrease in revenues of 25.1%.

A relevant part of our operational structure is designed to serve the São Paulo contract and, upon its termination, we will likely be required to significantly reallocate resources, including the potential early termination of employees currently servicing this contract and/or closure of certain facilities and projects solely related to our current operations in São Paulo, all of which could have the effect of increasing costs in the short-term. Furthermore, given the medium and long term nature of the majority of our contracts, we will not have the flexibility to immediately offset a decrease in revenues by increasing prices. Given the staggered timing of attractive competitive bidding opportunities occurring only on an intermittent basis as existing contracts come due, we will likely face challenges to quickly replace the lost revenues with new collections business. Given the size of the city of São Paulo, being the largest city in Brazil in terms of population according to 2017 IBGE data, we would likely have to secure several smaller contracts to replace the revenues lost under the contract. The significant loss of revenues could, in turn, impact our ability to comply with the covenants under any of our indebtedness or make payments as they come due.

 

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Our contract with the municipality of Curitiba

Cavo, which we acquired in 2011, has been servicing the Curitiba contract since 1995. Our contract with the municipality of Curitiba for collections, urban cleaning and street cleaning comprised approximately 12.0% of the Company’s revenues in 2018 (12.5% in 2017). In October 2018, we won the competitive bidding process for the Curitiba collections and cleaning contract. We signed a five-year contract on January 3, 2019 with a maximum value of R$844.8 million (a reduction in price of approximately 14.1% compared with the previous contract) and are currently providing the contractual services to Curitiba. In connection to the new contract, we are required to incur in expenses in order to comply with the terms of the new contract, which could further affect our short-term liquidity and therefore impact our ability to make payments as they become due.

Critical Accounting Policies and Estimates

Significant accounting policies and estimates are those that are important both to the presentation of our financial condition and results of operations and that require our management’s complex or subjective judgments, often as a result of the need to prepare estimates about matters that are inherently uncertain. As the number of variables and assumptions that affect the future resolution of uncertainties increases, these judgments become even more subjective and complex. In order to provide an understanding of how our management forms its judgments about future events, including the variables and assumptions underlying the estimates and the sensitivity of those judgments to different circumstances, we have identified the following significant accounting practices and estimates:

Allowance for doubtful accounts

As described under “—Adoption of New IFRS Accounting Standards—IFRS 9 Financial Instruments” below, IFRS 9 impacted our policy for recording allowance for doubtful accounts pursuant to which we now apply a simplified approach and record lifetime expected losses on all of our accounts receivable from both private C&I and public sector customers. Prior to the application of IFRS 9, an allowance for doubtful accounts was recorded for trade accounts receivable for all customers that were overdue by more than 360 days from their original maturity dates.

In assessing lifetime expected losses for our accounts receivable, we conducted a historical study of the behavior of our portfolio, creating a risk matrix by age range, and we now record allowance for doubtful accounts based on risk category in this matrix. Other factors that are considered when recording an allowance for doubtful accounts include a risk analysis conducted on each client’s portfolio, guarantees obtained, settlement agreements entered into with clients and probabilities of collection.

Our contracts with our private C&I and public sector customers typically provide for payment within 30 days from the date of the invoice, although invoicing arrangements can vary on a case-by-case basis based on the profile of the customer or municipality. Our experience is that our customers typically pay for current invoices between 30 to 45 days from the date of the invoice, but significant variation exists across the spectrum of our customers. As of December 31, 2018, accounts receivable from public sector customers represented approximately 87.0% of our total accounts receivable balance (85.8% as of December 31, 2017).

Specifically in relation to public sector customers, there is an element of seasonality with regard to payments, with a higher rate of payments during the first months of each year, as Brazilian municipalities receive an annual transfer of federal funds at the beginning of the year. As a result, in the beginning of the year, municipalities typically pay on time and, in addition, often make payments on past due amounts. On the other hand, the rate of late payments increases in the last quarter of the year, when municipalities are usually short of financial resources.

The payment of accounts receivable that are overdue will be renegotiated and the renegotiation process often takes a significant period of time (at times years) to be concluded and, in the meantime, we record an allowance for doubtful accounts based on this historical study of the behavior of the portfolio.

The allowance for doubtful accounts is recorded in selling expenses, net of recoveries, and are fully reversed whenever a debt is fully paid or partially reversed if its payment is effectively renegotiated through an installment payment arrangement. Trade accounts receivable are recorded net of allowances for doubtful accounts.

 

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In many cases, municipalities with whom we have overdue receivables enter into agreements with us, which we refers to as the “formal recognition of debts”, whereby we accept to renegotiate the timing of payment of their overdue debts, sometimes forfeiting penalties and part of the interest contractually due on late payments. When we have sufficient evidence that our customers are committing to their revised payment schedules (at least two months of timely payments), we reverse the corresponding previously recognized allowance for doubtful accounts while continuing to monitor the payment of this negotiation. These renegotiations rarely forfeit a principal amount of debt due and often include an inflation adjustment for the overdue amounts.

The balance of allowance for doubtful accounts increases as the historical payment behavior of clients worsens with a corresponding effect on risk classification in the matrix and such balance may decrease mainly for two reasons affecting the assessment of historical payment behavior: (i) payments are received on accounts that we recorded an allowance recorded, and (ii) upon the formal renegotiation of and the reaching of an agreement with the debtor relating to the amounts overdue.

Upon application of IFRS 9, we recorded a R$3.5 million decrease in the allowance for doubtful accounts on January 1, 2018.

Impairment of non-financial assets

We monitor the carrying value of our long-lived assets for potential impairment and test the recoverability of such assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable and, at least, on a yearly basis. These events or changes in circumstances, including management decisions pertaining to such assets, are referred to as impairment indicators. Typical indicators that an asset may be impaired include (i) a significant adverse change in legal factors in the business climate, (ii) an adverse action or assessment by a regulator and (iii) a significant adverse change in the extent or manner in which a long-lived asset is being utilized or in its physical condition. Impairment loss exists when the book value of an asset or cash-generating unit exceeds its recoverable amount, which is the higher of fair value less cost to sell and value in use. We calculate fair value less costs to sell based on information available about the current market for similar assets, less additional costs to dispose of the asset. Meanwhile, we calculate value in use based on discounted cash flow model, which does not consider restructuring activities that we have not yet committed to or significant future investments that will improve the asset subject to testing. The recoverable amount is, therefore, sensitive to the discount rate used in the discounted cash flow method, as well as expected future cash receipts and growth rate used for projection purposes.

For the year ended on December 31, 2018, 2017 and 2016, we recorded impairment charges on goodwill and other intangibles and fixed assets of R$547.7 million, R$37.2 million and R$44.8, respectively.

During 2018, the waste collection business of Estre presented a rapid deterioration, mainly due to the market conditions including strong margin compression. Declining margins in this business made it unattractive for us to renew certain of our collection contracts. Since we do not expect a recovery of market conditions in the future, we have decided to exit gradually from this market segment and such strategy was reflected in the estimated future cash flow used for impairment testing, which resulted in impairment losses recognized in 2018. See note 12 to our audited financial statements included elsewhere in this annual report.

Provision for legal proceedings

We are subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty. We established provisions for tax, civil and labor contingencies. We determine whether to disclose or accrue for loss contingencies based on an assessment of whether the risk of loss is remote, possible or probable and whether it can be reasonably estimated. Our assessment of the likelihood of loss is based on our evaluation of available evidence, the legal framework, available case laws, recent court rulings and analysis of their relevance, as well as the opinion of external legal counsel. Our provisions are reviewed and adjusted to take into consideration changes in circumstances such as applicable statutes of limitation, conclusions of tax audits or additional exposures identified based on new issues or court decisions. The settlement or resolution of these proceedings may result in amounts different from those estimated, due to inaccuracies inherent in the assessment process. We review our estimates and assumptions on at least an annual basis.

 

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We record losses related to contingencies in cost of operations or selling, general and administrative expenses, depending on the nature of the underlying transaction leading to the loss contingency.

Fair value of financial instruments

We have established a process for reviewing all significant fair value measurements, including Level 3 fair value measurements. When measuring the fair value of an asset or a liability, we use observable market information. Fair values are classified at different levels in a hierarchy, as follows:

 

   

Level 1—quoted prices are available in a market with high liquidity for identical assets and liabilities at the date of the financial statements, consisting mainly of financial instruments traded on a stock exchange.

 

   

Level 2—prices used are different from prices quoted at Level 1, although they are directly or indirectly observable at the date of the financial statements. In this modality, financial instruments are valued using some type of modeling or other valuation methodology based on current market values, volatility, future prices, time values or other economic measurements.

 

   

Level 3—the sources of price information used include sources that are generally less observable, but which can be based on objective sources. These sources can be used with methodologies internally developed by us.

Landfill accounting and provision for landfill closure

As part of our environmental obligations in relation to landfills, we recognize a provision for landfill closure as a corresponding entry of a property, plant and equipment item, and depleted based on landfill usage volume as a percentage of a total licensed capacity. Our provision for landfill closure is recognized at present value and accreted as landfill capacity is used, and accreted over time for the time value of money. In determining the amount of the provision, assumptions and estimates are made in relation to discount rates, the expected cost for landfill closure and future maintenance of the site and the expected timing of these costs.

The significant accounting aspects are summarized below:

 

   

Decommissioning costs are recorded for at the present value of expected costs to settle the obligation using estimated cash flows and are recognized as part of the cost of the relevant asset;

 

   

The cash flows are discounted at a pre-tax long-term risk-free rate that reflects the risks specific to the decommissioning liability. The unwinding of the discount is expensed as incurred and recognized in the statement of profit or loss. The estimated future costs of decommissioning are reviewed annually and adjusted as appropriate. Changes in the estimated future costs, or in the discount rate applied, are added to or deducted from the cost of the asset;

 

   

The estimated costs are recorded taking into account the present value of the obligation, discounted to an average long-term risk-free rate of 1%; and

 

   

Cost estimates are reviewed annually, with the consequent review of present value calculation, adjusting the amounts of assets and liabilities already accounted for.

Landfill Cost Basis. Costs capitalized and included in our landfill assets include engineering designs and plans, earth-moving and excavation costs, construction, safety equipment, costs of obtaining environmental licenses and operating permits, installing piping for collection of biogas and installing lining material that prevents leachate leaking into the soil. As landfill capacity is used, periodically further lining is installed to seal layers or sections of the landfill, which we refers to as the “implementation of cells.”

Costs that we expect to incur upon exhausting capacity at each of our landfills includes the ongoing maintenance costs such as soil and air monitoring, leachate drainage and disposal and site security.

 

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Costs capitalized into our landfill assets are recognized when incurred, and depreciated from the moment that they are in the condition in which they are able to be used, in line with IAS 16.55.

The discount rate used to bring future estimated landfill closing costs to present value is our pre-tax weighted average cost of capital, which we believe represents an appropriate rate reflecting market assessments of the time value of money and the risks specific to the liability, in line with IAS 37.47.

Amortization and Accretion. Our landfill assets are amortized over their expected useful lives calculated based on the usage volume of the landfill. Our provision for landfill closure is accreted as the capacity of each landfill site is used. The amount accreted is the total estimated closing and ongoing future operating costs expected to be occurred once landfill capacity is exhausted, discounted to present value, and divided by the usage of capacity in the period. The provision is further accreted for the passing of time as the expected date of closing approximates.

Licensed capacity is set by the environmental regulatory agencies, according to each landfill’s location, environmental and geological attributes.

Impairment Considerations. Landfill assets are grouped together with other assets including buildings and operating equipment in a given geographical area that form a cash generating unit (CGU), as these operate in an integrated manner serving waste collection contracts in nearby municipalities.

Our CGUs have goodwill allocated to them and are tested annually for impairment by comparing their carrying values to their recoverable amounts which are determined by the CGUs value-in-use based on projections of discounted future cash flows to be generated from the operations of each CGU.

In the event that an impairment test finds that the recoverable amount of a CGU is lower than its carrying amount, the assets of the CGU are impaired by firstly allocating any charges to goodwill, and subsequently to the remaining assets of the CGU.

Deferred tax assets

Deferred tax assets are recognized for all unused tax losses to the extent that it is probable that taxable profit will be available against which the losses can be used. Such assessment requires significant professional judgment as to determine the deferred tax asset amount to be recognized based on probable term and future taxable profit levels, in addition to future tax planning strategies. We did not recognize any deferred tax assets of December 31, 2018.

Fair value measurement of stock option

Estimating fair value for share-based payment transactions requires determination of the most appropriate valuation model, which depends on the terms and conditions of the grant. This estimate also requires determination of the most appropriate inputs to the valuation model including the expected life of the share option, volatility and dividend yield and making assumptions about them.

We use the Black & Scholes model to calculate the fair value of the shares that are part of the stock option plan approved by our Board of Directors on September 15, 2015. We have made an initial assessment of the estimates on the amount of shares to be issued. The impact of the valuation was recognized as an expense, with the corresponding adjustment in equity.

Principal Components of Our Statement of Profit or Loss

Revenue from services rendered

For a discussion of our revenue from services rendered, see “—A. Operating Results—Results of Operations—Revenue From Services Rendered” below.

 

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Costs of services

Our cost of services include the following main costs:

 

   

payroll, charges and benefits costs, which consist of salaries and wages, health and welfare benefits, incentive compensation and payroll taxes;

 

   

waste treatment and disposal of leachate costs, which consist primarily of costs associated with the physical, chemical and biological treatment of leachate, costs associated with the transportation of this residue from our landfills to treatment plants together with other disposal costs from our collection activities;

 

   

fuel costs, which include the direct cost of diesel fuel and lubricants used by our collection and transfer vehicles as well as our Oil & Gas operations and tractors operating in the landfills;

 

   

transportation costs, which consist of the costs associated with the collection of waste by third parties taken to our or third parties landfills as well as soil transportation costs in connection with our Oil & Gas segment;

 

   

lease of machinery and equipment, which consists of costs associated with the leasing of trucks for our collections business and tractors for landfills as well as lease of real estate and other equipment in connection therewith;

 

   

materials to operate landfills, which consist of access sign, identification and safety material;

 

   

maintenance equipment, which consist of maintenance costs of trucks, tractors and other machinery for our operations including third-party labor, parts and tires;

 

   

lease of real estate, equipment and vehicles, which consists of costs associated with the rental of real estate and rental or leasing of equipment or vehicles;

 

   

technical assistance costs, which consist of costs associated with topography and laboratory analysis of waste received;

 

   

depreciation, amortization and depletion, which includes depreciation of fixed assets over the estimated useful life of the assets using the straight-line method, and amortization and depletion of landfill space assets under the occupied capacity (units-of-consumption) methodology. We depreciate all fixed assets to a zero net book value, and do not apply salvage values;

 

   

analysis and monitoring costs, which consist of soil and water analysis as part of our control processes at our landfills and also, to a lesser extent, in connection with operations in our Oil & Gas segment;

 

   

travel and lodging costs, which consist of amounts expended to meet with prospective customers and visit existing customers throughout Brazil as well as shared labor costs between landfills; and

 

   

other expenses, which include expenses such as outsourced labor costs, certain maintenance and repair costs.

Operating income/expenses

Other operating income and expenses consists of selling, general and administrative expenses, including salaries, legal and professional fees. Salary expenses include salaries and wages, health and welfare benefits and incentive compensation for corporate and field general management, field support functions, sales force, accounting and finance, legal, m