Fibria Cellulose S.A. – Annual report – 31 December 2018
Notes to the consolidated financial statements at December 31, 2018
In thousands of Reais, unless otherwise indicated
1 Operations and current developments (extract)
(a) General information
Fibria Celulose S.A. is incorporated under the laws of the Federal Republic of Brazil, as a publicly-held company. Fibria Celulose S.A. and its subsidiaries are referred to in these consolidated financial statements as the “Company”, “Fibria”, or “we”. We have the legal status of a corporation, operating under Brazilian corporate law. Our headquarters and principal executive office is located in São Paulo, SP, Brazil.
As of December 31, 2018, we were listed on the Brazilian stock exchange (B3 S.A. – Brasil Bolsa Balcão (“B3”)) and the New York Stock Exchange (NYSE) and we were subject to the regulatory requirements of the Brazilian Comissão de Valores Mobiliários (CVM) and the U.S. Securities and Exchange Commission (SEC). Due to the corporate reorganization involving Fibria and Suzano Papel e Celulose S.A. (“Suzano”), the negotiation of our shares were suspended as from January 4, 2019, following the expected steps for the completion of the transaction.
Our activities are focused on the growth of renewable and sustainable forests and the manufacture and sale of bleached eucalyptus kraft pulp. Forests in formation are located in the states of São Paulo, Mato Grosso do Sul, Minas Gerais, Rio de Janeiro, Espírito Santo, Bahia and Rio Grande do Sul.
We operate in a single operating segment, which is the production and sale of short fiber pulp from our pulp production facilities located in the cities of Aracruz-ES, Três Lagoas-MS, Jacareí-SP and Eunápolis-BA (Veracel Celulose S.A. (“Veracel”), a jointly- controlled entity).
The pulp produced for export is delivered to customers by sea, under long-term contracts with shipping companies, through the ports of Santos, located in the State of São Paulo, Barra do Riacho, located in the State of Espírito Santo (operated by our subsidiary Portocel – Terminal Especializado Barra do Riacho S.A. (“Portocel”)) and Terminal Macuco located in the port of Santos, State of São Paulo (operated by our subsidiary Fibria Terminal de Celulose de Santos SPE S.A. (“Fibria Santos SPE”)), which began its operations in February 2018.
2 Presentation of financial statements and summary of significant accounting policies (extract)
Inventory is stated at the lower of average purchase or production cost and the net realizable value. Finished products and work-in-process consist of raw materials, direct labor, other direct costs and general production expenses.
The raw materials derived from biological assets are measured based on their fair value less cost to sell at the point of harvest, when transferred from biological assets to inventory.
Imports in transit are stated at the accumulated cost of each import. The net realizable value is the estimated sales price in the normal course of business, less selling expenses.
2.14 Biological assets
Biological assets are measured semi-annually (June and December) at fair value, net of estimated costs to sell. Depletion is calculated based on the total volume harvested. The fair value of the biological assets is estimated by Company’s management and the counter entry of the valuation is recorded in “Other operating income and expense”.
Biological assets consist of eucalyptus forests exclusively from renewable plantations and intended for the production of bleached pulp. The cycle of harvesting following replanting occurs between six and seven years.
3 Critical accounting estimates and assumptions (extract)
(d) Biological assets
The calculation of the fair value of biological assets takes into consideration various assumptions which require a high degree of judgment. Any changes in these assumptions, would have an impact on the discounted cash flow result, resulting in an appreciation or devaluation of these assets (Note 18).
The main assumptions used by Management to calculate the fair value of the biological assets and the correlation between changes in such premises and the fair value of the biological assets, are described as follows:
For the assumption called “actual planted area”, we consider that the immature forests (up to two years from the date of planting) are maintained at historical cost, as a result of the Management’s understanding that during this period, the historical cost of biological assets approximates their fair value.
The assumption regarding the “net average sale price” of biological assets (measured in R$/m³) is supported only in market prices research, in order to maximize the usage of external and independent data to measure the fair value of the forests.
4 Risk management (extract)
4.1 Social and environmental risks
(a) Risks associated with climate changes
Our activities are exposed to the potential effects of climate changes, which may affect the equilibrium of the ecosystems, the productivity of the forest and the availability of water and energy.
Fibria manages and operates its forest and industrial activities through the adoption of controls and monitoring tools, such as agronomic studies, genetic improvement for the production of eucalyptus that contemplate genetic modifications to adapt to different climatic conditions, monitoring of water consumption in forested areas, among others.
(b) Environmental risks
(i) Management of water resources – Fibria constantly monitors the situation in the watersheds where it operates with respect to water quantity and quality that might affect the Company’s forest management. Use of water by the industrial plants is governed by the environmental legislation of each location and the licensing requirements of each plant. All our facilities operate under proper and valid licenses.
(ii) Forest protection – protection of the forests against pests, disease, weeds and fires is based on a strategy involving continuous cycles of prevention, monitoring and control. The Company has ongoing efforts to select and plant increasingly resistant plant strains, and is also concerned with preserving an ecological balance and acquiring know-how to improve its forest management.
(iii) Biodiversity – the Company’s forestry activities are licensed by the relevant regulatory bodies and socioenvironmental planning activities are performed. Areas of native forest species are interspersed with eucalyptus plantations. Fibria strives to maintain its protected areas to conform to the Legal Reserves, Permanent Preservation Areas (APPs) and Private Natural Heritage Reserves (RPPNs) through the protection, restoration, management and integration of those areas with its forest activities. The Company also seeks to minimize external and degradation elements that may affect these areas.
(iv) Waste – Fibria is undertaking efforts to recycle pulp production waste by transforming them in products that can be used in the forestry area. This practice generates both environmental and economic benefits, with reduction in disposal of waste in landfills and replacing supplies with recycled waste in the silviculture operations.
(c) Impacts on communities
Fibria is committed to support communities with different economic, social and cultural backgrounds, which are affected positively or negatively and in different degrees, by the cultivation of eucalyptus trees. In order to maintain a healthy relationship with all communities, the Company has developed a plan to monitor these neighboring populations and classified them based on their degree of relationship with the Company. The relationship model has been implemented in all the forestry operations with respect to the silviculture and harvest activities.
(d) Contracting with suppliers
In order to mitigate the risk of our suppliers hiring child or forced labor, we require suppliers to provide a formal confirmation with respect to this matter.
Two other mandatory requirements to engage our suppliers are compliance with the environmental policies of Fibria and with the criteria for safe transportation (Safe Road Program). All contracts with suppliers and other business partners incorporate our Code of Conduct or refer to it. The Code reinforces the prohibition of discriminatory practices or violation of existing legislation. The process to certify approval of suppliers is renewed every two years.
4.2 Financial risks (extract)
(iii) Commodity price risk
This risk is related to the volatility in the price of pulp, which is considered a commodity. Prices fluctuate depending on demand, productive capacity, inventories, commercial strategies adopted by the major forestry companies, paper producers, and availability of substitutes for these products in the market.
This risk is managed through different strategies. The Company has a specialized team, which continuously monitors the price of pulp and analyses future trends, adjusting Fibria’s estimates, in order to assist in the process of taking preventive actions to best deal with the various scenarios. There is no liquidity in the market to sufficiently mitigate a substantive portion of the risk to which Fibria’s operations are exposed. Pulp price derivatives available in the market are characterized by their low liquidity and volume and as a result prices may be subject to significant distortion.
Currently, the Company executes no derivatives to hedge against the fluctuation of the pulp price.
6 Fair value estimates (extract)
The assets and liabilities measured at fair value in the balance sheet are classified based on the following fair value hierarchy Levels:
(a) Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities. Only the Brazilian Federal Government securities are classified as Level 1, recognized as marketable securities.
(b) Level 2 – inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices).
(c) Level 3 – inputs for the asset or liability that are not based on observable market data (that is, unobservable inputs).
Specific valuation techniques used to calculate the fair value of the assets and liabilities are:
• quoted market prices or dealer quotes for similar instruments;
• the fair value of interest rate swaps is calculated as the present value of the estimated future cash flows based on observable yield curves;
• the fair value of forward foreign exchange contracts is determined using forward exchange rates at the balance sheet date, with the resulting value discounted back to present value;
• other techniques, such as discounted cash flow analysis, are used to determine fair value for the remaining assets and liabilities.
• the fair value of future contracts on the inflation rate (such as embedded derivative contained in contracts accounted for as capital leases), based on future inflation rates at the balance sheet date, with the resulting value discounted to present value.
(*) See the changes in the fair value of the biological assets in Note 18.
There were no transfers between Levels 1, 2 and 3 during the years presented.
18 Biological assets
In determining the fair value of biological assets, the discounted cash flow model (“DCF”) was used, with projections based on a single scenario, with productivity and area of plantation (eucalyptus trees) for a harvest cycle of approximately seven years.
The projected cash flows are consistent with the project areas’ growing cycle. The volume of production of eucalyptus trees to be harvested was estimated considering the average productivity in cubic meters of wood from each plantation per hectare at the time of harvest, which is impacted by the distance between the farms and the mills. The average productivity index varies according to the genetic material, climate and soil conditions and the forestry management programs. This projected volume is based on the average annual growth by region.
The average net sales price was projected based on the estimated price for eucalyptus in the local market, through a market study and research of actual transactions, adjusted to reflect the price of standing timber by region. The average estimated cost contemplates expenses for selling, chemicals, control of growth, ant and other pest control, composting, road maintenance, inputs and labor services. Tax effects based on current rates, as well as the contribution of other assets, such as property, plant and equipment and land were considered in the estimated of average rates of return for those assets, based on the average of the existing lease agreements.
The valuation model considers the net cash flows after income taxes. The discount rate used also considers the tax effects.
Main assumptions considered in estimating the fair value of biological assets were:
(*) It includes 195,903 hectares of forests under two years, which are valued at cost, as at December 31, 2018 (188,622 hectares as at December 31, 2017).
The increase in the fair value of biological assets during the year ended December 31, 2018 was the result of the combined fluctuation of the assumptions presented above which resulted in a gain of R$ 26,778. The changes in the fair value of the biological assets are recognized in the profit and loss, within “Other operating income (expenses)” (Note 34).
The Company has no biological assets pledged as of December 31, 2018.
34 Expenses by nature
(i) Includes handling expenses, storage and transportation expenses and sales commissions, among others.
The Company has insurance coverage for operational risks, with a maximum coverage of R$ 6,957,280. Additionally, the Company has insurance coverage for civil general liabilities in the amount of US$ 25 million corresponding to R$ 96.8 million on December 31, 2018.
Fibria’s management considers these amounts sufficient to cover any potential liability, risks and damages to its assets and loss of profits.
The Company does not have insurance coverage for its forests. To mitigate the risk of fire, the Company maintains internal fire brigades, a watchtower network, and a fleet of fire trucks. There is no history of material losses from forest fires.
The Company has a domestic and international (import and export) transportation insurance policy effective through August 31, 2019, renewable for additional 12 months.
In addition, Fibria has insurance coverage for civil responsibility of its directors and officers for amounts considered adequate by management.
The assessment of the sufficiency of insurance coverage is not part of the scope of the examination of the financial statements by our independent auditors.