Cosan Ltd. 20-F 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number: 1-33659
(Exact name of Registrant as specified in its charter)
(Translation of Registrant’s name into English)
(Jurisdiction of incorporation or organization)
Av. Juscelino Kubitschek, 1726 – 6th floor
São Paulo, SP 04543-000, Brazil
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
Marcelo Eduardo Martins
Av. Juscelino Kubitschek, 1726 – 6th floor
São Paulo, SP 04543-000, Brazil
(Name, telephone, e-mail and/or facsimile number and address of Company contact person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
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 transition report.
The number of outstanding shares as of April 30, 2008 was:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
x Yes o 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.
o Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer x Accelerated Filer o Non-accelerated Filer o
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP x International Financial Reporting Standards as issued by the International Accounting Standards Board o Other o
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.
o Item 17 x 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).
o Yes x No
This transition report contains estimates and forward-looking statements, principally under “Item 3. Key Information – D. Risk Factors”, “Item 5. Operating and Financial Review and Prospects” and “Item 4. Information on the Company – B. Business Overview”. Some of the matters discussed concerning our business and financial performance include estimates and forward-looking statements.
Our estimates and forward-looking statements are mainly based on our current expectations and estimates on projections of future events and trends, which affect or may affect our businesses and results of operations. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to several risks and uncertainties and are made in light of information currently available to us. Our estimates and forward-looking statements may be influenced by the following factors, among others:
The words “believe”, “may”, “will”, “estimate”, “continue”, “anticipate”, “intend”, “expect” and similar words are intended to identify estimates and forward-looking statements. Estimates and forward-looking statements speak only as of the date they were made, and we undertake no obligation to update or to review any estimate and/or forward-looking statement because of new information, future events or other factors. Estimates and forward-looking statements involve risks and uncertainties and are not guarantees of future performance. Our future results may differ materially from those expressed in these estimates and forward-looking statements. In light of the risks and uncertainties described above, the estimates and forward-looking statements discussed in this transition report might not occur and our future results and our performance may differ materially from those expressed in these forward-looking statements due to but not limited to, the factors mentioned above. Because of these uncertainties, you should not make any investment decision based on these estimates and forward-looking statements.
Presentation of Financial and Other Information
We maintain our books and records in U.S. dollars and prepare our consolidated financial statements in accordance with U.S. GAAP.
We have modified our fiscal year to end on March 31. We have included in this transition report our audited consolidated financial statements at and for the eleven months ended March 31, 2009 and for the years ended April 30, 2008 and 2007 prepared in accordance with U.S. GAAP. For comparison purposes, we have also included as an exhibit to this transition report our unaudited condensed consolidated balance sheet, income statement, cash flows and statement of changes in shareholders’ equity for the eleven month period ended March 31, 2008. Unless otherwise indicated, all financial information of our company included in this transition report has been prepared in accordance with U.S. GAAP.
Cosan S.A. Indústria e Comércio or “Cosan” acquired Açucareira Corona S.A., or “Corona”, Mundial Açúcar e Álcool S.A., or “Mundial” and Usina Açucareira Bom Retiro S.A., or “Bom Retiro” and also increased its ownership in FBA—Franco Brasileira S.A. Açúcar e Álcool, or “FBA”, from 47.5% to 99.9% in fiscal year 2006. We also made other smaller acquisitions in fiscal year 2007. In addition, in December 2008, Cosan acquired 100% of the capital of Esso Brasileira de Petróleo Ltda., or “Essobras” (Cosan Combustíveis e Lubrificantes S.A., or “CCL”), and certain affiliates, marketers and distributors of fuel and lubricants in the Brazilian retail and wholesale markets as well as aviation fuel supply from ExxonMobil International Holding B.V., or “Exxon”, which may affect the comparability of the financial information for the periods presented in this transition report. See “Item 4. Information on the Company—A. History and Development of the Company—Acquisitions, Partnerships and Corporate Restructurings.”
We have modified our fiscal year end. Beginning in 2009, our and Cosan’s fiscal year ends on March 31. Previously our fiscal year ended on April 30. References in this transition report to “transition fiscal year 2009” and “transition period 2008” relate to the eleven months ended on March 31, 2009 and 2008, respectively. References in this transition report to “fiscal year 2008” or prior fiscal years relate to the fiscal year ended on April 30 of that calendar year. However, for purposes of calculating income and social contribution taxes in accordance with Brazilian tax laws, the applicable year ends on December 31.
We obtained market and competitive position data, including market forecasts, used throughout this transition report from market research, publicly available information and industry publications, as well as internal surveys. We include data from reports prepared by LMC International Ltd., or “LMC”, the Central Bank of Brazil (Banco Central do Brasil), or the “Central Bank”, Sugarcane Agroindustry Association of the State of São Paulo (União da Agroindústria Canavieira de São Paulo), or “UNICA”, Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or “IBGE”, the National Traffic Agency (Departamento Nacional de Trânsito), or DENATRAN, the Brazilian Association of Vehicle Manufactures (Associação Nacional dos Fabricantes de Veículos Automotores), or “ANFAVEA”, Datagro Publicações Ltda., or “Datagro”, F.O. Licht, Czarnikow, Apoio e Vendas Procana Comunicações Ltda., the São Paulo Stock, Commodities and Futures Exchange (BM&FBOVESPA S.A. – Bolsa de Valores, Mercadorias e Futuros), or “BM&FBOVESPA”, the International Sugar Organization, the Brazilian National Economic and Social Development Bank (Banco Nacional de Desenvolvimento Econômico e Social), or “BNDES”, the New York Board of Trade, or NYBOT, the New York Stock Exchange and the London Stock Exchange. We believe that all market data in this transition report is reliable, accurate and complete.
Terms Used in this Transition Report
In this transition report, we present information in gallons and liters. One gallon is equal to approximately 3.78 liters. In addition, we also present information in tons. In this transition report, references to “ton” refer to the metric ton, which is equal to 1,000 kilograms.
All references in this transition report to “TSR” are to total sugar recovered, which represents the total amount of sugar content in the sugarcane.
All references in this transition report to “U.S. dollars,” “dollars” or “US$” are to U.S. dollars. All references to the “real”, “reais” or “R$” are to the Brazilian real, the official currency of Brazil.
We have rounding adjustments to reach some of the figures included in this transition report. Accordingly, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.
The following table presents selected historical financial and operating data for Cosan Limited, or the “Company”, derived from our financial statements and for its predecessor for certain periods. You should read the following information in conjunction with our audited consolidated financial statements and related notes, and the information under “Item 5. Operating and Financial Review and Prospects” in this transition report.
The financial data at and for the eleven month period ended March 31, 2009 and at and for the fiscal years ended April 30, 2008, 2007, 2006 and 2005 have been derived from our audited consolidated financial statements prepared in accordance with U.S. GAAP. The financial data at and for the eleven month period ended March 31, 2008 is unaudited and presented solely for the purpose of providing a meaningful comparison with the eleven month period ended March 31, 2009.
Until March 4, 2005, there were two legal foreign exchange markets in Brazil, the commercial rate exchange market, or “Commercial Market”, and the floating rate exchange market, or “Floating Market”. The Commercial Market was reserved primarily for foreign trade transactions and transactions that generally required prior approval from Brazilian monetary authorities, such as registered investments by foreign persons and related remittances of funds abroad (including the payment of principal and interest on loans, notes, bonds and other debt instruments denominated in foreign currencies and registered with the Brazilian Central Bank or the “Central Bank”). The Floating Market rate generally applied to specific transactions for which Central Bank approval was not required. Both the Commercial Market rate and the Floating Market rate were reported by the Central Bank on a daily basis.
On March 4, 2005, the Central Bank issued Resolution No. 3,265, providing for several changes in Brazilian foreign exchange regulation, including: (1) the unification of the foreign exchange markets into a single exchange market; (2) the easing of several rules for acquisition of foreign currency by Brazilian residents; and (3) the extension of the term for converting foreign currency derived from Brazilian exports. It is expected that the Central Bank will issue further regulations in relation to foreign exchange transactions, as
well as on payments and transfers of Brazilian currency between Brazilian residents and non-residents (such transfers being commonly known as the “international transfers of reais”), including those made through the so-called non-resident accounts (also known as CC5 accounts). The Central Bank has allowed the real to float freely since January 15, 1999. Since the beginning of 2001, the Brazilian exchange market has been increasingly volatile, and, until early 2003, the value of the real declined relative to the U.S. dollar, primarily due to financial and political instability in Brazil and Argentina. According to the Central Bank, in 2004, 2005, 2006 and 2007, however, the real appreciated in relation to the U.S. dollar by 8.8%, 13.4%, 9.5% and 20.7%, respectively. In 2008, the real depreciated against the U.S. dollar by 24.2%. Although the Central Bank has intervened occasionally to control unstable movements in the foreign exchange rates, the exchange market may continue to be volatile as a result of this instability or other factors, and, therefore, the real may substantially decline or appreciate in value in relation to the U.S. dollar in the future.
The following tables set forth the exchange rate, expressed in reais per U.S. dollar (R$/US$) for the periods indicated, as reported by the Central Bank.
Exchange rate fluctuation will affect the U.S. dollar equivalent of the market price of our BDRs on BM&FBOVESPA, as well as the U.S. dollar value of any distributions we receive from our subsidiary Cosan, which will be made in reais. See “Item 3D. Risk Factors – Risks Related to Brazil”.
This section is intended to be a summary of more detailed discussion contained elsewhere in this transition report. Our business, financial condition or results of operations could be materially adversely affected by any of the risks and uncertainties described below. Additional risks not presently known to us, or that we currently deem immaterial, may also impair our financial condition and business operations.
Risks Related to Our Business and Industries
We operate in industries in which the demand and the market price for our products are cyclical and are affected by general economic conditions in Brazil and the world.
The ethanol and sugar industries, both globally and in Brazil, have historically been cyclical and sensitive to domestic and international changes in supply and demand.
Ethanol is marketed as a fuel additive to reduce vehicle emissions from gasoline, as an enhancer to improve the octane rating of gasoline with which it is blended or as a substitute fuel for gasoline. As a result, ethanol prices are influenced by the supply and demand for gasoline, and our business and financial performance may be materially adversely affected if gasoline demand or price decreases. The increase in the production and sale of flex fuel cars has resulted, in part, from lower taxation, since 2002, of such vehicles compared to gasoline only cars. This favorable tax treatment may be eliminated and the production of flex fuel cars may decrease, which could adversely affect demand for ethanol.
Historically, the international sugar market has experienced periods of limited supply—causing sugar prices and industry profit margins to increase—followed by an expansion in the industry that results in oversupply—causing declines in sugar prices and industry profit margins. In addition, fluctuations in prices for ethanol or sugar may occur, for various other reasons, including factors beyond our control, such as:
The prices we are able to obtain for sugar depends, in large part, on prevailing market prices. These market conditions, both in Brazil and internationally, are beyond our control. The wholesale price of sugar has a significant impact on our profits. Like other agricultural commodities, sugar is subject to price fluctuations resulting from weather, natural disasters, harvest levels, agricultural investments, government policies and programs for the agricultural sector, domestic and foreign trade policies, shifts in supply and demand, increasing purchasing power, global production of similar or competing products, and other factors beyond our control. In addition, a significant portion of the total worldwide sugar production is traded on exchanges and thus is subject to speculation, which could affect the price of sugar and our results of operations. The price of sugar, in particular, is also affected by producers’ compliance with sugar export requirements and the resulting effects on domestic supply. As a consequence, sugar prices have been subject to higher historical volatility when compared to many other commodities. Competition from alternative sweeteners, including saccharine and high fructose corn syrup, known as “HFCS”, changes in Brazilian or international agricultural or trade policies or developments relating to international trade, including those under the World Trade Organization, or “WTO”, are factors that can directly or indirectly result in lower domestic or global sugar
prices. Any prolonged or significant decrease in sugar prices could have a material adverse effect on our business and financial performance.
If we are unable to maintain sales at generally prevailing market prices for ethanol and sugar in Brazil, or if we are unable to export sufficient quantities of ethanol and sugar to assure an appropriate domestic market balance, our ethanol and sugar business may be adversely affected.
Sugar prices started to increase during 2009, reflecting the deficit in global sugar production principally due to the drop in production in India, a large exporter of sugar that became a large importer. Sugar prices in the current fiscal year reached the highest levels in nearly 30 years. Sugar prices may also be influenced by the Brazilian crop this year, which may suffer from a reduction in the sugarcane harvested and its quality, due to unusual rainfalls in periods of historical high yields.
The expected benefits of the integration of CCL within the Cosan group may not be realized, in the timeframe anticipated or at all, because of integration or other challenges.
We acquired CCL (formerly Essobras) on December 1, 2008. Achieving the expected cost benefits of the acquisition, including the amortization of goodwill associated with the anticipated merger of CCL with one of our subsidiaries, Cosanpar, will depend on the timely and efficient integration of our operations, business culture, technology and personnel within the Cosan Group. In addition, the benefits of our integration may be offset by changes in industry conditions, market demand, or other factors. Our management team has spent a considerable amount of time, and will continue to devote a considerable amount of time, to the integration process, diverting management attention from our business. The challenges involved in the integration include, among others:
We cannot assure you that the integration will be successful and cannot predict its effects on our business.
Ethanol prices are directly correlated to the price of sugar and are becoming closely correlated to the price of oil, so that a decline in the price of sugar will adversely affect both our ethanol and sugar businesses and a decline in the price of oil may adversely affect our ethanol business.
The price of ethanol generally is closely associated with the price of sugar and is increasingly becoming correlated to the price of oil. A vast majority of ethanol in Brazil is produced at sugarcane mills that produce both ethanol and sugar. Because sugarcane millers are able to alter their product mix in response to the relative prices of ethanol and sugar, this results in the prices of both products being directly correlated, and the correlation between ethanol and sugar may increase over time. In addition, sugar prices in Brazil are determined by prices in the world market, so that there is a strong correlation between Brazilian ethanol prices and world sugar prices.
Because flex fuel vehicles allow consumers to choose between gasoline and ethanol at the pump rather than at the showroom, ethanol prices are now becoming increasingly correlated to gasoline prices and, consequently, oil prices. We believe that the correlation among the three products will increase over time. Accordingly, a decline in sugar prices will have an adverse effect on the financial performance of our ethanol and sugar businesses, and a decline in oil prices may have an adverse effect on that of our ethanol business.
We may not successfully acquire or develop additional production capacity through greenfield projects or expansion of existing facilities.
We are currently building an ethanol plant in the State of Goiás, the Jataí mill, which is expected to be completed during the second quarter of fiscal year 2010 and will be able to crush approximately 4 million tons when operating at full capacity by 2013. The Jataí mill is part of our project to build three ethanol greenfield mills in the State of Goiás. We plan to invest in the construction of the two other mills. However, the investments are currently on hold and may be cancelled. We are also building another greenfield project called Carapó, which we acquired as part of Nova América acquisition. The completion of Carapó project construction is also expected to occur during the current fiscal year.
We expect to explore other greenfield projects in the future. Except for the ethanol greenfield project in the State of Goiás, we do not have environmental or other permits, designs or engineering, procurement and construction contracts with respect to any potential projects. As a result, we may not complete these greenfield projects on a timely basis or at all, and may not realize the related benefits we anticipate. In addition, we may be unable to obtain the required financing for these projects on satisfactory terms, or at all. For example, we may not be able to obtain all of the land for which we have obtained options in the State of Goiás or we may not have the appropriate personnel, equipment and know-how to implement projects. In particular, we have no significant prior experience in planning, developing and managing large-scale greenfield projects.
The integration of greenfield projects or expansion of our existing facilities may result in unforeseen operating difficulties and may require significant financial and managerial resources that would otherwise be used for the development and ongoing expansion of our existing operations. Planned or future greenfield projects or expansion of existing facilities may not enhance our financial performance.
We may not successfully implement our plans to sell energy from our cogeneration projects, and the Brazilian government’s regulation of the energy sector may affect our business and financial performance.
Our current total installed energy cogeneration capacity is approximately 294.3 MW, a substantial majority of which is used to generate energy for our own industrial operations. We have already won bids in seven government energy auctions and entered into four bilateral contracts to sell, for the next 15 years, approximately 2,696 GWh/year to the Brazilian electricity grid. We believe that five of our mills will start to deliver energy to the electricity grid this year. We have no significant prior experience in planning, developing and managing large-scale energy cogeneration projects. We may need to invest significant amounts to overcome any operating difficulties. In addition, the Brazilian government regulates the energy sector extensively. We may not be able to satisfy all the requirements necessary to acquire new contracts or to otherwise comply with Brazilian energy regulation. Changes to the current energy regulation or federal authorization programs, and the creation for more stringent criteria for qualification in future public energy auctions, may adversely affect the implementation of this element of our business strategy.
We may engage in hedging transactions, which involve risks that can harm our financial performance.
We are exposed to market risks arising from the conduct of our business activities—in particular, market risks arising from changes in commodity prices, exchange rates or interest rates. In an attempt to minimize the effects of volatility of sugar prices and exchange rates on our cash flows and results of operations, we engage in hedging transactions involving commodities and exchange rate futures, options, forwards and swaps. We also engage in interest rate-related hedging transactions from time to time. Hedging transactions expose us to the risk of financial loss in situations where the other party to the hedging contract defaults on its contract or there is a change in the expected differential between the underlying price in the hedging agreement and the actual price of commodities or exchange rate. In fiscal year 2006, we experienced losses of US$209.4 million from sugar price and exchange rate hedging transactions. In fiscal year 2007 and fiscal year 2008, we experienced gains of US$190.6 million and US$49.3 million, respectively, from sugar price and exchange rate hedging transactions. In fiscal year 2009, we experienced gains of US$22.9 million. We may incur
significant hedging-related losses in the future. We hedge against market price fluctuations by fixing the prices of our sugar export volumes. Since we record derivatives at fair value, to the extent that the market prices of our products exceed the fixed price under our hedging policy, our results will be lower than they would have been if we had not engaged in such transactions as a result of the related non-cash derivative expenses. As a result, our financial performance would be adversely affected during periods in which commodities prices increase. Alternatively, we may choose not to engage in hedging transactions in the future, which could adversely affect our financial performance during periods in which commodities prices decrease.
We face significant competition, which may adversely affect our market share and profitability.
The ethanol and sugar industries are highly competitive. Internationally, we compete with global ethanol and sugar producers such as Poet, Inc., Archer-Daniels-Midland Company, Cargill, Inc. and A.E. Staley Manufacturing Company (a subsidiary of Tate & Lyle, PLC). Some of our competitors are divisions of larger enterprises and have greater financial resources than our company. In Brazil, we compete with numerous small to medium-size producers. Despite increased consolidation, the Brazilian ethanol and sugar industries remain highly fragmented. Our major competitors in Brazil are Santelisa Vale (the second largest ethanol and sugar producer in Brazil), Group Louis Dreyfus (the third largest ethanol and sugar producer in Brazil), Grupo Carlos Lyra, Grupo São Martinho, Grupo Tercio Wanderley, Grupo Guarani, Grupo Zilor, Grupo Oscar Figueiredo, Grupo Santa Terezinha, Grupo Da Pedra, and Grupo Irmãos Biagi and other ethanol and sugar producers in Brazil market their ethanol and sugar products through the Cooperative of Sugarcane, Sugar and Ethanol Producers of the State of São Paulo (Cooperativa de Produtores de Cana-de-açúcar, Açúcar e Álcool do Estado de São Paulo), or “Copersucar”. During the 2008/2009 harvest, Copersucar had 33 members that produce ethanol and sugar in the states of São Paulo, Minas Gerais and Paraná. We are not a member of Copersucar.
We face strong competition from international producers – in particular, in highly regulated and protected markets, such as the United States and the European Union. Historically, imports of sugar have not provided substantial competition for us in Brazil due to, among other factors, the production and logistical cost-competitiveness of sugar produced in Brazil. If the Brazilian government creates incentives for sugar imports, we could face increased competition in the Brazilian market by foreign producers. Many factors influence our competitive position, including the availability, quality and cost of fertilizer, energy, water, chemical products and labor. Some of our international competitors have greater financial and marketing resources, larger customer bases and broader product ranges than we do. If we are unable to remain competitive with these producers in the future, our market share may be adversely affected.
The fuel distribution and lubricant market in Brazil is highly competitive. We compete with domestic fuel distributors who purchase substantially all of their fuels from Petrobras. There are very few domestic competitors, like us, who import certain products into Brazil. In addition, we compete with producers and marketers in other industries that supply alternative forms of energy and fuels to satisfy the requirements of our industrial, commercial and retail consumers. Certain of our competitors, such as Petrobras, have larger fuel distribution networks and vertically integrated oil refineries, and may be able to realize lower per-barrel costs or higher margins per barrel of throughput. Our principal competitors are larger and have substantially greater resources than we do. Because of their integrated operations and larger capitalization, these companies may be more flexible in responding to volatile industry or market conditions, such as shortages of crude oil and other feedstocks or intense price fluctuations. The actions of our competitors could lead to lower prices or reduced margins for the products we sell, which could have a material and adverse effect on our business or results of operations.
Anticompetitive practices in the fuel and lubricants distribution market may distort market prices.
In the last few years, anticompetitive practices have been one of the main problems affecting fuel distributors in Brazil. Generally these practices have involved a combination of tax evasion and fuel adulteration, such as the dilution of gasoline by mixing solvents or adding anhydrous ethanol in an amount greater than the 25% permitted by applicable law (the overall taxation of anhydrous ethanol is lower than
hydrated ethanol and gasoline). Taxes constitute a significant portion of the cost of fuels sold in Brazil. For this reason, tax evasion on the part of some fuel distributors has been prevalent, allowing them to lower the prices they charge. These practices have enabled certain distributors to supply large quantities of fuel products at prices lower than those offered by the major distributors, including us, which has resulted in a considerable increase in the sales volumes of the distributors who have adopted these practices. The final prices for fuels are calculated based on the taxes levied on their purchase and sale, among others factors. As a result, anticompetitive practices as such tax evasion may affect our sales volume, which could have a material and adverse effect on our business. If such practices become more prevalent, it could lead to lower prices or reduced margins for the products we sell, which could have a material and adverse effect on our business or results of operations.
Petrobras is our principal supplier of our base oils and of our fuel distribution business unit.
Significant disruption to our fuels and lubricant sales may occur, in the event of an interruption of supply from Petrobras. Any interruption would immediately affect our ability to provide fuel and lubricant products to our customers. If we are not able to obtain an adequate supply of fuel and base oil products from Petrobras under acceptable terms, we may seek to meet our demands through purchases on the international market. The cost of fuel and base oil products on the international market may be more expensive than the price we obtain through Petrobras.
We may face significant challenges in implementing our expansion strategy in other regions of Brazil and international markets.
Our growth strategy includes the expansion of our activities in other regions of Brazil and international markets, through organic growth and acquisitions. Our expansion to regions of Brazil in which we do not now operate may involve potential challenges, such as inadequate transportation systems and different state and local laws, regulations and policies. For example, we may not be able to secure an adequate supply of sugarcane either from suppliers or through our own cultivation in sufficient proximity to our mills to be economically viable in terms of transportation costs.
We are currently looking at opportunities worldwide, but have not yet identified any particular investment locations outside of Brazil. Our international expansion, to countries in which we do not now operate includes additional challenges, such as the following:
If we fail to address one or more of these challenges, our business and financial performance may be materially adversely affected.
Our export sales are subject to a broad range of risks associated with international operations.
In transition fiscal year 2009, our net sales from exports were US$929.2 million, representing 31.8% of our total net sales. During this same period, our net sales from sugar exports were US$733.4 million, representing 25.1% of our total net sales, and our net sales from exports of ethanol were US$187.2 million, representing 6.4% of our total net sales.
In fiscal year ended April 30, 2008, our net sales from exports were US$823.2 million, representing 55.2% of our total net sales. During this same period, our net sales from sugar exports were US$649.8 million, representing 43.6% of our total net sales, and our net sales from exports of ethanol were US$166.1 million, representing 11.1% of our total net sales.
Our net sales from exports in fiscal year ended April 30, 2007 totaled US$1,014.8 million, representing 60.4% of our total net sales. In fiscal year 2007, we had export net sales of sugar of US$873.0 million, representing 52.0% of our total net sales, and we had export net sales of ethanol of US$138.3 million, representing 8.2% of our total net sales. We expect to expand our ethanol exports in the future. Expansion of ethanol exports depends on factors beyond our control, including liberalization of existing trade barriers and the establishment of distribution systems for hydrous ethanol in countries outside of Brazil. Our future financial performance will depend, to a significant extent, on economic, political and social conditions in our main export markets.
Most ethanol and/or sugar producing countries, including the United States and member countries of the European Union, protect local producers from foreign competition by establishing government policies and regulations that affect ethanol and sugar production, including quotas, import and export restrictions, subsidies, tariffs and duties. As a result of these policies, domestic ethanol and sugar prices vary greatly in individual countries. We have limited or no access to these large markets as a result of trade barriers. If these protectionist policies continue, we may not be able to expand our export activities at the rate we currently expect, or at all, which could adversely affect our business and financial performance. Also, if new trade barriers are established in our key export markets, we may face difficulties in reallocating our products to other markets on favorable terms, and our business and financial performance may be adversely affected.
We may not be able to maintain rights to use blending formulas and brands supplied by ExxonMobil.
We, through our subsidiary CCL, are the exclusive manufacturer and distributor of lubricants products in Brazil based on formulas provided to us under a license from ExxonMobil under the Master Lubricants Agreement, which expires on December 1, 2018. We have also been granted a license to use the ExxonMobil brand to market fuels under the Fuels Trademark License Agreement, which expires on December 1, 2013. The termination of any of these licenses, or the failure by ExxonMobil to adequately maintain and protect its intellectual property rights, could materially and adversely affect our results of operations or could require significant unplanned investments by us if we are forced to develop or acquire alternative technology. In the future, it may be necessary or desirable to obtain other third-party technology licenses relating to one or more of our products or relating to current or future technologies to enhance our product offerings. However, we may not be able to obtain licensing rights to the needed technology or components on commercially reasonable terms or at all.
The expansion of our business through acquisitions and strategic alliances creates risks that may reduce the benefits we anticipate from these transactions.
We have grown substantially through acquisitions. We plan to continue to acquire, from time to time, other ethanol or sugar producers or facilities in Brazil or elsewhere that complement or expand our sugar and ethanol existing operations. Moreover, we plan to acquire and build, from time to time, fuel terminals, lubricant production assets, retail distribution stations and other assets that complement and expand our fuel and lubricants existing operations and also intend to expand our network of service stations through increased branding. We also may enter into strategic alliances to increase our competitiveness. However, our management is unable to predict whether or when any prospective acquisitions or strategic alliances will occur, or the likelihood of any particular transaction being completed on favorable terms and conditions. Our ability to continue to expand our business through acquisitions or alliances depends on many factors, including our ability to identify acquisitions or access capital markets on acceptable terms. Even if we are able to identify acquisition targets and obtain the necessary financing to make these acquisitions, we could financially overextend ourselves, especially if an acquisition is followed by a period of lower than projected ethanol and sugar prices.
Acquisitions, especially involving sizeable enterprises, may present financial, managerial and operational challenges, including diversion of management attention from existing business and difficulties in integrating operations and personnel. Any failure by us to integrate new businesses or manage any new alliances successfully could adversely affect our business and financial performance. Some of our major competitors may be pursuing growth through acquisitions and alliances, which may reduce the likelihood that we will be successful in completing acquisitions and alliances. In addition, any major acquisition we consider may be subject to antitrust and other regulatory approvals. We may not be successful in obtaining required approvals on a timely basis or at all.
Acquisitions also pose the risk that we may be exposed to successor liability relating to prior actions involving an acquired company, or contingent liabilities incurred before the acquisition. Due diligence conducted in connection with an acquisition, and any contractual guarantees or indemnities that we receive from sellers of acquired companies, may not be sufficient to protect us from, or compensate us for, actual liabilities. A material liability associated with an acquisition, such as labor- or environmental-related liabilities, could adversely affect our reputation and financial performance and reduce the benefits of the acquisition.
A reduction in market demand for ethanol or a change in governmental policies that ethanol be added to gasoline may materially adversely affect our business.
Governmental authorities of several countries, including Brazil and certain states of the United States, currently require the use of ethanol as an additive to gasoline. Since 1997, the Brazilian Sugar and Alcohol Interministerial Council (Conselho Interministerial do Açúcar e Álcool) has set the percentage of anhydrous ethanol that must be used as an additive to gasoline (currently, at 25% by volume). Approximately one-half of all fuel ethanol in Brazil is used to fuel automobiles that run on a blend of anhydrous ethanol and gasoline; the remainder is used in either flex fuel vehicles or vehicles powered by hydrous ethanol alone. Five districts in China require the addition of 10% ethanol to gasoline. Japan is discussing the requirement the addition of 3% of ethanol to gasoline, increasing such requirement to 20% in 2030 and nine states and four union territories in India require the addition of 5% of ethanol to gasoline. Other countries have similar governmental policies requiring various blends of anhydrous ethanol and gasoline. In addition, flex fuel vehicles in Brazil are currently taxed at lower levels than gasoline-only vehicles, which has contributed to the increase in the production and sale of flex fuel vehicles. Any reduction in the percentage of ethanol required to be added to gasoline or increase in the levels at which flex fuel vehicles are taxed in Brazil, as well as growth in the demand for natural gas and other fuels as an alternative to ethanol, lower gasoline prices or an increase in gasoline consumption (versus ethanol), may cause demand for ethanol to decline and affect our business. In addition, ethanol prices are influenced by the supply and demand for gasoline; therefore, a reduction in oil prices resulting in a decrease in gasoline prices and an increase in gasoline consumption (versus ethanol), may have a material and adverse effect in our business.
Government policies and regulations affecting the agricultural and fuel sectors and related industries could adversely affect our operations and profitability.
Agricultural production and trade flows are significantly affected by Brazilian federal, state and local, as well as foreign, government policies and regulations. Governmental policies affecting the agricultural industry, such as taxes, tariffs, duties, subsidies and import and export restrictions on agricultural commodities and commodity products, may influence industry profitability, the planting of certain crops versus others, the uses of agricultural resources, the location and size of crop production, the trading levels for unprocessed versus processed commodities, and the volume and types of imports and exports.
Future government policies in Brazil and elsewhere may adversely affect the supply, and demand for, and prices of, our products or restrict our ability to do business in our existing and target markets, which could adversely affect our financial performance. Sugar prices, like the prices of many other staple goods in Brazil, were historically subject to controls imposed by the Brazilian government. Sugar prices in Brazil have not been subject to price controls since 1997. However, additional measures may be imposed in the future. In addition, our operations are currently concentrated in the State of São Paulo. Any changes affecting
governmental policies and regulations regarding ethanol, sugar or sugarcane in the State of São Paulo may adversely affect our company.
In addition, petroleum and petroleum products have historically been subject of price controls in Brazil. Currently there is no legislation or regulation in force giving the Brazilian government power to set prices for petroleum, petroleum products, ethanol or NGV. However, given that Petrobras, the only supplier of oil-based fuels in Brazil, is a state-controlled company, prices of petroleum and petroleum products are subject to government influence, resulting in potential inconsistencies between international prices and internal oil derivative prices that affect our business and our financials results, which are not linked to international prices.
We may not be successful in reducing operating costs and increasing operating efficiencies.
As part of our strategy, we continue to seek to reduce operating costs and increase operating efficiencies to improve our future financial performance. For example, we are purchasing new harvesters and increasing the outsourcing of the mechanical harvesting with the goal of having, by fiscal year 2012, approximately 80% of our sugarcane harvested mechanically. We may not be able to achieve the cost savings that we expect to realize from this and other initiatives. Any failure to realize anticipated cost savings may adversely affect our competitiveness and financial performance.
We incur substantial costs to comply with environmental regulations and may be exposed to liabilities in the event we fail to comply with these regulations or as a result of our handling of hazardous materials.
We are subject to various Brazilian federal, state and local environmental protection and health and safety laws and regulations governing, among other matters:
We are also required to obtain permits from governmental authorities for certain aspects of our operations. These laws, regulations and permits often require us to purchase and install expensive pollution control equipment or to make operational changes to limit actual or potential impacts on the environment and/or health of our employees. Currently, we do not anticipate any material claims or liabilities resulting from a failure to comply with these laws and regulations. However, any violations of these laws and regulations or permit conditions can result in substantial fines, criminal sanctions, revocations of operating permits and/or shutdowns of our facilities.
Due to the possibility of changes to environmental regulations and other unanticipated developments, the amount and timing of future environmental expenditures may vary substantially from those currently anticipated. Under Brazilian environmental laws, we could be held strictly liable for all of the costs relating to any contamination at our or our predecessors’ current and former facilities and at third-party waste disposal sites used by us or any of our predecessors. We could also be held responsible for any and all consequences arising out of human exposure to hazardous substances, such as pesticides and herbicides, or other environmental damage.
We are party to a number of administrative and judicial proceedings for alleged failures to comply with environmental laws which may result in fines, shutdowns, or other adverse effects on our operations. We have not recorded any provisions or reserves for these proceedings as we do not currently believe that they will result in liabilities material to our business or financial performance. Our costs of complying with current and future environmental and health and safety laws, and our liabilities arising from past or future releases of, or exposure to, hazardous substances could adversely affect our business or financial performance.
Government laws and regulations governing the burning of sugarcane could have a material adverse impact on our business or financial performance.
Approximately 40% of our sugarcane is currently harvested by burning the crop, which removes leaves and destroys insects and other pests. The State of São Paulo and some local governments have established laws and regulations that limit our ability to burn sugarcane or that reduce and/or entirely prohibit the burning of sugarcane. We currently incur significant costs to comply with these laws and regulations, and there is a likelihood that increasingly stringent regulations relating to the burning of sugarcane will be imposed by the State of São Paulo and other governmental agencies in the near future. As a result, the costs to comply with existing or new laws or regulations are likely to increase, and, as a result, our ability to operate our own plants and harvest our sugarcane crops may be adversely affected.
Any failure to comply with these laws and regulations may subject us to legal and administrative actions. These actions can result in civil or criminal penalties, including a requirement to pay penalties or fines, which may range from R$50.00 to R$50.0 million (US$21.60 to US$21.6 million) and can be doubled or tripled in case of recidivism, an obligation to make capital and other expenditures or an obligation to materially change or cease some operations.
Adverse weather conditions may reduce the volume and sucrose content of sugarcane that we can cultivate and purchase in a given harvest, and we are affected by seasonality of the sugarcane growing cycle.
Our sugar production depends on the volume and sucrose content of the sugarcane that we cultivate or that is supplied to us by growers located in the vicinity of our mills. Crop yields and sucrose content depend primarily on weather conditions such as rainfall and temperature, which vary. Weather conditions have historically caused volatility in the ethanol and sugar industries and, consequently, in our results of operations by causing crop failures or reduced harvests. Flood, drought or frost can adversely affect the supply and pricing of the agricultural commodities that we sell and use in our business. Future weather patterns may reduce the amount of sugar or sugarcane that we can recover in a given harvest or its sucrose content. In addition, our business is subject to seasonal trends based on the sugarcane growing cycle in the Center-South region of Brazil. The annual sugarcane harvesting period in the Center-South region of Brazil begins in April/May and ends in November/December. This creates fluctuations in our inventory, usually peaking in November to cover sales between crop harvests (i.e., December through April), and a degree of seasonality in our gross profit, with ethanol and sugar sales significantly lower in the last quarter of the fiscal year. Seasonality and any reduction in the volumes of sugar recovered could have a material adverse effect on our business and financial performance.
We may be adversely affected by a shortage of sugarcane or by high sugarcane costs.
Sugarcane is our principal raw material used for the production of ethanol and sugar. In transition fiscal year 2009, sugarcane purchased from suppliers accounted for 30% of our consolidated costs of goods sold and operating expenses. We purchase 40% of the sugarcane that we use in our production of ethanol and sugar directly from thousands of third-party sugarcane growers. Historically, approximately 80% of the sugarcane purchased by us has been under medium- and long-term contracts with sugarcane growers, 5% on a spot basis and the remaining 15% from sugarcane growers with whom we have long-term relationships but no contractual arrangements. We generally enter into medium- and long-term supply contracts for periods varying from three and one-half to seven years. As of March 31, 2009, we also leased approximately 355,165 hectares under approximately 1,861 land lease contracts with an average term of five years. Any shortage in sugarcane supply or increase in sugarcane prices in the near future, including as a result of the termination of supply contracts or lease agreements representing a material reduction in the sugarcane available to us for processing or increase in sugarcane prices may adversely affect our business and financial performance.
We are exposed to the credit and other counterparty risk of our customers in the ordinary course of our business.
We have various credit terms with virtually all of our wholesale and retail industrial customers, and our customers have varying degrees of creditworthiness which exposes us to the risk of nonpayment or other default under our contracts and other arrangements with them. In the event that a significant number of material customers default on their payment obligations to us, our financial condition, results of operations or cash flows, could be materially and adversely affected.
Our business would be materially adversely affected if operations at our transportation, terminal and storage and distribution facilities experienced significant interruptions. Our business would also be materially adversely affected if the operations of our customers and suppliers experienced significant interruptions.
Our operations are dependent upon the uninterrupted operation of our terminal and storage facilities and various means of transportation. We are also dependent upon the uninterrupted operation of certain facilities owned or operated by our suppliers and customers. Operations at our facilities and at the facilities owned or operated by our suppliers and customers could be partially or completely shut down, temporarily or permanently, as the result of any number of circumstances that are not within our control, such as:
Any significant interruption at these facilities or inability to transport products to or from these facilities or to or from our customers for any reason would materially adversely affect our results of operations and cash flow.
Fire and other disasters could affect our agricultural and manufacturing properties, which would adversely affect our production volumes and, consequently, financial performance.
Our operations will be subject to risks affecting our agricultural properties and facilities, including fire potentially destroying some or our entire yield and facilities. In addition, our operations are subject to hazards associated with the manufacture of inflammable products and transportation of feed stocks and inflammable products. Our insurance coverage may not be sufficient to provide full protection against these types of casualties. Our Da Barra mill was responsible for approximately 15% of our total sugar production in the 2008/2009 harvest. Any material damage to our Da Barra mill would adversely affect our production volumes and, consequently, our financial performance.
Disease and pestilence may strike our crops which may result in destruction of a significant portion of our harvest.
Crop disease and pestilence can occur from time to time and have a devastating effect on our crops, potentially rendering useless or unusable all or a substantial portion of affected harvests. Even when only a portion of the crop is damaged, our business and financial performance could be adversely affected because we may have incurred a substantial portion of the production cost for the related harvest. The cost of treatment of crop disease tends to be high. Any serious incidents of crop disease or pestilence, and related costs, may adversely affect our production levels and, as a result, our net sales and overall financial performance.
Disruption of transportation and logistics services or insufficient investment in public infrastructure could adversely affect our operating results.
One of the principal disadvantages of Brazilian agriculture sector is that key growing regions lie far from major ports. As a result, efficient access to transportation infrastructure and ports is critical to the growth of Brazilian agriculture as a whole and of our operations in particular. As part of our business strategy, we intend to invest in areas where existing transportation infrastructure is under developed. Improvements in transportation infrastructure are likely to be required to make more agricultural production accessible to export terminals at competitive prices. A substantial portion of Brazilian agricultural production is currently transported by truck, a means of transportation significantly more expensive than the rail transportation available to U.S. and other international producers. Our dependence on truck transport may affect our position as low-cost producer, so that our ability to compete in world markets may be impaired.
Even though road and rail improvement projects have been considered for some areas of Brazil, and in some cases implemented, substantial investments are required for road and rail improvement projects, which may not be completed on a timely basis – if at all. Any delay or failure in developing infrastructure systems could hurt the demand for our products, impede our delivery of products or impose additional costs on us. We currently outsource the transportation and logistics services necessary to operate our business. Any disruption in these services could result in supply problems at our processing plants and impair our ability to deliver processed products to our customers in a timely manner. In addition, a natural disaster or other catastrophic event could result in disruption in regional transportation infrastructure systems affecting our third-party transportation providers.
We depend on third parties to provide our customers and us with facilities and services that are integral to our business.
We have entered into agreements with third-party contractors to provide facilities and services required for our operations, such as the transportation and storage of ethanol and sugar. The loss or expiration of our agreements with third-party contractors or our inability to renew these agreements or to negotiate new agreements with other providers at comparable rates could harm our business and financial performance. Our reliance on third parties to provide essential services on our behalf also gives us less control over the costs, efficiency, timeliness and quality of those services. Contractors’ negligence could compromise the safety of the transportation of ethanol from our production facilities to our export facilities. We expect to be dependent on such agreements for the foreseeable future, and if we enter any new market, we will need to have similar agreements in place.
Technological advances could affect demand for our products or require substantial capital expenditures for us to remain competitive.
The development and implementation of new technologies may result in a significant reduction in the costs of ethanol production. We cannot predict when new technologies may become available, the rate of acceptance of new technologies by our competitors or the costs associated with such new technologies. Advances in the development of alternatives to ethanol also could significantly reduce demand or eliminate the need for ethanol as a fuel oxygenate. Any advances in technology which require significant capital expenditures to remain competitive or which otherwise reduce demand for ethanol will have a material adverse effect on our business and financial performance.
Alternative sweeteners have negatively affected demand for our sugar products in Brazil and other countries.
We believe that the use of alternative sweeteners, especially artificial alternative sweeteners such as aspartame, saccharine and HFCS, has adversely affected the growth of the overall demand for sugar in Brazil and the rest of the world. Soft drink bottlers in many countries have switched from sugar to, or increased consumption of, alternative sweeteners. In addition, the use of alternative sweeteners by sugar consumers, including soft drink bottlers, may also reduce the demand for sugar in Brazil. A substantial decrease in sugar
consumption, or the increased use of alternative or artificial sweeteners, would decrease demand for our sugar products and could result in lower growth in our net sales and overall financial performance.
Our sugar and ethanol products are sold to a small number of customers which may be able to exercise significant bargaining power concerning pricing and other sale terms.
A substantial portion of our sugar and ethanol production is sold to a small number of customers that acquire large portions of our production and thus may be able to exercise significant bargaining power concerning pricing and other sale terms. In the transition fiscal year 2009, five of our customers accounted for 66.8% of our net sales of sugar. In the same fiscal year, five of our customers accounted for 60.5% of our net sales of ethanol. In addition, intensive competition in the ethanol and sugar industries further increases the bargaining power of our customers.
Our subsidiary’s port concession is subject to termination by the granting authority.
We own and operate a sugar-loading terminal at the Port of Santos in the State of São Paulo through our subsidiary Rumo Logística S.A., or “Rumo”. This port terminal is a result of the association of two previous terminals, Cosan Operadora Portuária S.A., or “Cosan Portuária”, and Teaçu Armazéns Gerais S.A., or “Teaçu” (previously owned by Nova América). The close proximity of our mills to the port enables us to benefit from lower transportation costs. Pursuant to the port concession agreement with the State of São Paulo’s Port Authority (Companhia de Docas do Estado de São Paulo – CODESP), or “CODESP”, Cosan Portuária’s concession to operate this terminal will expire on 2016, and it may be renewed for an additional 20 years if Cosan Portuária meets its obligations under the port concession agreement. We are already discussing with the CODESP the renewal of this concession, but we cannot provide assurances that we will be able to renew the concession at all or on favorable terms. The South Terminal concession (formerly Teaçu) was initially scheduled to in 2016, but has been extended until 2036. All port concessions may be unilaterally terminated by the granting authority prior to that time upon:
Termination of the port concession agreement may adversely impact our transportation costs and the turn-around time for the export of our products as well as our revenues from service agreements related to our port facilities.
We may be adversely affected by unfavorable outcomes in pending legal proceedings.
We are involved in a significant number of tax, civil and labor proceedings, which we estimate involve claims against us aggregating US$1,493.8 million, and as to which, at March 31, 2009, we recorded a provision totaling US$423.7 million, net of judicial deposits in an aggregate amount of US$74.0 million. We cannot predict whether we will prevail in these or other proceedings, or whether we will have to pay significant amounts, including penalties and interest, as payment for our liabilities, which would materially and adversely impact our business and financial performance.
Funding, especially on terms acceptable to us, may not be available to meet our future capital needs.
Global market and economic conditions have been, and continue to be, disruptive and volatile. The debt capital markets have been impacted by significant write-offs in the financial services sector and the re-pricing of credit risk, among other things. These events have negatively affected general economic conditions. In
particular, the cost of raising money in the debt capital markets has increased substantially while the availability of funds from those markets has diminished significantly. Also, as a result of concerns about the stability of financial markets generally and the solvency of counterparties specifically, the cost of obtaining money from the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards and reduced and, in some cases, ceased to provide funding to borrowers on commercially reasonable terms or at all.
If funding is not available when needed, or is available only on unfavorable terms, meeting our capital needs or otherwise taking advantage of business opportunities or responding to competitive pressures may become challenging, which could have a material and adverse effect on our revenue and results of operations.
The production of lubricants and the storage and transportation of fuel products, lubricant products are inherently hazardous.
The complex manufacturing operations we perform at our Lubricants Oil Blending Plant, or LOBP, involve a variety of safety and other operating risks, including the handling, production, storage and transportation of toxic materials. These risks could result in personal injury and death, severe damage to or destruction of property and equipment and environmental damage. A material accident at one of our plants, service stations or storage facilities could force us to suspend our operations and result in significant remediation costs and lost revenue. In addition, insurance proceeds, if available, may not be received on a timely basis and may be insufficient to cover all losses, including lost profit. Equipment breakdowns, natural disasters, and delays in obtaining supplies or required replacement parts or equipment could also materially adversely affect our manufacturing operations and consequently our results of operations.
We are not insured against business interruption for our Brazilian operations and most of our assets are not insured against war or sabotage. In addition, our insurance coverage may be inadequate to cover all losses and/or liabilities that may be incurred in our operations.
We do not maintain coverage for business interruptions of any nature for our Brazilian operations, including business interruptions caused by labor disruptions. If, for instance, our workers were to strike, the resulting work stoppages could have a material and adverse effect on us. In addition, we do not insure most of our assets against war or sabotage. Therefore, an attack or an operational incident causing an interruption of our business could have a material and adverse effect on our financial condition or results of operations. Our operations are subject to a number of hazards and risks. We maintain insurance at levels that are customary in our industry to protect against these liabilities; however, our insurance may not be adequate to cover all losses or liabilities that might be incurred in our operations. Moreover, we will be subject to the risk that we may not be able to maintain or obtain insurance of the type and amount desired at reasonable rates. If we were to incur a significant liability for which we were not fully insured, it could have a materially adverse effect on our business, financial condition and results of operations.
We are highly dependent on our chief executive officer and other members of our management to develop and implement our strategy and to oversee our operations.
We are dependent upon Mr. Rubens Ometto Silveira Mello, our chairman and chief executive officer, other members of senior management and certain members of our board of directors, especially with respect to business planning, strategy and operations. If any of these key members of our management leaves our company, our business and financial performance may be negatively affected. Our business is particularly dependent on Mr. Rubens Ometto Silveira Mello, who is also our controlling shareholder. We currently do not carry any key man insurance.
We are indirectly controlled by a single individual who has the power to control us and all of our subsidiaries.
Mr. Rubens Ometto Silveira Mello, our controlling shareholder, chairman and chief executive officer, has the power to indirectly control us, including the power to:
Our class B common shares have ten votes per share and our class A common shares have one vote per share. Currently, because of our share capital structure, our controlling shareholder is able to control substantially all matters submitted to our shareholders for a vote or approval even if the controlling shareholder comes to own less than 50% of the issued and outstanding share capital in the company. The concentrated control will limit your ability to influence corporate matters and, as a result, we may take actions that our shareholders do not view as beneficial. As a result, the market price of our class A common shares could be adversely affected.
We may face conflicts of interest in transactions with related parties.
We engage in business and financial transactions with our controlling shareholder and other shareholders that may create conflicts of interest between our company and these shareholders. For example, we enter into land leasing agreements with our affiliates, including Amaralina Agrícola Ltda., or “Amaralina”, Santa Bárbara Agrícola S.A., or “Santa Bárbara” and São Francisco S.A., or “São Francisco”. The accounts payable balances result mainly from the lease of agriculture land, which are at prices and on terms equivalent to the average terms and prices of transactions that we enter into with third parties. Commercial and financial transactions between our affiliates and us, even on if entered into on an arm’s length basis, create the potential for, or could result in, conflicts of interests.
Risks Related To Brazil
Brazilian economic, political and other conditions, and Brazilian government policies or actions in response to these conditions, may negatively affect our business and financial performance and the market price of our class A common shares.
The Brazilian economy has been characterized by frequent and occasionally extensive intervention by the Brazilian government and unstable economic cycles. The Brazilian government has often changed monetary, taxation, credit, tariff and other policies to influence the course of Brazil’s economy. For example, the government’s actions to control inflation have at times involved setting wage and price controls, blocking access to bank accounts, imposing exchange controls and limiting imports into Brazil. We have no control over, and cannot predict, what policies or actions the Brazilian government may take in the future.
Our business, financial performance and prospects, as well as the market prices of our class A common shares, may be adversely affected by, among others, the following factors:
These factors, as well as uncertainty over whether the Brazilian government may implement changes in policy or regulations relating to these factors, may adversely affect us and our business and financial performance and the market price of our class A common shares.
Cosan generally invoices its sales in Brazilian reais, but a substantial portion of Cosan’s net sales are from export sales that are billed in U.S. dollars. At the same time, the majority of Cosan’s costs are denominated in reais. As a result, our operating margins are negatively affected when there is an appreciation of the real to the U.S. dollar. Additionally, we have indebtedness with fixed and floating rates, and we are thus exposed to the risk of fluctuations in interest rates. If there is an increase in interest rates, our financial results may be affected.
Inflation and government measures to curb inflation, may adversely affect the Brazilian economy, the Brazilian securities market, our business and operations and the market prices of our class A common shares.
At times in the past, Brazil has experienced high rates of inflation. According to the General Market Price Index (Índice Geral de Preços – Mercado), or “IGP-M”, a general price inflation index, the inflation rates in Brazil were 12.4% in 2004, 1.2% in 2005, 3.8% in 2006, 7.7% in 2007 and 9.8% in 2008. In addition, according to the National Extended Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo), or “IPCA”, published by the IBGE, the Brazilian price inflation rates were 7.6% in 2004, 5.7% in 2005, 3.1% in 2006 and 4.5% in 2007 and 5.9% in 2008. The Brazilian government’s measures to control inflation have often included maintaining a tight monetary policy with high interest rates, thereby restricting availability of credit and reducing economic growth. Inflation, actions to combat inflation and public speculation about possible additional actions have also contributed materially to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets.
Brazil may experience high levels of inflation in future periods. Periods of higher inflation may slow the rate of growth of the Brazilian economy, which could lead to reduced demand for our products in Brazil and decreased net sales. Inflation is also likely to increase some of our costs and expenses, which we may not be able to pass on to our customers and, as a result, may reduce our profit margins and net income. In addition, high inflation generally leads to higher domestic interest rates, and, as a result, the costs of servicing any floating-rate real-denominated debt may increase, resulting in lower net income. Inflation and its effect on domestic interest rates can, in addition, lead to reduced liquidity in the domestic capital and lending markets, which could affect our ability to refinance our indebtedness in those markets. Any decline in our net sales or net income and any deterioration in our financial performance would also likely lead to a decline in the market price of our class A common shares.
Our reporting currency is the U.S. dollar but a substantial portion of our sales is in Brazilian reais, so that exchange rate movements may increase our financial expenses and negatively affect our profitability.
Cosan generally invoices its sales in Brazilian reais, but reports results in U.S. dollars. The results of Cosan and our other Brazilian subsidiaries are translated from reais into U.S. dollars upon consolidation. When the U.S. dollar strengthens against other currencies, our net sales and net income may decrease.
Significant volatility in the value of the real in relation to the U.S. dollar could harm our ability to meet our U.S. dollar-denominated liabilities.
The Brazilian currency has historically suffered frequent devaluations. In the past, the Brazilian government has implemented various economic plans and exchange rate policies, including sudden
devaluations and periodic mini-devaluations, during which the frequency of adjustments has ranged from daily to monthly, floating exchange rate systems, exchange controls and dual exchange rate markets. There have been significant fluctuations in the exchange rate between the Brazilian currency and the U.S. dollar and other currencies. In fiscal year 2004, the real devalued slightly by 1.9%, ending at R$2.945 per US$1.00. In fiscal year 2005, the real ended at R$2.531 per US$1.00, which represented a 14.0% appreciation. In fiscal year 2006, the real appreciated by 17.5%, ending at R$2.089 per US$1.00. In fiscal year 2007, the real appreciated by 2.6%, ending at R$2.034 per US$1.00. In fiscal year 2008, the real appreciated by 20.5%, closing at R$1.687 per US$1.00. In transition fiscal year 2009, the real devalued by 37.2%, closing at R$2.315 per US$1.00.
Because Cosan generally invoices its sales in Brazilian reais, devaluation of the real against foreign currencies may generate losses in our foreign currency-denominated liabilities as well as an increase in our funding costs with a negative impact on our ability to finance our operations through access to the international capital markets and on the market value of the class A common shares. A strengthening of the real in relation to the U.S. dollar generally has the opposite effect. Further devaluations of the Brazilian currency may occur and impact our business in the future. These foreign exchange and monetary gains or losses can be substantial, which can significantly impact our earnings from one period to the next. In addition, depreciation of the real relative to the U.S. dollar could (1) result in additional inflationary pressures in Brazil by generally increasing the price of imported products and services and requiring recessionary government policies to curb demand and (2) weaken investor confidence in Brazil and reduce the market price of the class A common shares. On the other hand, further appreciation of the real against the U.S. dollar may lead to a deterioration of the country’s current account and the balance of payments and may dampen export-driven growth.
Because a substantial portion of Cosan’s indebtedness is, and will continue to be, denominated in or indexed to the U.S. dollar, our foreign currency exposure related to Cosan’s indebtedness as of March 31, 2009 was US$1,099.8 million. We manage a portion of our exchange rate risk through foreign currency derivative instruments, but our foreign currency debt obligations are not completely hedged. In addition, a devaluation of the real would effectively increase the interest expense in respect of our U.S. dollar-denominated debt.
Changes in tax laws may increase our tax burden and, as a result, adversely affect our profitability.
The Brazilian government regularly implements changes to tax regimes that may increase the tax burden on Cosan and its customers. These changes include modifications in the rate of assessments and, on occasion, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. In April 2003, the Brazilian government presented a tax reform proposal, which was mainly designed to simplify tax assessments, to avoid internal disputes within and between the Brazilian states and municipalities, and to redistribute tax revenues. The tax reform proposal provided for changes in the rules governing the federal Social Integration Program (Programa de Integração Social), or “PIS”, the federal Contribution for Social Security Financing (Contribuição para Financiamento da Seguridade Social), or “COFINS”, the federal Tax on Bank Account Transactions (Contribuição Provisória sobre Movimentação ou Transmissão de Valores e de Créditos e Direitos de Natureza Financeira), or “CPMF”, the state Tax on the Circulation of Merchandise and Services (Imposto Sobre a Circulação de Mercadorias e Serviços), or “ICMS”, and some other taxes. The effects of these proposed tax reform measures and any other changes that result from enactment of additional tax reforms have not been, and cannot be, quantified. Moreover, as a measure to avoid unfair competitive practices in the ethanol business, the federal government has recently enacted Law No. 11,727/08. According to this new law, the collection of PIS and COFINS has shifted from the distributors to distilleries, thereby increasing the burden of these taxes collected at the distilleries from 25% to 40%. The law further requires the installation of flow meters at distilleries to control the output of ethanol. However, some of these measures may result in increases in our overall tax burden, which could negatively affect our overall financial performance.
Risks Related to our Common Shares
We are a Bermuda company, and it may be difficult for you to enforce judgments against us or our directors and executive officers.
We are a Bermuda exempted company, so that the rights of holders of our shares will be governed by Bermuda law and our bye-laws. The rights of shareholders under Bermuda law may differ from the rights of shareholders of companies incorporated in other jurisdictions. All of our directors and some of the experts referred to in this transition report are not citizens or residents of the United States, and all of our assets are located outside the United States. As a result, it may be difficult for investors to effect service of process on those persons in the United States or to enforce judgments obtained in U.S. courts against us or those persons based on the civil liability provisions of the U.S. federal or state securities laws. We have been advised by our Bermuda counsel, Attride-Stirling & Woloniecki, that uncertainty exists as to whether courts in Bermuda will enforce judgments obtained in other jurisdictions, including the United States, against us or our directors or officers under the securities laws of those jurisdictions or entertain actions in Bermuda against us or our directors or officers under the securities laws of other jurisdictions. The United States and Bermuda do not currently have a treaty providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. Therefore, a final judgment for the payment of money rendered by any federal or state court in the United States based on civil liability, whether or not based solely on U.S. federal or state securities laws, may not necessarily be enforceable in Bermuda.
Bermuda law differs from the laws in effect in the United States and Brazil and may afford less protection to shareholders.
Our shareholders may have more difficulty protecting their interests than shareholders of a company incorporated in the United States or Brazil. As a Bermuda company, we are governed by the Companies Act 1981. The Companies Act 1981 differs in material respects from laws generally applicable to U.S. or Brazilian corporations and their shareholders, including the provisions relating to interested directors, amalgamations, takeovers, shareholder lawsuits and indemnification of directors.
Under Bermuda law, directors and officers of a company generally owe fiduciary duties to the company and not to individual shareholders. Class actions and derivative actions are generally not available to shareholders under Bermuda law. The Bermuda courts may, however, in certain circumstances permit a shareholder to commence an action in the name of a company to remedy a wrong to the company where the act complained of is alleged to be beyond the corporate power of the company or illegal, or would result in the violation of the company’s memorandum of association or bye-laws. Consideration would be given by a Bermuda court to acts that are alleged to constitute a fraud against the minority shareholders or, for example, where an act requires the approval of a greater percentage of the company’s shareholders than that which actually approved it. The Companies Act 1981 imposes a duty on directors and officers to act honestly and in good faith with a view to the best interests of the company and to exercise the care and skill that a reasonably prudent person would exercise in comparable circumstances. Directors of a Bermuda company have a duty to avoid conflicts of interest. However, if a director discloses a direct or indirect interest in any contract or arrangement with us as required by Bermuda law, our bye-laws provide that such director is entitled to be counted for quorum purposes, but may not vote in respect of any such contract or arrangement in which he or she is interested. In addition, the rights of our shareholders and the fiduciary responsibilities of our directors under the Companies Act 1981 are not as clearly established as under statutes or judicial precedent in jurisdictions in the United States, particularly in the State of Delaware.
Provisions in our bye-laws may discourage takeovers, which could affect the return on the investment of our shareholders.
Our bye-laws contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions provide, among other things, for:
These bye-laws provisions could deter a third party from seeking to acquire us, even if the third party’s offer may be considered beneficial by many shareholders.
As a holding company, we may face limitations on our ability to receive distributions from our subsidiaries.
We conduct all of our operations through subsidiaries and are dependent upon dividends or other intercompany transfers of funds from our subsidiaries to meet our obligations. For example, Brazilian law permits the Brazilian government to impose temporary restrictions on conversions of Brazilian currency into foreign currencies and on remittances to foreign investors of proceeds from their investments in Brazil, whenever there is a serious imbalance in Brazil’s balance of payments or there are reasons to expect a pending serious imbalance. The Brazilian government last imposed remittance restrictions for approximately six months in 1989 and early 1990. The Brazilian government may take similar measures in the future. Any imposition of restrictions on conversions and remittances could hinder or prevent us from converting into U.S. dollars or other foreign currencies and remitting abroad dividends, distributions or the proceeds from any sale in Brazil of common shares of our Brazilian subsidiaries. We currently conduct all of our operations through our Brazilian subsidiaries. As a result, any imposition of exchange controls restrictions could reduce the market prices of the class A common shares.
Our bye-laws restrict shareholders from bringing legal action against our directors and officers and also provide our directors and officers with indemnification from their actions and omissions, although such indemnification for liabilities under the Securities Act is unenforceable in the United States.
Our bye-laws contain a broad waiver by our shareholders of any claim or right of action, both individually and on our behalf, against any of our officers or directors. The waiver applies to any action taken by an officer or director, or the failure of an officer or director to take any action, in the performance of his or her duties, except with respect to any matter involving any fraud or dishonesty on the part of the officer or director. This waiver limits the right of shareholders to assert claims against our officers and directors unless the act or failure to act involves fraud or dishonesty. Our bye-laws also indemnify our directors and officers in respect of their actions and omissions, except in respect of their fraud or dishonesty. The indemnification provided in our bye-laws is not exclusive of other indemnification rights to which a director or officer may be entitled, provided these rights do not extend to his or her fraud or dishonesty. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling us pursuant to the foregoing provisions, we understand that, in the opinion of the staff of the SEC, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable in the United States.
The sale, or issuance, of a significant number of our common shares may adversely affect the market value of our class A common shares.
The sale of a significant number of our common shares, or the perception that such a sale could occur, may adversely affect the market price of our class A common shares. We have an authorized share capital of 1,000,000,000 class A common shares and 188,886,360 class B common shares, of which 174,355,341 class A common shares are issued and outstanding and 96,332,044 class B series 1 common shares are issued and outstanding as of March 31, 2009. In accordance with lock-up agreements, holders of our class B common
shares have agreed, subject to limited exceptions, not to offer, sell, transfer, or dispose in any other way, directly or indirectly before August 16, 2010 less than all of the class B common shares that they own. After the end of such lock-up period, such previously restricted class B common shares may be traded freely.
Our bye-laws establish that our board of directors is authorized to issue any of our authorized, but unissued share capital. Our shareholders at a shareholders general meeting may authorize the increase of our authorized share capital. As a result, we will be able to issue a substantial number of new shares after the lock-up period, which, if we decided to do so, could dilute the participation of our shareholders in our share capital.
Actual dividends paid on our shares may not be consistent with the dividend policy adopted by our board of directors.
Our board of directors will adopt a dividend policy that provides, subject to Bermuda law, for the payment of dividends to shareholders equal to approximately 25% of our annual consolidated net income (as calculated in accordance with U.S. GAAP). Our board of directors may, in its discretion and for any reason, amend or repeal this dividend policy. Our board of directors may decrease the level of dividends provided for in this dividend policy or entirely discontinue the payment of dividends. Future dividends with respect to our common shares, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, distribution of dividends made by our subsidiaries, contractual restrictions, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant.
Cosan has a dividend policy that is similar to that of our company, although the net income is calculated in accordance with Brazilian GAAP (subject to certain adjustments mandated by Brazilian corporate law). Because Brazilian GAAP differs in significant respects from U.S. GAAP, Cosan’s dividends to us may be lower than the corresponding amounts under our dividend policy, which is based upon net income under U.S. GAAP. Accordingly, we may not be able to pay the dividends anticipated under our dividend policy in the event that Cosan’s net income under Brazilian GAAP is substantially lower than our net income under U.S. GAAP.
To the extent we pay dividends to our shareholders, we will have less capital available to meet our future liquidity needs.
Our business strategy contemplates substantial growth over the next several years, and we expect that such growth will require considerable liquidity. To the extent that we pay dividends in accordance with our dividend policy, the amounts distributed to our shareholders will not be available to us to fund future growth and meet our other liquidity needs.
We may require additional funds in the future, which may not be available or which may result in dilution of the interests of shareholders in our company.
We may need to issue debt or equity securities in order to obtain additional public or private financing. The securities that we issue may have rights, preferences and privileges senior to those of our shares. If we decide to raise additional capital through an offering of common shares, the participation of our shareholders in our share capital may be diluted. Moreover, additional funding that may be required in the future may not be available under favorable terms.
The price of our class A common shares is subject to volatility.
The market price of our class A common shares could be subject to significant fluctuations due to various factors, including actual or anticipated fluctuations in our financial performance, losses of key personnel, economic downturns, political events in Brazil or other jurisdictions in which we operate, developments affecting the ethanol and sugar industries, changes in financial estimates by securities analysts, the introduction of new products or technologies by us or our competitors, or our failure to meet expectations of analysts or investors.
We are a limited liability exempted company incorporated under the laws of Bermuda on April 30, 2007 for an indefinite term. We are registered with the Registrar of Companies in Bermuda under registration number EC 39981. Our registered office is located at Crawford House, 50 Cedar Avenue, Hamilton HM11, Bermuda. Our principal executive office is located at Av. Juscelino Kubitschek, 1726 – 6th floor, São Paulo – SP, Brazil and our general telephone and fax numbers are 55 11 3897-9797 and 55 11 3897-9799, respectively.
The objects of our business are set forth in our memorandum of association and provide that we have unrestricted objects and powers and rights including to:
Our history dates back to 1936 when the Costa Pinto mill was established by the Ometto family in the city of Piracicaba in the State of São Paulo, with annual sugarcane crushing capacity of 4.0 million tons. Beginning in the mid 1980s, we began to expand our operations through the acquisition of various milling facilities in the State of São Paulo. In 1986, Usina Santa Helena and Usina São Francisco became part of Cosan, with annual sugarcane crushing capacity of 2.1 and 1.4 million tons, respectively. In 1988, Usina Ipaussu added an extra 2.0 million tons of annual sugarcane processing capacity. In 1996, we were granted a concession from the Brazilian government for the construction, development and operation of a sugar-loading terminal at the Port of Santos, currently managed by our subsidiary Cosan Portuária. In 1998, Usina Diamante and Usina da Serra became part of our group, with annual sugarcane crushing capacity of 2.0 and 1.8 million tons, respectively.
In February 2000, Cosan’s then shareholders approved an increase in the share capital of Irmãos Franceschi Agrícola Industrial e Comercial Ltda., Cosan’s predecessor company, in exchange for the contribution to Cosan of the Costa Pinto, Santa Helena, São Francisco and Tamandupá mills. As result, Cosan became a corporation and changed its name to Cosan S.A. Indústria e Comércio. Since 2000, we have expanded our operations primarily through acquisitions, partnerships and corporate restructurings, taking strategic advantage of the deregulation of the sugar industry in Brazil.
Our operating activities are carried out primarily through Cosan and Usina Da Barra S.A. Açúcar e Álcool, or Da Barra. We also operate a terminal at the Port of Santos through Cosan Portuária and own a 22% interest in another ethanol terminal located at the Port of Santos through TEAS. We also own Cosan Distribuidora de Combustíveis Ltda., a fuel distribution company that is currently non-operative but maintains all of the necessary governmental licenses to distribute fuel in Brazil. The sole purpose of our non-operating subsidiary, Administração de Participações Aguassanta Ltda., is to hold shares of Da Barra. We own and operate the Costa Pinto, São Francisco, Santa Helena, Rafard, Serra, Diamante, Mundial and Bom Retiro mills and lease the Junqueira mill. Da Barra owns the Da Barra, Ipaussu, Gasa, Destivale, Bonfim, Univalem, Benalcool and Tamoio mills and leases the Dois Córregos mill.
Acquisitions, Partnerships and Corporate Restructurings
Since May 2004, we have expanded our annual sugarcane crushing capacity by 141.9% from approximately 24.8 million tons to approximately 49.1 million tons as of March 31, 2009 primarily through
acquisitions, partnerships and corporate restructurings (after the completion of Nova América acquisition, on June 18, 2009 we added approximately 10.6 million tons to our sugarcane crushing capacity). As a result of these acquisitions, partnerships and corporate restructurings, our net sales and gross profit have increased significantly. However, we have not realized all of the expected cost savings from these transactions, as they have also increased our sugarcane planting-related general and administrative expenses and capital expenditures in order to improve the condition of certain sugarcane fields that we acquired under these transactions.
Our principal acquisitions, partnerships and corporate restructurings since May 2004 consist of the following:
Corporate Structure and Ownership.
The following chart sets forth our current capital structure:
The following table sets forth our capital expenditures, net of cash received from sale of long term assets, for the eleven months ended March 31, 2009 and fiscal years ended April 30, 2008 and 2007:
We are continuously searching for opportunities to increase our production capacity of sugar, ethanol and bio-electricity, including the development of greenfield projects. In 2009, two new mills will start operations. Jataí mill in the State of Goiás and Carapó mill in the State of Mato Grosso do Sul (the latter is a project that we took over in its final stage of development) after the Nova América acquisition. When all current projects and de-bottlenecking initiatives are operating at full capacity, we expect that by fiscal year 2013, Cosan will have capacity to crush more than 60.0 million tons of sugarcane a year.
Our capital expenditure program is focused on four key areas:
We are currently building ethanol and sugar plants in the States of Goiás and Mato Grosso do Sul, Brazil. We have acquired the land for the industrial facilities and entered into leases for sugarcane cultivation. Our estimated capital expenditures for the Goiás project amounts to approximately US$390 million, and production is expected to begin in 2009, reaching full capacity by fiscal year 2013, with an expected crushing capacity of 4 million tons of sugarcane and production of approximately 97 million gallons (370 million liters) of ethanol per year. Our estimated capital expenditures for the Mato Grosso do Sul project is approximately US$245 million, and production is expected to begin in 2009 reaching full capacity by fiscal
year 2011, with an expected crushing capacity of 2 million tons of sugarcane and production of approximately 75 million liters of ethanol per year.
Expansion of Our Crushing Capacity
We intend to make additional investments to expand the crushing capacity of our mills. These investments are expected to be applied primarily to our Univalem, Gasa, Presidente Prudente, Destivale, Mundial, Bonfim and Junqueira mills, both in industrial equipment and in new sugarcane crop plantation. See “Item 4. Information on the Company—A. History and Development of the Company—Acquisitions, Partnerships and Corporate Restructurings.”
We intend to invest in cogeneration projects in an additional six of our existing 21 mills and in our greenfield projects, which will allow these mills to sell energy to third parties. Besides those projects, we have already finalized cogeneration projects in Costa Pinto, Rafard, Tarumã and Maracaí mills. By the end of 2012, all these projects will have received R$2.4 billion in investments, out of which approximately R$1.0 billion have already been invested.
Cosan has already won bids in seven government energy auctions and entered into four bilateral contracts to sell, during the next 15 years, approximately 2.7 GWh/year to the Brazilian electricity grid at an average price of R$156.00 to R$160.00/MWh (approximately US$ 78-80/MWh). We expect that five of our mills will start delivering this fiscal year energy to the grid.
Strategic Acquisitions along the Business Chain
We invested approximately US$1.0 billion in strategic acquisitions along the business chain in the past year. We have added fuel distribution operations through the acquisition of downstream assets of ExxonMobil in Brazil and taken equity stakes in Radar, a newly incorporated land development company, Rumo, a new sugar logistics company, and Uniduto, a newly incorporated company that is exploring an ethanol pipeline project in the central-south region of Brazil. In November 2007, we acquired 50% interest in Vertical UK LLP, a leading ethanol trading company.
On December 1, 2008, Cosan acquired 100% of the capital of Essobras (now CCL) and certain affiliates, marketers and distributors of fuel and lubricants in the Brazilian retail and wholesale markets as well as aviation fuel supply from Exxon. On May 2009, we sold the aviation fuel business to Shell for US$75 million, aligned with our strategy of focusing on our core businesses.
On June 18, 2009, Cosan acquired 100% of the outstanding shares of Curupay, the parent company of Nova América and controlling shareholder of other assets related to trading, logistics and industrial production of sugar and ethanol and energy co-generation. Nova América is a producer of sugar, ethanol and energy co-generation which also operates in trading and logistics. The assets acquired include the non-controlling interest in Novo Rumo representing 28.82% of its outstanding shares which were issued in the Teaçu acquisition, and 100% of the outstanding shares of two operating companies, Nova América S.A. Trading and Nova América S.A. Agroenergia, and the “União” brand, which is the leading sugar brand in Brazil. Nova América is a producer of sugar, ethanol and energy co-generation and also operates in trading and logistics. We are now focused on the integration of these assets and extraction of synergies, however we will continue to analyze opportunities to grow organically or through strategic acquisitions and partnerships.
We are a leading global ethanol and sugar company in terms of production with low-cost, large-scale and integrated operations in Brazil. Our production is based on sugarcane, a competitive and viable feedstock for ethanol, sugar and energy because of its low production cost and high energy efficiency ratio relative to other ethanol sources, such as corn and sugar beet. We believe that we are:
For our sugar and operations, we operated 18 mills, one greenfield (Jataí), two refineries, two port facilities and numerous warehouses, as of March 31, 2009. All of these facilities are located in the Center-South region of Brazil, which is one of the world’s most productive sugarcane regions primarily because of its favorable soil, topography and climate, nearby research and development organizations and infrastructure facilities. Following the Nova América acquisition and the finalization of the greenfield, we now operate 23 mills and four refineries.
We were incorporated as a Bermuda company to better position ourselves to take advantage of favorable industry trends in ethanol and sugar markets in Brazil and globally. We are constantly pursuing opportunities to capitalize on the growing demand for ethanol and sugar in the world. We are focused on increasing our production capacity through expansion of existing facilities, development of greenfield projects and, as opportunities present themselves, acquisitions. We are also continuing to invest in cogeneration of electricity, which allows us to be energy self-sufficient and also represents a potential additional source of future cash flow.
Our management team has experience in running large-scale facilities, as well as a track record of acquiring, improving and integrating companies and extracting operational synergies. We significantly expanded our businesses through acquisitions and organic growth, increasing our crushing capacity to approximately 49.1 million tons as of March 31, 2009, from 13.2 million tons since Cosan’s inception in February 2000.
We believe that, as a low-cost, large-scale producer with well-established integrated operations and long-standing relationships with key customers and suppliers, we can capitalize on the favorable trends in the ethanol and sugar industries—particularly, in light of our competitive strengths:
Our existing mills and other facilities are strategically located in the Center-South region of Brazil. Our operations also are in close proximity to our customers, sugarcane fields owned by us and growers, port terminals and other transportation infrastructure and warehouses. These factors help us to manage our operating costs. Increasing mechanization in our agricultural processes and improvements in industrial operations, combined with our energy self-sufficiency, should allow us to continue to lower our operating costs.
Leading market position
Our market position as one of the largest global producers and exporters of ethanol and sugar provides us with competitive advantages over our main competitors, particularly in terms of cost-efficiencies, higher pricing power and integrated logistics. We also believe we have the largest sugarcane crushing capacity in Brazil, as our production is approximately three times greater than that of the second largest Brazilian producer. We are focused on increasing our production capacity and maintaining our market leadership through expansion of existing facilities, development of greenfield projects and, as opportunities present themselves, acquisitions.
Moreover, our market position in Brazil as the fourth largest distributor of fuel products provides us with competitive advantages. Our retail station network is supported by an efficient logistics and distribution network. We have a 5.3% market share of the Brazilian fuel distribution market and approximate 11.7% market share of the Brazilian lubricants market. The large scale of our operations provides us with competitive advantages, principally meaningful cost-efficiencies and integrated logistics. Additionally, our retail station network, strategically concentrated in urban areas of higher population density and thus higher throughput per station, cannot be easily replicated by competitors without significant capital investments in brand conversion. We believe that the “Esso” brand is associated with high quality and reputation, differentiating our company from other fuel retailers.
We are engaged in both the agricultural and industrial aspects of ethanol and sugar production. We purchase as well as cultivate, harvest and process sugarcane. We produce approximately 55% of our sugarcane requirements on owned and leased land and purchase most of the remaining 45% mainly from third parties under long-term contracts. These contracts incorporate ethanol and sugar-linked purchase price provisions, which provide us with a natural hedge and mitigate the risk of potential margin compression. In addition, we own a sugar terminal and a stake in an ethanol terminal, both in the Port of Santos, the largest commercial port complex in South America, and numerous warehouses, which reduces our dependence on logistics services provided by third parties.
We also are the fourth largest fuel distribution company in Brazil. Therefore, we have a fully integrated platform from sugarcane plantation to retail fuel distribution. We will continue supplying ethanol to a diversified base of clients, and CCL will continue purchasing ethanol from multiple suppliers. As a result, we benefit from superior visibility on price formation, allowing us to better manage our inventory levels, with regard to ethanol and indirectly gasoline. In addition, a vertically integrated platform secures ethanol supply and optimizes our logistical, distribution and storage activities, saving storage and transportation costs. We believe we are in a unique position to anticipate market dynamics and increase our participation in the ethanol distribution market.
Innovative approach to business
Our acquisition of CCL has allowed us to directly expand into fuel distribution, and will lead to a more vertically integrated Cosan. With this acquisition, Cosan expands its business model to become the first integrated renewable energy company in Brazil, with operations ranging from sugarcane cultivation to fuel distribution and sales in the retail market.
We develop innovative products, production techniques and distribution methods to ensure that we continue to be at the forefront of technological improvements and standards in our industry. For example, we monitor the development of our crops by satellite and have also introduced innovative distribution methods to the Brazilian ethanol and sugar industry. We have established research and development partnerships with leading Brazilian institutions which resulted not only in new sugarcane varieties with higher sucrose content but also in implementing new techniques, such as agricultural and industrial yield improvements, new planting methods and genetic engineering improvements.
Strategic business relationships
We have developed important strategic relationships in our business, including the Kuok Group (one of the largest agricultural-focused conglomerates in Asia) and Sucres et Denrées, or “Sucden” (one of the two largest sugar trading companies in the world). Both the Kuok Group and Sucden are current shareholders of Cosan. We have also developed strong business relationships with some of our leading customers, such as Petrobras Distribuidora S.A. and Shell Brasil Ltda. in the ethanol business and Sucden, Tate & Lyle International and Coimex Trading Ltd. in the sugar business.
We produce virtually every type of ethanol and sugar consumed in the Brazilian and international markets. Our facilities allow us to adjust our production (within certain capacity limits) between ethanol and sugar, as well as between different types of ethanol and sugar, to respond promptly to changes in customer demand and market prices at any point during the crushing process.
Strategically located operations and significant geographic overlap with Cosan mills
Our fuel distribution terminals are strategically located near major fuel product markets and our mills, thus improving delivery times, increasing operating efficiencies, facilitating response to shifts in demand, fulfilling orders and reducing costs. Additionally, we have a pier facility available for importing raw material, which gives us operational flexibility and a significant competitive advantage since we can arbitrage raw material prices. Upon receipt of ANP approval, we plan to use our fuel distribution terminals and fuel tanks to further maximize logistic gains and reduce our operating costs.
We recorded an operating loss of US$48.8 million in transition fiscal year 2009 and of US$138.1 million in fiscal year 2008 and operating income of US$232.9 million in fiscal year 2007. We also recorded net loss of US$188.1 million in transition fiscal year 2009, net income of US$16.6 million in fiscal year 2008 and US$176.7 million in fiscal year 2007. Our selling and general and administrative expenses totaled US$353.4 million in transition fiscal year 2009, compared to US$283.8 million in fiscal year 2008. As of March 31, 2009, we had US$1,420.7 million in net debt (including US$456.5 million in perpetual notes and US$215.6 million in self-liquidating debt), and a highly liquid position of cash and cash equivalents and marketable securities of US$508.8 million. We also benefit from a higher credit rating (“BB-” from Standard & Poor’s Rating Group, “Ba3” from Moody’s Investors Service, Inc. and “BB-” Fitch Ratings) than many global ethanol producers. We believe that our financial condition and solid capital structure should allow us to access capital as needed to fund our growth strategy.
Experienced and professional management team
Our management team has considerable industry experience and knowledge. In addition, unlike many of our local competitors in the sugar and ethanol business, we have completed the shift from a family-operated business to a company managed by professionals with significant experience in the sugar and ethanol industries. Our fuel distribution and lubricants business is led by a management team with a proven track record in the fuel distribution and lubricant markets. Our management team of 30 executives possesses an average of 20 years of experience in the industry.
Our overall objective is to achieve sustainable and profitable growth, further reduce our operating costs and build on our competitive strengths in order to expand our leadership to become a global company with a worldwide platform in the ethanol and sugar markets. The principal components of our strategy are to:
Enhance our leadership position in the Brazilian and global ethanol and sugar markets and increase our market share in the fuel distribution and lubricants business
We expect to take advantage of future export opportunities likely to emerge from the liberalization of trade barriers that traditionally limited our access to some major markets, as well as mandatory blending requirements to use ethanol as an additive to gasoline. We intend to establish new commercial and distribution partnerships with international industry players to expand and diversify our client base. We closely monitor developments in the Brazilian and global ethanol and sugar industries and will continue to pursue selective acquisitions and partnerships in Brazil and internationally. We also intend to continue to expand our existing facilities and build additional large-scale facilities, featuring technology improvements and enhanced logistics.
We had a 5.3% market share in the Brazilian fuels marketing sector by volume sold in 2008, through a network of 1,458 Esso-branded retail stations. We have added 20 retail stations to date in 2009 with the “Esso” brand and plan to add an additional 130 retail stations in the remainder of 2009. The majority of our new retail stations will be added in the Southeast region of Brazil, which has higher exposure to gasoline and ethanol consumption and offers higher synergies with Cosan and our logistics infrastructure.
Capitalize on further integration with our business.>
With our recent acquisition of CCL, we form a fully integrated platform from sugarcane plantation to retail fuel distribution. The scale and integration advantages provide us with logistic synergies and unique market intelligence. We plan to improve our inventory and storage management to deliver ethanol through our retail fuel distribution network, by efficient use of our fuel tanks and the building of new distribution terminals near or at our mills.
Take advantage of the fast-growing ethanol demand.
Ethanol has become the most used fuel within the passenger vehicle industry in Brazil. According to ANP, demand for ethanol exceeded gasoline in 2008 due to the anhydrous ethanol blended gasoline. The increase in ethanol sales in Brazil has been supported by the increase in flex-fuel cars sold in Brazil. In 2008, flex-fuel car sales accounted for 82.1% of total new vehicle sales in Brazil, according to ANFAVEA. We plan to increase our presence in the Brazilian ethanol market and take advantage of the fragmentation in the supply of ethanol where we as the largest player, account for approximately 8.2% of the market. We believe we are well positioned to benefit from increasing ethanol demand, since our vertical integration with CCL optimizes our logistical, distribution and inventory management capabilities.
Continue to realize operating efficiencies and margins
We are seeking to further improve the efficiency and productivity gains of our operations through investments in the development of new varieties of sugarcane, more efficient agricultural, industrial and logistic processes, expanded satellite monitoring of sugarcane development in the region, increased mechanization of harvests, emphasis on employee training programs and improvements in information flows and internal control systems.
We will continue to focus on improving the efficiency of our operations in the fuel distribution and lubricants business by focusing on three key areas: (1) exploring synergies among our business units, (2) maximizing the utilization of our retail stations and (3) focusing on the highest-value lubricant products. Our vertical integration, combining market intelligence, production and distribution strategies, will allow for
synergies in logistics and acquiring ethanol, further reducing our costs by means of inventory optimization, transportation efficiencies and infrastructure rationalization. We continuously monitor the profitability and use of each service station in the retail network and eliminate underperforming sites, particularly in regions we consider less strategic. We will also continue to focus on high-grading our lubricant product mix and distributor network to be more heavily weighted towards higher margin products. In 2008, our premium, higher margin products represented approximately 64% of our lubricant volume sold, an increase of approximately 10 percentage points from approximately 54% in 2006. In addition, we have also re-channeled our sales directly through 15 well-established, exclusive high-grade distributors.
Continue increasing sales of premium lubricants products
Sales of premium products, such as synthetic lubricants (i.e., Mobil 1 RACING 2T and Mobilith SHC 007), represented approximately 64% of our total lubricant volume sold in 2008, a significant increase compared to approximately 54% in 2006. We plan to continue improving our product mix and margins by focusing on premium high margin products. We plan to continue investing in marketing, training our employees and exclusive distributors, developing new innovative products and delivering superior services.
Increase investments in cogeneration
We are self-sufficient in energy by generating our own electricity through the burning of sugarcane bagasse in boilers. Our current total installed capacity of cogeneration energy is approximately 294.3 MW, the substantial majority is used to generate energy for our own industrial operations. In 2003, we built a successful pilot cogeneration plant at one of our mills, from which we sell surplus energy to Companhia Paulista de Força e Luz - CPFL, one of the largest electric power distributors in the State of São Paulo. We participated in two auctions of "new energy" held in December 2005 and October 2006, to sell 6,837,028 MWh in 15 years for distributing electricity to the Brazilian current average price of US$75.03 per MWh. In 2008, the company participated in the first auction reserve, by selling energy through, the UTEs Barra, Bonfim and Jataí. The volume of electricity sold by the three thermal plants is 9,504,600 MWh to be delivered in 15 years, the average price of US$69.35/MWh, adjusted by the IPCA. We invested approximately U$$159.3 million system in co-generation plants and Costa Pinto and Rafard, to provide the energy sold under such contracts. We believe that energy sales represent a source of additional cash flow. Currently, we plan to install cogeneration systems in ten of our 21 existing mills and in our greenfield projects to permit sales of energy to third parties. These investments would sum approximately US$1.3 billion and would allow Cosan to sell 2,696 GWh per year.
Maintain capital investments discipline
We continue to take a disciplined and long-term approach to investments in order to sustain our returns. Our capital investments for the fuel distribution business unit include projects to further optimize our distribution terminals, further upgrade safety systems and lower operating costs. Investments aimed at increasing our distribution capacity will focus on supporting the expansion of our DODO Esso-branded station network in the Southeast region of Brazil intended to generate attractive returns, taking advantage of our existing distribution network and leveraging the closeness of Cosan’s mills.
Focus on environmental and social awareness
We are committed to being an environmentally and socially conscious company. The IFC, one of Cosan’s lenders and equity investors, has recently conducted a social and environmental assessment of Cosan. Under the IFC loans, we are required to comply on an ongoing basis with IFC’s environmental policies.
We plan to increase investments in the mechanization of our harvests, which not only is cost-efficient in the long-term but also will reduce our emission levels and decrease burning of sugarcane fields for manual harvesting. We continue to improve and develop new training programs for our employees, as well as programs to reduce workforce accidents.
We lead the Brazilian fuel industry with our low incident rate of work related injuries and illnesses. We will continuously work to improve the safety and health of our employees and contractors and our environmental and social awareness. We will continue to train our employees on effective safety, security, health and environmental leadership. We will continuously seek environmental best practices, benchmark technologies and clean operations, to sustain our best-in-class results and strengthen our relationship and cooperation with local environmental authorities and agencies.
Sugarcane is the principal raw material used in the production of ethanol and sugar. Sugarcane is a tropical grass that grows best in locations with stable warm temperatures and high humidity, although cold and dry winters are an important factor for the sucrose concentration of sugarcane. The soil, topography, climate and land availability of the Center-South region of Brazil are ideal for the growth of sugarcane. The Center-South region of Brazil accounted for approximately 88.8% of Brazil’s sugarcane production in the 2008/2009 harvest.
At March 31, 2009, we leased approximately 355,165 hectares, or approximately 85% of the land that we cultivate, through approximately 1,861 land lease contracts with a large number of lessors. The lessors under three of these contracts (covering 37,574 hectares, or approximately 11.4% of the land leased by us) are entities controlled by our chief executive officer and controlling shareholder. These land lease contracts have an average term of five years, with terms ranging from one to twenty years. Under these land leases, we make lease payments based on the market value of sugarcane per hectare (in tons) used by us in each harvest, with the market value based on the price of sugarcane established by the regulations of CONSECANA and a fixed amount of total recoverable sugar per ton. See “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions—Recurring Transactions with Shareholders.”
We also purchase sugarcane directly from thousands of third-party sugarcane growers. Of our sugarcane purchases from third-party growers, we historically have purchased approximately 80% through medium- and long-term contracts with sugarcane producers, 5% on a spot basis and the remaining 15% from sugarcane producers with whom we have long-term relationships but no contractual arrangements. We generally enter into medium- and long-term contracts for periods varying from three and a half to seven years. All of our third-party sugarcane suppliers are responsible for the harvest of the sugarcane and its delivery to our mills. The price that we pay to third-party sugarcane growers is based on the total amount of sugar content in the sugarcane, measured by the amount of sugar recovered and on the prices of ethanol and sugar sold by each mill.
We harvested from owned or leased lands approximately 53%, or 22.7 million tons, of the sugarcane that we crushed in transition fiscal year 2009, and purchased from third-party growers the remaining 20.4 million tons of sugarcane, or approximately 47% of the total amount of sugarcane that we crushed in fiscal year 2008. The following table compares the amount of sugarcane grown on owned or leased land with the amount purchased from third parties during the last four fiscal years.
Sugarcane Harvesting Cycle
The annual sugarcane harvesting period in the Center-South region of Brazil begins annually in May and ends in November. We plant several species of sugarcane, and the species we use in a particular area depends on the soil quality, rain levels and the resistance to certain types of pestilences, among other factors. Once planted, sugarcane is harvested each year for several continuous years. With each subsequent harvest, agricultural yields decrease, and the current optimum economic cycle is five or six consecutive harvests. However, the harvests must be carefully managed in order to continue to attain sugar yields similar to the newly-planted crop.
Ideally, the sugarcane should be harvested when the crop’s sucrose content is at its highest level. Harvesting is either done manually or mechanically. As of March 31, 2009 approximately 49% of our sugarcane is harvested manually. Manual harvesting begins by burning the sugarcane field, which removes leaves and destroys insects and other pests. The amount of the crop that we may burn is subject to environmental regulations. The remaining 51% of our sugarcane is harvested mechanically.
Sugarcane yield is an important productivity measure for our harvesting operations. Geographical factors, such as land composition, topography and climate, as well as the agricultural techniques that we implement, affect our sugarcane yield. Although our agricultural yields are above the average Brazilian yields, we believe that by reducing the average age of our sugarcane fields and choosing new sugarcane varieties, our agricultural yields may continue to increase.
In transition fiscal year 2009, our average sugar extraction yield was 139.2 kilograms of TSR per ton of sugarcane and our agricultural yield was 93.8 tons of sugarcane per hectare, compared to 142.5 kilograms of TSR per ton of sugarcane and 84.4 tons of sugarcane per hectare in fiscal year 2008, and 147.5 kilograms of TSR per ton of sugarcane and 84.1 tons of sugarcane per hectare in fiscal year 2007.
The average Brazilian sugar extraction yield for the 2008/2009 harvest was 140.2 kilograms of TSR per ton of sugarcane and the agricultural yield was 82.3 tons of sugarcane per hectare. The average Brazilian sugar extraction yield for the last five years was 142.4 kilograms of TSR per ton of sugarcane and 80.2 tons of sugarcane per hectare. The average sugar extraction yield in the State of São Paulo for the 2007/2008 harvest was 142.5 kilograms of TSR per ton of sugarcane and 90.8 tons of sugarcane per hectare. The average sugar extraction yield in the State of São Paulo for the last five years was 144.6 kilograms of TSR per ton of sugarcane and 87.8 tons of sugarcane per hectare.
Once the sugarcane is harvested, it is loaded onto trucks and riverboats owned by third parties and transported to one of our eighteen mills for inspection and weighing. The average distance from the fields on which our sugarcane is harvested to our mills is approximately 25 kilometers (or approximately 16 miles). The proximity of our milling facilities to the land on which we cultivate sugarcane reduces our transportation costs and enables us to process the sugarcane within up to 48 hours of harvesting, thereby maximizing sucrose recovery as sucrose concentration in sugarcane starts to decrease upon harvesting. Currently our average sugarcane freight cost is approximately US$2.35 per ton of sugarcane.
In transition fiscal year 2009, we crushed 43.1 million tons of sugarcane, or approximately 7.6% of Brazil’s total sugarcane production. In fiscal year 2008, we crushed 40.3 million tons of sugarcane, or approximately 8.2% of Brazil’s total sugarcane production and in fiscal year 2007, we crushed 36.2 million tons of sugarcane, or approximately 8.5% of Brazil’s total sugarcane production. Currently, we operate a total of 18 milling facilities, 16 of which we own and two of which we lease. The mills that we own have a total crushing capacity of 49.1 million tons. Our Da Barra mill has the world’s largest crushing capacity (approximately 7 million tons). Sixteen of our mills are prepared to produce both sugar and ethanol and the other two prepare only sugar. Out of the eighteen facilities, two of our mills produce refined sugar. Each of these facilities also has packaging and distribution capabilities.
Ethanol Production Process
We produce ethanol through a chemical process called yeasting, which is a process of fermenting the sugars contained in both sugarcane juice and molasses. Initially, we process the sugarcane used in ethanol production the same way that we process sugarcane for sugar production. The molasses resulting from this process is mixed with clear juice and then with yeast in tanks, and the by-product resulting from the yeasting process, called “yeasted wine”, has an ethanol content of approximately 7% to 9%. After the yeasting process, which takes approximately 10 hours, the yeasted wine is centrifuged, so that we can separate the yeast from the liquid. We use the separated yeast in the ethanol production process. We then boil the yeasted wine at different temperatures, which causes the ethanol to separate from other liquids. Hydrous ethanol is produced after different distillation stages. In order to produce anhydrous ethanol, hydrous ethanol undergoes a dehydration process. The liquid remaining after these processes is called vinasse, a by-product we use as fertilizer in our sugarcane fields. After the distillation and dehydration processes, we produce hydrous, anhydrous, neutral and industrial ethanol, and store the ethanol in large tanks.
The ethanol production flow can be summarized as follows:
The following diagram presents a schematic summary of the above-described ethanol production flow:
Production Capacity and Output
Our current annual ethanol production capacity is approximately 446 million gallons (1.7 billion liters). All of our mills produce ethanol except for the São Francisco and Bomfim mills. We were the largest producer of ethanol in Brazil in fiscal years 2007 and 2008 and transition fiscal year 2009, producing approximately 326.7 million gallons (1.2 billion liters) of ethanol, representing approximately 7% of Brazil’s total ethanol production and approximately 402.8 million gallons (1.5 billion liters) of ethanol, representing approximately 7% of Brazil’s total ethanol production and approximately 446.0 millions gallons (1.7 billion liters) of ethanol, representing approximately 6% of Brazil total ethanol production 2007, 2008 and 2009, respectively.
We produce and sell three different types of ethanol: hydrous ethanol and anhydrous ethanol for fuel and industrial ethanol. The primary type of ethanol consumed in Brazil is hydrous ethanol, which is used as an alternative to gasoline for ethanol-only fueled vehicles and for flex fuel vehicles (as opposed to anhydrous ethanol which is used as an additive to gasoline). As a result, hydrous ethanol represented approximately 51% of our ethanol production in fiscal year 2008 and 57% in transition fiscal year 2009.
We sell ethanol primarily through gasoline distributors in Brazil mainly at the mill that sell it to retailers that then sell it at the pump to customers. The distributors are required by law to distribute gasoline with an ethanol content ranging from 20% to 25%. Since July 1, 2007, the required ethanol content for gasoline has been set at 25%. These distributors include Petrobras Distribuidora S.A., Shell Brasil Ltda., Esso Brasileira de Petróleo Ltda. (who we have acquired), and Cia. Brasileira de Petróleo Ipiranga who has acquired Texaco Brasil Ltda. Produtos de Petróleo, among others. We also sell bottled alcohol products, such as liquid and gel alcohol to consumers in the Brazilian market and industrial alcohol, which are used in the chemical and pharmaceutical sectors. In the fiscal years 2007, 2008 and 2009, our largest ethanol customer was Shell Brasil Ltda., accounting for 14.8%, 20.1% and 27.0% of our total ethanol net sales, respectively.
In transition fiscal year 2009, we exported 30.5%, by volume, of the ethanol we sold, which consisted primarily of refined hydrous ethanol for industrial purposes, compared to 26.4% in fiscal year 2008 and 20.8% in fiscal year 2007. Our main customers are trading companies, which distribute our products mainly to the United States, Japan and Europe.
The following table sets forth the amount of ethanol that we sold to our principal customers in transition fiscal year 2009 as a percentage of our net sales of ethanol.
For the international market, Cosan entered into as of April 2009, contracts for exports totaling approximately 610,000 cubic meters of ethanol, of which 96% based on FOB Santos (585,000 m³) and 4% based on Ex Works (25,000 m³) . Of this total volume exported, approximately 10% were done on the basis of price index ESALQ and were concluded with customers such as Mitsubishi Corporation, Vertical, Kolmar and Tradhol. For the remaining volume, the prices realized were done according to the market price on the date of each closing with companies such as Sekab, Morgan Stanley Commodities, Vertical, Astra Oil Dreyfus Commodities, Kolmar and Crystalsev. Approximately half of the shipment volume was concentrated between the months of April and July 2009 and were secured by letters of credit issued by leading financial institutions.
For the Brazilian market, Cosan has entered into agreements with Cia Brasileira de Petróleo Ipiranga, Alesat Combustíveis Ltda., Petrobras Distribuidora S.A. and Shell Brasil Ltda. for the sale of approximately 383,000 m³ (383 million liters) of ethanol in transition fiscal year 2009. Approximately 20% of this amount is delivered by Cosan to the clients, which optimizes Cosan’s logistic potential. Pricing is based on the ESALQ index and payment generally occurs within 16 days from delivery. We sell our surplus in Brazil on a spot basis.
Sales and Distribution
In transition fiscal year 2009 our net sales from ethanol operations were US$548.7 million or 18.7% of our total net sales, compared to net sales of US$604.7 million in fiscal year 2008, or 40.5% of our total net sales, and compared to net sales of US$551.5 million in fiscal year 2007, or 32.8% of our total net sales in that year.
The following table sets forth our domestic net sales and volumes of ethanol for the periods indicated:
The following table sets forth our export net sales and volumes of ethanol for the periods indicated:
Although we primarily sell ethanol in Brazil, we believe that the international ethanol market has a strong potential to expand substantially. The global trend toward adoption of cleaner-burning fuel and renewable sources of energy and alternative fuels, the tendency to reduce reliance on oil producing countries and the increasing use of flex fuel cars are expected to increase the demand for ethanol. Broader international acceptance of ethanol as a fuel or fuel additive could boost our exports of ethanol significantly.
The majority of our ethanol customers in Brazil receive shipments of ethanol at our mills. We distribute approximately 11% of our ethanol production in Brazil through third parties. We transport the ethanol that we produce for export to the Port of Santos primarily through third-party trucking companies.
The price of ethanol we sell in Brazil is set according to market prices, using the indices for ethanol published by ESALQ and BM&FBOVESPA, indices for ethanol as a reference. The prices of the industrial and neutral ethanol (a type of ethanol which has low impurity levels and is used as a raw material in the food, chemical and pharmaceutical industries) that we sell are also determined in accordance with market prices, which historically has been up to 20% higher than the price of fuel ethanol. Prices of ethanol for export are set according to international market prices for ethanol. The international ethanol market is highly competitive. In May 2004, the New York Board of Trade began trading a futures contract for ethanol, known as the World Ethanol Contract.
The following table sets forth our average selling prices (in US$ per thousand liters) for ethanol in the Brazilian market and for exports for the periods indicated:
Ethanol Loading Terminal at the Port of Santos
On March 31, 2009 we owned a 32% interest in TEAS, an ethanol loading terminal at the Port of Santos, fully dedicated to ethanol exports that has a storage capacity of approximately 10.3 million gallons (40 million liters) of ethanol and loading rate of approximately 600,000 m3 per year. After the acquisition of Nova América, our participation increased to 40%.
Sugar Production Process
There are essentially three steps in the sugar manufacturing process. First, we crush the sugarcane to extract the sugarcane juice. We then filter the juice to remove any impurities and boil it until the sugar crystallizes, forming a thick syrup. We use these impurities as fertilizer in our sugarcane fields. Lastly, we spin the syrup in a centrifuge which produces raw sugar and molasses. The raw sugar is refined, dried and
packaged at our sugar refineries. We use the molasses in our production of ethanol, animal feed and yeast, among other products.
Production Capacity and Output
We were the largest producer and seller of sugar in Brazil in fiscal year 2007, selling 3.2 million tons of sugar, representing 11.0% of Brazil’s total sugar production output. In fiscal year 2008, we sold 3.1 million tons of sugar, representing 11.8% of Brazil’s total sugar production output. In transition fiscal year 2009, we sold 3.1 million tons of sugar, representing 10.2% of Brazil’s total sugar production output.
As the production capacity of our mills is used for both ethanol and sugar, if we had produced only sugar (one ton of VHP sugar is equivalent to approximately 156 gallons (592 liters) of anhydrous ethanol and 163 gallons (618 liters) of hydrous), our sugar production for 2007, 2008 and 2009 would have been approximately 5.2 million tons, approximately 5.7 million tons and approximately 5.9 million tons, respectively, which would have made us the second largest sugar producer in 2007 and 2008 and the largest world sugar producer in 2009.
We produce a wide variety of standard sugars, including raw sugar (also known as VHP sugar), crystal sugar and organic sugar, and refined sugars, including granulated refined white sugar, amorphous refined sugar, refined sucrose liquid sugar and refined inverted liquid sugar. Currently, all of our mills produce standard ethanol and sugar, other than the São Francisco and Tamoio mills that only produce sugar. The São Francisco mill and the Da Barra mill are our mills that produce refined sugar. The “Da Barra” brand is the second largest in the Brazilian market in terms of volume and, after Nova América’s acquisition, we also sell sugar under the União brand, which is the largest in the Brazilian market in terms of volume.
Standard sugars. VHP sugar, a raw sugar with approximately 99% sucrose content, is similar to the type of sugar traded in major commodities exchanges, including through the standard NY11 contract. The main difference between VHP sugar and the sugar that is typically traded in the major commodities exchanges is the sugar content of VHP sugar and the price premium that VHP sugar commands in comparison to most sugar traded in the commodities exchanges. We export VHP sugar in bulk, to be refined at its final destination. We also sell a small amount of VHP sugar to the Brazilian market. Crystal sugar is a non-refined sugar produced directly from sugarcane juice and sold to industrial companies in Brazil to be used as an ingredient for food products. We also sell a small amount of crystal sugar to the Brazilian retail market and to export markets. Organic sugar is a kind of raw sugar produced from organic sugarcane and is not submitted to any chemical treatments during its manufacturing process. We sell organic sugar in the international and Brazilian markets.
Refined sugars. We refine VHP sugar and crystal sugar into both granulated and amorphous (non-crystallized) sugar. We sell refined sugar in the Brazilian and export retail and industrial markets. Refined sugar is used as an ingredient in processed food products such as milk and chocolate powders, bakery products, powder refreshments, and pharmaceutical syrups.
Liquid sugars. We refine crystal sugar to produce sucrose liquid sugar and inverted liquid sugar, which has a higher percentage of glucose and fructose than sucrose liquid sugar. We sell both types of sugar for industrial use, mainly for the production of soft drinks.
We sell sugar to a wide range of customers in Brazil and in the international markets. We primarily sell raw sugar in the international markets through international commodities trading firms and Brazilian trading companies. Our customers in Brazil include retail supermarkets, foodservice distributors and food manufacturers, for which we primarily sell refined and liquid sugar.
The following table sets forth the amount of sugar that we sold to our principal customers in transition fiscal year 2009 as a percentage of our net sales of sugar. No sugar customer in Brazil represented more than 5% of our net sales of sugar in transition fiscal year 2009
For the international market, we have entered into agreements with our principal customers with terms of up to three years and have approximately 6.1 million tons of sugar contracted for fiscal year 2010, 2011 and 2012. Under these agreements, we deliver agreed-upon volumes of sugar and prices are not pre-determined. Payment is made through letters of credit from first tier Brazilian banks prior to each shipment.
For the Brazilian market, we sell sugar to a broad and consistent client base but we do not commit to set volumes or prices in advance.
Sales and Distribution
The following table sets forth our export sales and volumes of sugar for the periods indicated:
The following table sets forth our domestic net sales and volumes of sugar for the periods indicated:
We coordinate our Brazilian sugar distribution from our warehouses located in Barra Bonita, São Paulo and Cachoeirinha, all in the State of São Paulo. We also deliver sugar products to our customers in Brazil primarily via third-party trucking companies.
Prices for our sugar products for export are set in accordance with international market prices. Prices for raw sugar are established in accordance with the NY11 futures contracts. Prices for refined sugar are established in accordance with the Lon 5 futures contract, traded on the LIFFE. Prices for sugar we sell in Brazil are set in accordance with Brazilian market prices, using an index calculated by the Agriculture School of the University of São Paulo (Escola Superior de Agricultura Luiz de Queiroz), or “ESALQ”. The following
table sets forth our average selling prices per ton in U.S. dollars for sugar in the Brazilian market and for export for the periods indicated:
Sugar Loading Terminal at the Port of Santos
Our exports of VHP sugar are shipped through the sugar loading terminal operated by our subsidiary, Rumo, at the Port of Santos, which is located an average distance of 190 kilometers (approximately 118 miles) from our mills. Our sugar-loading terminal is equipped with modern freight handling and shipment machinery. The close proximity of our mills to the port enables us to benefit from lower transportation costs.
Our sugar-loading terminal has the capacity to load approximately 50,000 tons of sugar per day, and to storage approximately 380,000 tons of sugar. The port facility serves clients, including Sucden, Coimex, Tate & Lyle PLC, Edfman, Cargill, Bunge and LDC Corp among others, with their transport and export of sugar and soy products. Pursuant to the Port Concession Agreement with the State of São Paulo’s Port Authority, the concession granted to operate the south terminal (Cosan Portuária) will expire in 2036 and the concession granted to the north terminal (Teaçu), acquired in 2009, expires in 2016, and can be automatically renewed for an additional 20 years.
In March 2009, Cosan, through its subsidiary Rumo, entered into an agreement with America Latina Logística or “ALL” for the rail transportation of bulk sugar and other sugarcane by-products. The agreement envisages investments of approximately R$ 1.2 billion by Rumo, which we will expect to raise through equity at the subsidiary level. These investments will allow the transportation of around nine million tons per year to the Port of Santos.
Fuel distribution and lubricants
Our acquisition of CCL has placed us among the four largest fuel distribution companies in Brazil. We distribute fuel and produce and distribute lubricants through CCL.
Our fuel distribution business consists of the sale of fuel gasoline and ethanol products through our branded retail stores and to wholesale distributors. We distribute ethanol, gasoline, diesel, NGV, kerosene and fuel oil. For the four-month ended March 31, 2009, CCL’s net revenue from sales and services from fuel distribution operations were US$1,349.2 million, or 46.1% of our total net revenue from sales and services.
We are the fourth largest fuel distributor in Brazil with an estimated 5.3% market share in terms of volume sold in 2008, according to ANP. In 2008, CCL recorded sales of more than 4.6 billion liters of fuels, principally gasoline, ethanol, diesel and fuel oil. We have a strong market presence in the South and Southeast regions of Brazil, where for the three months ended March 31, 2009, our fuel sales amounted to 1.1 billion liters (6.6% market share) and 3.1 billion liters (6.4% market share) in 2008, respectively, according to ANP. The Southeast and South regions are the largest markets in Brazil, accounting for 49.6% and 17.3%, respectively, of the total Brazilian fuel market in terms of volume sold in 2008, according to ANP.
We have a large, well-established distribution and logistics network to support our fuel marketing operations, with facilities strategically located in 21 states and concentrated near Brazil’s major fuel markets.
Our distribution network consists of 45 terminals – ten owned by us, four joint ventures operated by us, 14 joint venture operated by others and 17 terminals in which we have throughput arrangements. These terminals have a total static storage capacity of 749 million liters, of which 238 million liters corresponds to our exclusive capacity, and through which a total throughput of 14.8 billion liters were distributed in 2008.
We believe our best-in-class performance in safety, health and environmental protection is comparable to the highest international standards adopted by our peers, based on a wide range of management systems we apply to ensure operations integrity, consistent procedures and optimal behavior awareness in all aspects of our business. Safety is a top priority in our distribution terminals, where we have had a record of more than ten years of accident-free operations. As a result, our distribution organization received the ExxonMobil´s global Flawless Operations Award in each of the last five years, in recognition of our performance in safety, health and environment standards. In our logistic operations, our delivery vehicles (tank-trucks) traveled more than 12 million miles without an incident in 2008, reaching a full accident-free year. As a result of our excellent operational standards, in 2008 and 2007, we were recognized as one of the leading fuel distribution companies in Brazil, according to the Petrobras Responsible Partnership Program, in recognition of our superior operational execution.
We purchase gasoline and diesel under contracts with Petrobras at set prices paid by us and our competitors. The terms of our supply agreements with Petrobras are for one-year terms. We purchase our ethanol from Cosan and other suppliers in the spot market and, to a lesser extent, under contracts. The price is dependent on the price of sugar and demand.
In the four-month period ended March 31, 2009, we sold approximately 600 million liters of fuels through a network of 1,458 Esso-branded retail stations, which accounted for 6.6% of Brazil’s total branded stations as of March 31, 2009, according to ANP. We have a five-year licensing agreement with ExxonMobil for the use of the “Esso” brand, expiring in 2013, renewable at ExxonMobil’s sole discretion. We believe that the “Esso” brand is associated with a reputation for high quality, differentiating our company from certain other fuel retailers. We assist a majority of our independent dealers invest and improve their infrastructure through our market-assistance programs.
We believe that we are the second most efficient fuel distributor in Brazil among the five largest distributors measured by retail fuel volume sold per service station in 2008, based on ANP data. We have an average throughput per Esso-branded retail station of 231,000 liters per month, well above the industry average of 163,000 liters per month. We believe that we achieved our high level of efficiency through a review of our retail network which we implemented over the last few years, resulting in the elimination of underperforming sites, particularly in less strategic areas.
Our retail network is concentrated in and around the most strategic Brazilian fuel markets. Approximately 56% and 25% of Esso-branded stations in Brazil are located in the Southeast and South regions of Brazil, respectively, reflecting a stronger presence in urban areas with higher population density. As a result, our exposure to passenger fuel such as gasoline and ethanol is higher than cargo fuels such as diesel. We believe that this is a key competitive advantage as passenger fuel has historically offered superior margins and growth compared to cargo fuels. Within our passenger fuels sales, our ethanol throughput per station offers significant growth potential compared to gasoline, a strategy we intend to intensely develop and build upon, particularly after being acquired by Cosan. In 2008, gasoline, diesel and ethanol accounted for 38.0%, 44.5% and 13.9%, respectively, of our volume sold, which totaled 4.2 billion liters.
We also have a significant presence in the convenience store market with 200 “Stop & Shop” and “Hungry Tiger” stores in Brazil, as of March 31, 2009. These are two of the leading brands in the Brazilian convenience store market with a combined revenue market share of 10.1% in 2008 according to SINDICOM. Our license for the use of these brands expires in 2013. In addition, our convenience store brands have the highest monthly revenue per store in Brazil according to SINDICOM, having sold US$32.6 thousand per store per month in 2007, well above the industry average of US$21.4 thousand per store per month. We are
not involved in the operation of the convenience stores. Instead, we are entitled to a start-up fee and to payments calculated as a percentage of convenience stores sales plus an amount for advertising expenses. In 2008, we recorded consolidated net revenue from franchising fees of US$3.8 million from our convenience stores.
Industrial & Wholesale Division
We are also an industrial and wholesale, or I&W, fuel distributor, with sales of 458 million liters of gasoline, diesel, fuel oil, ethanol and kerosene to our industrial and wholesale clients in 2008. Most of our sales are concentrated in diesel oil and gasoline. In 2008, diesel oil and gasoline accounted for 82.9% and 6.2% of our I&W volume, respectively. Most of our industrial and wholesale sales are through spot sales and short term contracts. We focus on high grade customers, such as large Brazilian corporations, as well as flag independent retailers and resellers.
The total Brazilian lubricants market by volume of liters sold in 2008 was 1,113 million liters, according to SINDICOM, ranking Brazil as the world's fifth largest lubricants market by volume. In 2008, CCL sold a total of 128.9 million liters of lubricants. For the three months ended March 31, 2009, we sold a total of 27.4 million liters of lubricants, corresponding to an estimated market share of 11.7%, according to SINDICOM, and making us the fourth largest lubricant player in Brazil. We sell passenger vehicle lubricants, commercial vehicle lubricants and industrial lubricants under the “Mobil” and “Esso” brands, among others, both of which are licensed to us until 2018 by ExxonMobil. We use distributors and Esso-branded retail stations to sell our lubricants products, as well as direct sales to industrial customers. We capture significant synergies by selling to our retail service station network and I&W customer accounts.
Our Lubricants Distributor Program is recognized as a competitive advantage in the Brazilian market. Participating distributors can only sell Mobil and Esso lubricants and are currently limited to 15 with exclusive geographical coverage. An important differential is the common ERP system used by the distributors that interfaces with our SAP business software system. We believe that these characteristics make our distributors network unique, allowing us to launch new products and implement new programs with speed and flawless execution.
ExxonMobil is a leading brand in the lubricants industry, operating through global strategic alliances with automotive and industrial equipment manufactures, including Caterpillar, Mercedes-Benz, Peugeot, Toyota and Honda, collaborating to develop new formulations. We have a licensing agreement for our use of ExxonMobil’s brands and formulations until 2018, renewable at ExxonMobil’s sole discretion, which gives us access to ExxonMobil’s leading technology and international feedstock supplies.
We have focused on high-grading our product mix to be more heavily weighted towards higher margin products. In 2003, we commenced a plan to focus on simplifying our product offering and supply chain, with a particular emphasis on high margin products such as synthetic lubricants (i.e., Mobil 1 RACING 2T and Mobilith SHC 007). In 2008, our premium, higher margin products represented approximately 64% of our lubricant volume sold, an increase of approximately 10 percentage points from approximately 54% in 2006. In addition, we have also re-channeled our sales directly through 15 well-established, exclusive high-grade distributors. These efforts have resulted in a strong perception of quality and confidence in our products by our customer base.
Production Capacity and Output
Our lubricant operations consist of a wholly-owned Lubricants Oil Blending Plant, or LOBP, located in Rio de Janeiro, with annual production capacity of 265.2 million liters of lubricants and 5,112 tons of grease for 2008. Our LOBP facility has operated for over twelve years without a single lost-time incident, which represents more than 6 million worker-hours worked in a safe workplace, and operates at a utilization rate of approximately 50% of its total capacity as of March 31, 2009. This utilization rate offers an opportunity for growth through expansion of our market share or participation in Brazil’s steady market growth with limited
additional capital investments required. We also own Duque de Caxias base oil terminal and one secondary warehouse in Manaus.
We purchase virtually all of our base oils from Petrobras, to use as feedstock in our blending plant located in Rio de Janeiro. In addition, we also have a pier facility available for importing raw material, which gives us additional flexibility and a significant competitive advantage. The lubricants produced at our LOBP are sold to exclusive distributors and direct customers. Distributors have an evergreen contract, and most direct customers have a five year contract at prices set by us. Distributors then resell the products to customers in our retail market. In addition, distributors are contractually obligated to sell “Esso” and “Mobil” products and may not sell products directly competing with such brands. Approximately 97% of our sales volume is blended domestically, with the majority of the production delivered to the domestic market. Most of our lubricant sales are concentrated in the Southeast and South regions of Brazil.
Our LOBP provides an efficient and reliable local blending facility with the ability to import base oils. Approximately 6% of our finished lubricants volumes comes from our branded service stations. Since 2004, our branded service stations have been entirely served by our distributors, highlighting the significant synergies between our fuel marketing and lubricants businesses. On average, the LOBP receives approximately 2,600 orders per month, 4,100 invoices per month and has 540 shipments per month with 60% delivered FOB during 2008. The LOBP was built as a grassroots facility and commenced operations in 1957. Significant investments were undertaken in 2002. The distribution and logistics system for LOBP relies on six packaged carriers, three bulk carriers and one inbound carrier to distribute the products. Our LOBP is also supported by warehouses in Duque de Caxias and Manaus.
Cogeneration of Electrical Power
Sugarcane is composed of water, fibers, sucrose and other sugar molecules (glucose and fructose) and minerals. When the sugarcane goes through the milling process, we separate the water, sugar and minerals from the fibers, and are left with sugarcane bagasse. Sugarcane bagasse is an important by-product of sugarcane, and it is used as fuel for the boilers in our plants, through the so-called cogeneration process.
Cogeneration is the production of two kinds of energy—usually electricity and heat—from a single source of fuel. In our process, sugarcane bagasse is burned at very high temperatures in boilers, heating the water that is transformed into steam. This steam can be used in the form of: mechanical energy (to move crushers, for example), thermo energy (to heat the juice in the crystallization process, for example) and electricity, when this steam is used to move turbo-generators. Historically, the energy produced by Brazilian mills has not been price competitive, when compared to the low cost Brazilian hydro-electricity, which accounts for almost 90% of the country’s electricity matrix. Consequently, the majority of the groups in the sugar and ethanol sector have not invested in expanding their energy generation for sale, and the majority of the mills were constructed with low-pressure boilers, which are considered not to be the most efficient process.
Since 2000, the Brazilian economy has experienced significant growth, which in turn has resulted in increased demand for energy. However, hydro- and thermo-electricity have not been able to keep pace for the following reasons: (1) new hydro-electric plants are located in regions (such as the Amazon) distant from consumption centers; (2) significant lead-time is required to construct new hydro- and thermo-electric plants; (3) significant investments are required for transmission lines, pipelines (for natural gas used in thermo-electric plants) and barges; (4) significant environmental costs associated with both types of electricity generation; and (5) increased price of the fuel (natural gas) for thermo-electricity and dependence on Bolivia (principal natural gas supplier). As a result, energy prices in Brazil have been increasing and other alternative sources, such as the electricity from the cogeneration of the sugarcane bagasse, have become increasingly competitive and viable options to satisfy increasing energy demands.
All of our plants are currently energy self-sufficient and the majority of them use low-pressure boilers. In order to expand the energy cogeneration in our mills, we have to replace our current low-pressure boilers with new high-pressure boilers. The steam generated by burning the same amount of bagasse in high-pressure boilers will yield higher pressure and higher temperature and, in turn, turbo-generators will be able to produce
significantly more electricity. Excess energy can be sold to the grid. In 2001, we invested in changing one of the boilers at Usina da Serra, which made it possible for us to generate excess electricity that we sold to Companhia Paulista de Força e Luz (CPFL), one of the largest electric power distributors in the State of São Paulo, pursuant to a ten-year power purchase agreement. The installed capacity for third-party sales of this pilot project is only 9 MW. Our current total installed capacity is approximately 294.3 MW, of which a substantial majority is used to generate energy for our own industrial operations. Based on internal studies, we believe that we can increase this capacity to approximately 980 MW, of which approximately 700 MW would be available to generate electricity for third-party consumption. Currently, we plan to install cogeneration systems in thirteen of our 23 mills, for which we have already developed internal studies. We have already invested approximately R$1.0 billion in cogeneration systems for six mills, which will generate approximately 800 MWh/year to be sold to the Brazilian electricity grid starting in 2009, and currently plan to invest approximately R$1.4 billion for an additional seven mills subject to our obtaining financing at favorable conditions
In December 2005, our subsidiary Cosan Bioenergia S.A. won in a federal government-held auction the right to sell and supply excess electricity generated from our Costa Pinto and Rafard mills. Pursuant to the terms of the agreement, we can sell approximately 271,500 MWh per year at the current average price of US$75.8 per MWh, beginning with the 2009/2010 harvest for a period of 15 years, adjusted annually for inflation according to variation in the IPCA. In October 2006, Corona Bioenergia also won a public bid to sell electric energy generated by our Bonfim facility to a pool of 24 electricity distributors. Pursuant to the terms of this agreement, we can sell approximately 183,960 MWh per year at an average price of US$66.3 per MWh, beginning with the 2011/2012 harvest for a period of 15 years, adjusted annually for inflation according to variation in the IPCA.
On August 14, 2008, Cosan (through its subsidiary Barra Bioenergia S.A.) signed an agreement with CPFL Comercialização Brasil S.A., or “CPFL” to sell to it between 2,900 GWh and 3,600 GWh of electric power over a 15-year period, totaling approximately R$ 500 million, adjusted annually by the variation in the IGP-M inflationary index. The energy will be supplied by a cogeneration facility to be built in association with the Gasa unit. The agreement also envisages the supply of any surplus electricity from the same plant, including from the increased use of biomass, i.e. the use of sugarcane leaves and straw in addition to bagasse.
Given the advanced stage of the cogeneration projects in the Costa Pinto and Rafard plants, scheduled for start-up in 2009, Cosan S.A. Bioenergia will also supply CPFL with 100 GWh over six months beginning in September/08. In addition, January/09 will see the first revenue from the energy sold at the 2005 auction, representing a monthly cash intake of approximately R$4.0 million.
On August 14, 2008, Cosan (through its subsidiaries Barra Bioenergia S.A. and Cosan Centroeste S.A. Açúcar e Álcool) was awarded a energy contract at the First Reserve Energy Auction. The Barra, Bonfim and Jataí units will build biomass cogeneration plants to produce 9,504.6 GWh over 15 years as of 2010, with a present value of around R$1.5 billion adjusted by the IPCA consumer price index.
On September 11, 2008, Cosan, through its bioenergy subsidiaries, also entered into other contracts for the supply of biomass electricity through bilateral agreements with Rede Comercializadora de Energia S/A, in accordance with which, the Univalem and Diamante plants will also provide approximately 3,000 GWh at a current amount of close to R$489 million, adjusted annually by the variation in the IGP-M inflationary index.
On September 30, 2008, Cosan (through its subsidiary Cosan Centroeste S.A. Açúcar e Álcool) was awarded a energy contract at the 7th New Energy Auction. A biomass cogeneration project will be commercially operated at the Paraúna unit for the period of 15 years starting in 2013, for the total of 4,599 GWh with present value of approximately R$670 million, adjusted by the IPCA.
We believe that the principal advantages of energy generated by burning sugarcane bagasse are:
In addition, smaller investments in transmission lines to the Brazilian power grid are required because our mills are located close to consumption centers.
Brazil’s electricity system is undergoing widespread reforms. In light of projected growth rates in the Brazilian economy, we believe that increased investments in alternative energy sources, such as cogeneration, will be required as hydro-electric energy prices continue to rise. We believe investments in cogeneration will be encouraged by the Brazilian government, which has offered incentives, such as more attractive financing lines from BNDES, for generation from sugarcane bagasse.
Pursuant to the Kyoto Protocol, signatory nations will have the option of engaging in emissions trading in order to comply with Kyoto Protocol emissions levels. The emissions trading option enables a country to purchase Assigned Amount Units, or “AAUs”, Certified Emissions Reductions, or “CERs”, Emission Reduction Units or “ERUs” and Removal Units, or “RMUs” from another country that has excess unused AAUs, CERs, ERUs and RMUs, also known as carbon credits. The purchasing country can then use these carbon credits to meet its climate mitigation objectives. Demand has arisen primarily from European, Japanese and Canadian companies.
Since 2002, we have been selling carbon credits generated from the energy we sell at Serra mill. Through this pilot project we initiated our investments in electric energy cogeneration, in order to sell the surplus. The amount of energy sold annually is currently immaterial (approximately 30 GWh), which corresponds to 9000 CERs generated annually. On March 31, 2009, we have sold 8,692 tons of CO2 CERs for US$132 thousand. The Serra mill has been accredited to sell CERs for a first period of seven years, which expires in 2009. However, we are in the process of renewing for an additional seven-year period. This project was a pioneer initiative recognized and approved by the United Nations as one of the first carbon credit trading projects in the world. We generate carbon credits as we are producing and selling a cleaner electricity generated from bagasse, which is a renewable source. As a result, when we send this energy to the grid, we are providing a substitute for a fossil fuel source of energy. This substitution is measured by companies accredited by the United Nations, through approved methodologies, to quantify the amount of carbon credits to be generated and therefore available for sale.
We are also developing four new projects in our Costa Pinto, Rafard, GASA and Bonfim Mills, which are expected to generate 300,000 tons of carbon credits annually. These four new projects are currently under the United Nations certification process. Moreover, we believe that Cosan has a great potential for generating carbon credits, if similar projects are implemented in the other cogeneration plants. However, we cannot predict the future of this market, or to quantify our ability to generate and sell any amount of CERs, as these private sector emissions trading markets remain new, uncertain and very dynamic.
The sugar industry in Brazil has experienced increased consolidation through merger and acquisition activity during the last several years. Most of this activity has involved companies and facilities located in the Center-South region of Brazil, one of the most productive sugar producing regions in the world. Despite this recent wave of consolidation, the industry remains highly fragmented with more than 320 sugar mills and 100 company groups participating. We are the largest ethanol and sugar producer in Brazil in terms of production
volume and sales, with 43.1 million tons of crushed sugarcane in fiscal year 2009, more than three times the amount of sugarcane crushed by Grupo Santelisa Vale, the second largest ethanol and sugar producer in Brazil.
Many ethanol and sugar producers in Brazil, including Grupo Zillo Lorenzetti and Grupo Irmãos Biagi, market their ethanol and sugar products through the Copersucar. Copersucar is a private cooperative that was created in 1959 by 10 sugar mills in the State of São Paulo in order to provide a shared commercial distribution for their ethanol and sugar production. Currently, Copersucar is comprised of 33 producers in the states of São Paulo, Minas Gerais and Paraná. During the 2007/2008 harvest, Copersucar’s affiliated mills crushed approximately 68 million tons of sugarcane.
We also face competition from international sugar producers. We are the third largest sugar producer in the world, behind British Sugar (4.4 million tons of sugar produced in the 2008/09 harvest) and Südzucker AG of Germany (with 4.0 million tons of sugar sold in the same period). These producers, however, are the beneficiaries of considerable governmental subsidies in their principal sales markets.
In the fuel the distribution business, we are subject to competition, both from companies in the industries in which we operate and from companies in other industries that produce similar products. Our competitors include service stations of large integrated oil companies, independent gasoline service stations, convenience stores, fast food stores, and other similar retail outlets, some of which are well-recognized national or regional retail systems. The Brazilian fuel distribution industry has consolidated significantly in recent years, with the five major distributors increasing their combined market share from 65.2% in 2000 to 75.3% in 2008. The top-five distributors in Brazil are: Petrobras, operating through the BR Distribuidora brand, Ultrapar S.A., through the Ipiranga and Texaco brands, Shell Brasil Ltda., a subsidiary of Royal Dutch Shell, Gas and Petrochemical Group and AleSat Combustíveis S.A., a domestic Brazilian fuels distribution. The principal competitive factors affecting the retail marketing operations include site location, product price, selection and quality, site appearance and cleanliness, hours of operation, store safety, customer loyalty and brand recognition. We believe that we are in a strong position to compete effectively on ethanol due to the synergies that further integration with Cosan will bring.
We also face competition from international ethanol producers that use other ethanol sources, such as corn and sugar beet for the generation of fuel ethanol.
Cosan has 39 trademarks registered with the National Intellectual Property Institute, or “INPI”, along with 24 pending trademark registration requests. Our principal trademark, Da Barra, is registered with INPI in multiple classes, which allows us to use this trademark in the sugar, chocolate and various other markets.
CCL has no trademarks registered with the INPI and have sixteen pending trademark registration requests. We are licensed to use ExxonMobil trademarks. We have a five-year agreement for fuels and ten-year agreement for lubricants, with ExxonMobil, expiring in 2013 and 2018 respectively, renewable at ExxonMobil's sole discretion, for the use of the “Esso” and “Mobil” brands, among others.
We currently have no patents registered with the INPI.
Research and Development
In 2002, we established a partnership with the University of Campinas (Universidade de Campinas), or UNICAMP, to develop a geographic information system to improve the monitoring of our crops. Through this partnership, we have developed a tool that monitors the sugarcane crops with the use of satellite images. By using the system we are able to have more accurately production estimative. Further, we are able to get extremely detailed information on the state of our crops, which gives us the opportunity to improve the
procedures of agricultural crop treatment. Currently, we monitor all land where we produce sugarcane, either in our own land, on leased areas or areas of suppliers.
Development of Sugarcane Varieties and other Products
We have agreements with the following technological institutes for the development of new varieties of sugarcane: Sugarcane Technology Center (Centro de Tecnologia Canavieira), or “CTC”, in which we are a major shareholder; Federal University of São Carlos (Universidade Federal de São Carlos), or “UFSCAR”; and Research Agronomical Institute (Instituto Agronômico de Pesquisa), or “IAC”. CTC is a private institution focused on research and development of new technologies for agricultural activities, logistics, and industry, as well as creating new varieties of sugarcane. CTC has already developed biological ways for controlling pests and biodegradable plastic (PHB), and also created a VVHP-type (very, very high polarization) sugar that requires less energy to be processed, and cogeneration technology.
We also analyze and develop different products used to facilitate and enhance the growth of sugarcane, such as herbicides and fertilizers, also taking into consideration the different conditions of our sugarcane fields. We share this technology with our sugarcane suppliers to enable them to enjoy higher yields and better quality sugarcane.
In June 2006, we engaged CanaVialis S.A., or “CanaVialis”, to provide Cosan access to its sugarcane genetic improvement program specifically tailored to our mills. CanaVialis, which is affiliated with Monsanto, is Brazil’s only privately-owned firm focused on the genetic improvement of sugarcane. We believe we will benefit from their support services and use of their biofactory (the largest in Brazil), which will allow us to decrease the amount of time required for seedling production and grant us access to new, improved sugarcane varieties through their genetic improvement program. CanaVialis set up an experimental station in our Univalem mill, which began testing new species of sugarcane especially selected for Cosan’s production framework.
We invested approximately US$3.4 million and US$2.9 million in research and development in the fiscal years 2007 and 2008. In transition fiscal year 2009, we invested US$2.3 million.
Sugarcane varieties for greenfields
We have also identified other areas where we can build additional greenfield projects. We believe Brazil has land available to expand sugarcane plantations. The areas where we believe there is potential for sugarcane growth are illustrated below:
We have collected weather and soil data for all these areas. However, in order to obtain the productivity levels that we expect, we will first establish field trials to identify the varieties that can be cultivated in each target region. We will select sugarcane varieties adapted to each target region through a customized genetic selection program. For that purpose, we intend to establish up to ten small field stations in the regions specified in the right side map above.
CanaVialis has been working with Cosan to organize this network of stations and to ensure the quality of the field trials and the region-specific genetic selection program. Approximately US$25.0 million of the net proceeds of our initial public offering were used in funding this network of field stations over the next six years. We plan to use advanced genetic research provided by CanaVialis to select and breed sugarcane varieties for each of these new production environments.
We are subject to various Brazilian federal, state and local environmental protection and health and safety laws and regulations as well as foreign environmental protection and health and safety laws and regulations governing, among other things:
We may not have been or may not be at all times in complete compliance with such laws and regulations. Violation of these laws and regulations can result in substantial fines, administrative sanctions, criminal penalties, revocations of operating permits and/or shutdowns of our facilities.
We may be required to repair or remediate environmental damage we cause, as well as damage caused by third-party subcontractors. Additionally, under certain environmental laws, we could be held strictly liable for all of the costs relating to any contamination at our or our predecessors’ current and former facilities and at third-party waste disposal sites. We could also be held liable for any and all consequences arising out of human exposure to hazardous substances such as pesticides and herbicides or other environmental damage.
Permits. Certain environmental laws also require us to obtain from governmental authorities permits, licenses and authorizations to install and operate our mills, to burn sugarcane, and to perform some of our other operations. In addition, under federal and state laws, we are required to obtain authorizations to use water resources for irrigation and industrial purposes. Violations of such laws and regulations can result in the revocation or modification of our licenses, permits and authorizations, as well as administrative sanctions, fines and injunctions for the individuals and entities involved.
In Brazil, prior to the construction, setting up, extension or operation of facilities or the performance of activities that use natural resources or that may have a current or potential polluting effect, environmental licenses must be obtained from the proper federal, state and/or municipal governmental authorities. In issuing such environmental licenses, the competent governmental authority establishes conditions, restrictions and inspection measures applicable to the project, according to environmental laws and administrative regulations, including pollution control and environmental management requirements.