Risk Factors

Investment in our securities involves exposure to certain risks. Before making an investment decision on any of our securities, potential investors must carefully review all information in this Reference Form, the risks mentioned below, as well as our financial statements and notes. Our business, financial condition, operating results, cash flow, liquidity and/or our future business may be adversely affected by any of the risk factors detailed below. The market price of our securities may decrease due to the occurrence of any of these and/or other risk factors, in which case potential investors may lose all or a substantial part of their investment in our securities. The risks detailed below are those we know of and believe that, on the date of this Reference Form, may materially and adversely affect us. In addition, additional risks not currently known or considered irrelevant may also adversely affect us.

Our Company operates in the copper chain, transforming and refining copper concentrate to produce refined copper, which results in products such as electrolytic copper (cathodes), rods and drawn wire, as well as semi-finished products of copper and its alloys. The main risks related to our Company, inherent in metal commodities businesses, are presented below in order of relevance.

For the purpose of this section “4. Risk Factors”, unless expressly stated otherwise or if the context requires, the mention that a risk, uncertainty or problem may cause or will cause an “adverse effect” or “negative effect” for the Company, or similar expressions, means that the risk, uncertainty or problem could have a material adverse effect on our business, financial condition, operating results, cash flow, liquidity and/or future business, as well as the price of our securities. Similar expressions included in this section “4. Risk Factors” should be understood in this context.

Notwithstanding the subdivision of this section “4. Risk Factors”, certain risk factors that are in an item may also apply to other items in this section “4. Risk Factors”.

a. Risks related to our Company.

a.1. Our business demands substantial investments, which we may not receive or get the cost/satisfactory conditions, which could adversely affect our operations. The Company has a high working capital requirement and depends on credit lines with financial institutions, capital markets or deadlines with suppliers for the efficiency of operations.

Our business strategy is organic growth by maximizing the use of our installed capacity. This means that we will need constant investments to, among other purposes, manage assets, purchase new equipment, perform maintenance of existing equipment and comply with environmental regulations. If the funds generated internally and availabilities arising from financial institutions and capital markets are not sufficient to meet our need for resources, we may require additional credits or increase our capital. However, such credits may not be available or, if available, may not be available on satisfactory terms. Future financing, if available, may result in: (i) increase in the average cost of our debt, (ii) greater leverage; (iii) lower availability of own resources to meet the maximization plans of our production capacity and (iv) lower availability of funds for the payment of dividends to shareholders. If we are unable to generate or obtain additional resources in the future, we may be forced to reduce or delay expenditures or investments, sell assets, restructure or refinance our debts.

In addition, our ability to implement our business strategy, particularly the occupation of our production capacity, also depends on our ability to generate operating cash and maintain a framework of appropriate capital for the business.

It should be noted that our business model requires substantial investments and financing, which may be obtained, for example, by raising bank credit lines and/or credit providers. In a scenario of deterioration of our financial indicators and/or in the case of a reduction in credit supply, influenced by political, economic and market conditions in Brazil, our ability to obtain any future funding needed for working capital, capital expenditures and/or payments of principal and interest on the debt is limited, which could result in reductions in production volumes and the consequent degradation of our economic performance and even a reduction in our workforce.

Global and Brazilian credit markets have been experiencing significant volatility. This factor and the ongoing market disruption have had, and may continue to have, an adverse effect on us, including our ability to refinance debts. Moreover, the continuing uncertainty in the capital and credit markets may negatively impact our ability to access additional short and long term funding, negatively affecting our liquidity and financial condition.

With the limitation of credit contraction, we may also not be able to improve the quality of our debt and may increase our cost of funding.

As disclosed in the financial statements, the Company closed the fiscal year ended December 31, 2018 with a net debt of R$1,850.7 thousand, compared to R$1,669.2 thousand on December 31, 2017 and R$1,706.3 thousand on December 31, 2016. For more information on the Company’s net debt, please refer to items 3.2 and 10.1 of this Reference Form.

a.2. The Company is subject to specific obligations and restrictions on its ability to incur additional debt in terms of some financial contracts.

With the implementation of Debt Restructuring, the Company’s financial instruments negotiated under the Global Agreement have come into force, which require, among other conditions and obligations, that the Company complies with (i) the payment of accrued interest within the term established in the Global Agreement; (ii) the limits of certain financial covenants, such as (a) current liquidity index, (b) minimum inventory and receivables limits, (iii) restrictions on the contraction of new loans and funding, subject to the exceptions set out in the Global Agreement, (iv) restrictions on the constitution of new encumbrances on properties, assets and rights of the Company, subject to the exceptions set out in the Global Agreement, and (v) restrictions on the declaration of dividends and interest on equity.

If the Company is not able to comply with its obligations (financial or non-financial) or the limitations set forth in the respective contracts, this may result in the early maturity of existing debts, in limited access of the Company and its subsidiaries to new financing lines to execute its investment plan, as well as adversely affect the Company’s business and operating results.

a.3. The Company may not be able to access new financing on attractive terms in order to meet its capital needs or its financial obligations.

The Company’s business model depends on substantial investments and financing obtained by raising bank credit lines and funding. The need for recovery and modernization of our industrial parks is usually supported by third party resources, through special financing lines with financial institutions and development banks. In addition, the global market and economic conditions have been, and are expected to remain, volatile.

Furthermore, the Global Agreement entered into under the Restructuring (as defined in item 6.3 of this Reference Form) imposes a limitation on the amounts that can be raised through loans or financing for investment in CAPEX.

Also, debt markets have recently been impacted by significant lows in the financial services sector and the re-pricing of credit costs, among other factors. Such events adversely affected economic conditions in general. In particular, the cost of raising funds in debt markets showed a substantial increase, while the availability of funds from these markets declined significantly. In addition, as a result of concerns about the stability of financial markets in general and the solvency of counterparties, the cost of borrowing in credit markets increased, as many lenders raised interest rates, adopted stricter lending criteria and reduced its volume – in some cases, disrupting the supply of financing on reasonable commercial terms.

If the Company is not able to obtain new financing or to refinance its debts when necessary, or if credit is only available on unfavorable terms to the Company, it may become a challenge for the Company to meet its capital needs, its financial obligations and/or take advantage of business opportunities. These may materially adversely affect the Company, its business and/or its operating results.

For more information on loan and financing agreements and their covenants and waivers, please refer to item 10.1 (f) of this Reference Form.

a.4. The Company may not be able to comply with the covenants of its loan agreements.

With the Restructuring already implemented, the Company is subject to certain financial covenants based on its quarterly financial information, such as (a) current liquidity index based on the Current Assets/Current Liability ratio equal to or greater than 1.0x; (b) Net Debt/Recurring and Unadjusted EBITDA ratio equal to or less than (i) -50.9x on 12/31/2017; (ii) 63.1x on 06/30/2018; (iii) 16.6x on 12/31/2018; (iv) 14.6x on 06/30/2019; (v) 10.4x on 12/31/2019; (vi) 9.0x on 06/30/2020; (vii) 7.0x on 12/31/2020; (viii) 6.5x on 06/30/2021; (ix) 5.8x on 12/31/2021; (x) 5.8x on 06/30/2022; (xi) 5.2x on 12/31/2022; (xii) 5.0x on 06/30/2023; (xiii) 4.3x on 12/31/2023; (xiv) 4.6x on 06/30/2024; and (xv) 3.9x on 12/31/2024; and (c) Minimum Limit of Inventories and Receivables without any Encumbrances, of the total debt of the Company, on the dates of verification, represented by certain agreements and other ACC (Advance on Exchange Contracts)/ACE (Advance on Delivered Exchange Operations) without real or fiduciary guarantees contracted by the Company as of the date of the signing of the Global Agreement.

For purposes of item (b), the eventual non-compliance with the financial index obtained from the Net Debt/Recurring and Unadjusted EBITDA ratio, on a consolidated basis, on (x) December 31, 2017, (y) June 30, 2018, and (z) December 31, 2018, will not result in the anticipated maturity of the Definitive Contracts.

Despite the exception of the previous paragraph, if the Company is not able to (i) comply with the covenants established or renegotiated with such creditors and/or (ii) renegotiate the financial covenants established with such creditors, this may result in the early maturity of existing debts, in limited access by the Company and its subsidiaries to new financing lines to execute its investment plan, as well as adversely affect the Company’s business and operating results.

For more information on loan and financing agreements and their covenants and waivers, please refer to item 10.1 (f) of this Reference Form.

a.5. The purchase of our main raw materials production and sale of our products are denominated in US dollars, which may impact our results due to the exchange rate volatility.

Our functional currency is the Real, while our operating and financial results are subject to the impact of currency fluctuations, because we are exposed to foreign currencies, especially the US dollar, due to: (i) relevant part of our sales being held or denominated in US dollars; (ii) relevant part of our raw material costs, particularly copper concentrates, copper scrap and cathodes are in dollars or dollar-denominated; and (iii) a significant portion of our assets and liabilities are linked to the US dollar, including receivables, payable, inventory and financial instruments. These situations may impact the Company’s results due to the exchange rate volatility of the currencies to which the Company is exposed.

In addition, the exchange rate fluctuation may also negatively impact the results of derivative instruments used by the Company in accordance with our risk management strategy, which may adversely affect our results, the payment of future dividends and the risk perception.

a.6. Our business is highly dependent on the level of demand for copper products and copper prices, and may be adversely affected by decreased demand for copper and/or the volatility of copper prices.

Copper is a commodity traded internationally, and its prices are determined by major metal exchanges, including the London Metal Exchange (“LME”). Demand for copper products is highly cyclical and is affected by varied and complex factors beyond our control, including:

• Global level of supply and demand and inventory levels;
• Global economic and geopolitical conditions;
• Government policies;
• Level of activity and speculation in the commodities market;
• Prices and availability of substitute products;
• Technology changes, including changes resulting from the substitution of products traditionally made of copper or copper alloys for products made of other materials such as newly developed synthetic products; and;
• Changes in demand from China, which has become the largest consumer of refined copper in the world.

The prices we charge our customers for our copper products are based on copper prices on the LME plus premiums that vary according to the shape, chemical composition, quality and product specifications. A fluctuation in copper prices on the LME and, therefore, in the prices of our products, may have an adverse effect on us, on the value of our assets and/or our ability to pay off debts and meet other obligations, having an impact on the trading prices of our securities.

In addition, prolonged changes in market prices on the LME without counterpart from the adjustment of the TC/RC (Treatment Charge/Refining Charge) we get from mining companies (copper concentrate suppliers) may negatively impact the profitability of our operations and lead us to review our operational plans, including reduction of production, impediment or delay of expansion projects, revision of operating costs and investments, which may, consequently, adversely affect our results.

a.7. The Company may not be able to reduce its financial leverage, which would increase its cost of debt and negatively affect its financial condition, investment capacity and operational results.

Historically, we have addressed our liquidity needs (including funds necessary to cover principal and interest payments, debt refinancing, working capital and investments) with operating cash flow, loans, debt offerings and asset sales. Global credit markets have in recent years suffered a significant price volatility and liquidity, impacting spreads and making financing terms less attractive and, in many cases, resulting in the availability of certain types of financing.

Increased market volatility and lack of liquidity may have an adverse effect on us, including cost of stocks and ability to refinance our existing debt. In addition, the increased uncertainty in the capital and credit markets may adversely affect our ability to access short and long-term financing.

a.8. We are involved in several lawsuits that may cause adverse effects on our business, if the final decisions are not favorable to us.

We are involved in several lawsuits related to our activities, including civil, tax and labor actions, as well as administrative and environmental proceedings.

If there is an unfavorable decision for the Company in a claim that involves a significant amount and over which no provision was made, or if the estimated losses result in amounts higher than the provisions made, our business may be materially and adversely affected.

In addition, under Brazilian law, a taxpayer with the intention to challenge a specific tax in court should normally provide guarantees in the same amount in order to suspend collections. In some cases, related to the application and/or collection of certain taxes, we may be required to provide collateral or some form of guarantee to the court and, depending on the nature, value and/or scope of such collateral and/or guarantee, it may have a significant impact on our business.

a.9. Production of copper and its products is subject to risks such as accidents that may affect our operations and cause us to incur significant liabilities, high repair costs and/or lost sales, for which we may not have adequate insurance coverage and indemnity limits.

Our operations are subject to risks such as fires, explosions, mechanical failure, power failure, uncontrolled leaks or releases of hazardous substances causing soil, water and air contamination, as well as other hazards associated with the manufacture of copper materials. We are also subject to events that may cause damage or destruction of our production or transportation facilities, equipment or shipped products, as well as result in personal injury or death, environmental damage, waste of resources or intermediate products, delays or interruptions in our production or transportation activities, monetary losses, possible legal liabilities, destruction of fixed assets and equipment, among others. Additionally, we may be held liable for any casualties incurred, being required to pay compensation to the victims, which may have adverse effects on our business, financial condition and operating results. Also, if we were to suspend any of our operations temporarily, we could lose substantial amount of business to our competitors, which would also have material adverse effects on the Company.

a.10. Our governance and compliance processes may fail to prevent fines and other regulatory penalties and reputational damage.

We operate in a global environment, subject to frequent inspection. Our compliance and governance processes may not be sufficient to avoid future violations of the law and/or accounting and governance standards. We may be subject to fraudulent and deceptive actions by our employees, suppliers or other agents. If we fail or ceased to comply with applicable laws and other regulations, we may incur fines, as well as other penalties, loss of operating licenses and damage to our reputation, which could affect us materially and adversely in several fronts, including our image and results.

a.11. Limitations of logistics infrastructure may affect purchases of raw materials and/or sales of finished products.

We mainly depend on marine and road transportation to the receipt of raw materials necessary for our production process and delivery of our products to our customers. Disruption of any of these services, regardless of the reason that caused them, such as, for example, bad weather, mechanical difficulties, natural disasters, collisions, strikes – by our own employees or employees of contractors, such as port or ships operators – blockages, bottlenecks or other events may hinder our ability to receive the necessary inputs for the manufacture of our products or to deliver our products to customers, which would may lead to adverse effects on the Company. Any disruption in transportation and logistics services could negatively affect us, as this may result in lower levels of production, sales and revenue generation. Lower shipping volumes over long periods may also make our customers look for other suppliers to meet their demand.

a.12. The Company may not pay dividends or interest on equity to its shareholders.

The Company’s Bylaws provide for the allocation of 25% of net income for the fiscal year as mandatory minimum dividends, after the necessary adjustments as required by legal provisions. By resolution of the Board of Directors, the Company may pay its shareholders interest on equity, which will be deducted from the mandatory dividend. The result of a given fiscal year can be used to offset accumulated losses from previous years. The distribution of dividends may be affected by the Company’s short-term financial condition and its investment plan, as well as operating results over the periods.

a.13. The Company may not be able to fully implement its business strategy.

The Company cannot guarantee that it will be able to implement its business strategy, especially the increase in the use of its installed capacity, which mainly depends on the operational cash generation capacity and the maintenance of adequate capital structure, enabling investments in our plants for the execution of improvement and maintenance projects in our production lines.

a.14. The Company is subject to labor disputes that may adversely affect it and it may be held liable for the outsourcing of certain activities.

Most of our employees are represented by unions and are covered by collective agreements subject to periodic renegotiation. We may not successfully complete labor negotiations on satisfactory terms or have other material disputes with our workforce. Disputes with our employees may result in a significant increase in labor costs, strikes or labor disturbances that would disrupt our operations.

In addition, we hired some companies to outsource specific tasks and services. If the outsourced company fails to comply with the requirements of applicable labor laws and regulations, we may be jointly and severally liable for the obligations of the outsourced company and, therefore, also be fined and/or sentenced to pay the fines imposed by the competent authorities.

All the risk factors set forth in this item may materially and adversely affect the Company.

a.15. The shares issued by Paranapanema are subject to the risks associated with the market in which they are traded.

Our shares may not have significant liquidity in the market in which they are traded and may be impacted by volatility above the market average.

In case of loss in the year-end, our shareholders may not receive dividends or interest on equity.

Also, we may need additional capital in the future through the issuance of securities, which may result in dilution of shareholders’ participation in the Company’s capital, if they do not follow the subscription.

a.16. The relative volatility and lack of liquidity of the securities of Brazilian companies may substantially limit the ability of investors to sell the securities issued by the Company at the desired time and price.

Investment in securities of emerging market companies, such as Brazil, involves a greater risk compared to investment in securities of companies from more developed countries, and are generally considered speculative investments. Investments in securities issued by the Company are subject to economic and political risks, including, but not limited to: (i) changes in the Brazilian regulatory, tax, economic, and political scenarios, which may affect the ability of investors to receive payments, fully or partially, relating to their investments; and (ii) restrictions on foreign investments and repatriation of invested capital. Brazilian capital markets are substantially smaller, less liquid, more concentrated and more volatile than the main US and European capital markets, and are not as strictly regulated and supervised as these markets. The relative lack of liquidity and lower market capitalization of Brazilian capital markets may substantially limit the ability of investors to sell their securities at their desired price and time.

a.17. We benefit from the tax incentives, whose suspension, expiry of the period of validity, cancellation or non-renewal could adversely affect our results.

We benefit from the tax incentives of the Industrial Development and Economic Integration Program of the State of Bahia (“Desenvolve”). This benefit applies only to domestic sales. The need to focus our sales in the foreign market due to the reduction of domestic demand substantially impacts the results of this benefit.

We cannot ensure that the tax incentives for which we are currently beneficiaries will be maintained, renewed, or that we will be able to obtain new tax benefits on favorable terms. If this benefit is not renewed, this may have a material adverse effect on our results.

a.18. The compliance procedures, policies and programs established by the Company may not be sufficient to eliminate violations of existing laws and regulations related to the fight against corruption.

The Company is subject to compliance with the national legislation related to the fight against corruption in the jurisdictions in which it operates as an issuer of securities. Specifically, the Company is subject to compliance in Brazil with Law No. 12,846, of August 1, 2013. The Company has internal procedures aimed at ensuring compliance with these laws, however it is not possible to ensure that such policies and procedures are sufficient or that the Company’s employees, directors, officers, partners, representatives or service providers have not adopted or will not adopt any type of action in violation of such policies and procedures that could ultimately generate liability for them or for the Company. Violations of anti-corruption laws may result in financial penalties, reputational damage, or other legal consequences that may adversely affect the Company’s activities, operating results or financial condition.

b. Risks related to our direct or indirect controller or controlling group.

There are no risks related to controllers or controlling group, since the Company has a wide group of investors, and there is no controlling shareholder neither a Shareholders’ Agreement or the Controlling Group, direct or indirect.

c. Risks related to our shareholders.

c.1. We have no controlling shareholder or controlling group, which may make us susceptible to alliances among shareholders, conflicts between shareholders and other events arising from the absence of a controlling shareholder or controlling group that may result in changes in our composition and strategy.

We do not have a controlling shareholder or controlling group. However, alliances or agreements among shareholders may be formed, which could have the same effect as a controlling group. If a controlling group is formed and has decision-making power, we could suffer sudden and unexpected changes in our corporate policies and strategies, including the replacement of our directors. The absence of a controlling group may hinder certain decision-making processes, as the minimum quorum required by law for certain deliberations may not be reached. Given the number of shareholders, attendance at meetings below the minimum quorum required by Law No. 6,404, of December 15, 1976 (“Brazilian Corporate Law”), as amended, invalidates the vote and the resolution of the matters in the agenda, and a second or third call should be made. In addition, any sudden or unexpected change in our management team, our company policy or strategic direction, takeover bid or any dispute between shareholders concerning their respective rights may adversely affect our business and operating results.

c.2. Risks related to the economic and financial situation of a shareholder may cause adverse effects on the share price in the market.

Although we do not have a controlling shareholder or controlling group, since the Company has a wide group of investors, some shareholders hold significant stake in our capital. The possible deterioration of the economic and financial situation of any of these shareholders may result in the need to divest some of their assets, including our shares, adversely impacting their price.

c.3. The Company may require additional funds in the future, which may be obtained through increases in its capital stock. Such capital increases may dilute investors’ participation in the Company’s capital stock.

The raising of additional funds through the sale of shares and the issuance of shares or securities convertible into shares, which, in accordance with Brazilian Corporate Law, may exclude the preemptive rights of the Company’s shareholders, including its investors, and may therefore dilute the shareholding of such investors.

d. Risks related to our subsidiaries and affiliates.

Our subsidiaries and affiliates are subject, in addition to the risks related to us, to the following risk factor:

d.1. The logistics of distribution and storage of our products and raw material is partially carried out by our subsidiary CDPC.

Any disruption in transportation and logistics services could adversely affect CDPC, as it may result in lower levels of distribution, sales and revenue generation. Furthermore, CDPC is subject to the occurrence of claims that, even if indemnifiable, may compromise its operations and, consequently, directly impact our operations.

e. Risks related to our suppliers.

e.1. The interruption in the receipt of raw materials such as copper concentrate, cathode and/or scrap, could adversely affect our operations and our results.

We fully depend on the supply of copper concentrate by local and international suppliers, which is mainly regulated by long-term contracts. Interruptions in copper supply may occur due to: (i) a major accident or incident in the mines of suppliers and/or its ore processing plants; (ii) problems related to the transportation of raw materials; and/or (iii) environmental irregularity of mines or non-compliance with technical conditions required by environmental agencies, leading to a potential suspension of operations; and/or (iv) any other fortuitous or unforeseeable factor. The impossibility of obtaining raw materials in order to keep constant production due to failure to maintain current relationships with suppliers of raw materials, the renegotiation of contracts due to the factors above, or for any other reason, may have an adverse impact on our business.

The supply of raw materials for the production of bars, profiles, laminates, wires, pipes and connections is subject to the receipt of raw material, the cathode (electrolytic copper), provided by the Bahia plant or imported and/or scrap from customers for processing into final products or bought in the domestic market or imported. The production of semi-finished products may be impacted by the interruption of the cathode supply if the Bahia plant experiences some type of disruption in the production or if the customers who provide copper scrap for processing undergo some kind of reduction in the consumption of their products and have to reduce production and/or inventories.

e.2. Our operations may be affected by shortages, lack and/or increased energy, water and fuel prices.

The Company has an electricity supply agreement with Companhia Hidroelétrica do São Francisco (CHESF), which corresponds to 70% of the average consumption of the Dias d’Ávila (BA) unit. The agreement will last until February 2037 and is fundamental to the long-term security energy of the Dias d’Ávila plant and the perpetuation of the processing, refining and transformation activities of electrolytic copper.

Several productive processes require a substantial amount of electricity and water, and shortages, lack and/or increase in the prices of these inputs could adversely affect our operating results. Electricity and water prices may be subject to variations due to, among other things, laws, regulations, increases in taxes or tariffs, or even changes in price levels practiced by concessionaires responsible for supplying these inputs. To a lesser extent, our operations also depend on fuel supplies, particularly oil and gas, whose price is almost impossible to predict. If we are unable to pass on increases in the price of electricity, water or fuel to our customers, we could be adversely impacted.

e.3. The Company may face shortages of equipment, services and qualified personnel.

We are subject to shortages in the supply of equipment and spare parts, as well as in the availability of services providers and qualified personnel during periods of high demand and intensive development of competing projects. We may experience longer periods for the supply of equipment, as well as problems with the quality of contracted engineering, construction and maintenance services. We compete with other companies for the hiring of professionals with relevant technical and industry experience, and we may not be able to attract and/or retain such people. Shortages of equipment, services and/or qualified personnel in peak periods can cause a negative impact on our operations, resulting in higher investment and inventory costs, production disruptions, project delays and possible reduction in production and revenue generation.

e.4. Problems in maintenance, exchange and installation of systems, equipment, machinery and tools can impact the volume and quality of production, and may even result in partial shutdown of our activities, adversely impacting our results.

The production processes of copper and copper products rely on some crucial equipment, as well as internal logistics and distribution channels, such as roads and ports. Problems in the maintenance, exchange and installation of systems, equipment, machinery or tools can result in disruptions in our production processes, our internal logistics, or our distribution channels, which may significantly and adversely affect us.

e.5. The termination of certain contracts for the supply of raw materials or the sale of the products of our plants may adversely affect our operations.

If any of our major suppliers terminate a supply contract or become delinquent, it may lead to unfavorable and adverse results on our revenues.

If any of our largest consumers of sulfuric acid terminate a supply contract or become delinquent, we can seek for selling alternatives which may bring unfavorable results.

e.6. The Company may be affected by lack of supply or increase of prices of raw materials due to extraction and transportation costs.

We do not have our own source of raw material and are subject to supply through mining companies and scrap suppliers. We may be adversely affected by lack of supply or increase in prices of certain raw materials essential for the production of certain products.

Copper concentrate and copper scrap are our main raw materials in the production of refined copper, and the supply of copper concentrate mostly comes from external suppliers. Also, we may occasionally buy cathodes from outside suppliers in installments, if we believe that the conditions are favorable to our business strategy.

Our raw materials, especially copper concentrate and scrap, are usually supplied on the basis of long-term supply agreements. If the supply of inputs we purchase from third parties is discontinued, delayed or interrupted for any reason, we may not be able to produce certain types of copper products in a timely manner, in sufficient amounts or under acceptable conditions, which may negatively affect the Company in many ways.

The price of copper concentrate is generally based on the LME spot price (cathodes) discounted treatment and refining charges (TC/RC), negotiated with our suppliers based on the annual benchmark. In case of shortage of copper concentrate in the world market, the TC/RC may fall to levels that do not allow Paranapanema to cover its processing costs, severely impacting its margins.

Finally, the raw materials we purchase from third parties may be subject to price increases due to several other factors, including commodity price fluctuations (mainly spot copper prices on the LME), inflation rates, exchange rate fluctuations, shortages or increased import taxes. If raw material prices increase or their offer is reduced, our business, financial condition and results of operations could be adversely affected if we are unable to pass on the increase in the price of the raw materials to our customers or replace the supplier in a timely manner.

e.7. Fluctuations in transportation costs may adversely affect our ability to deliver products to our customers.

Transportation costs represent a significant portion of the cost of distributing our products. Therefore, transportation costs are a critical factor in the purchase decision of our customers. Transportation costs include payments to third-party carriers and ancillary costs related to transport safety. The Company may not be able to fully pass on these increases without reducing our competitiveness, especially against competitors whose facilities are geographically closer to customers. Furthermore, significant reductions in transportation costs could result in increased international competition.

f. Risks related to our customers

f.1. We are subject to risks usually related to the granting of credit.

In the normal course of sales operations, the granting of payment terms to customers is based on credit analysis according to the Standard and Procedure published and approved by the Company’s Management, considering not only financial and result figures, as well as data relating to customer relationship, commercial and restrictive references. The Company is not able to guarantee that the daily monitoring of the portfolio performance, including monthly indicators, compared to market momentum, demand and credit liquidity, as well as the Company’s strategy, will ensure that results are not affected.

If the default rate is higher than estimated, if the cost of credit increases, or if there is a reduction of liquidity and availability of credit in the market, affecting customer financing, our results may be impacted.

f.2. Judicial reorganization, bankruptcy or the loss of some of our customers may have a significant adverse impact.

A significant portion of our revenues come from a limited number of customers. We usually maintain short-term supply contracts, which are renewed on a yearly basis, with annual price revisions. The deterioration of the Brazilian market conditions creates a significant risk of loss of customers in the domestic market.

Cathode prices are usually determined by reference to the price of copper on the LME (ie, the market price of copper concentrate), plus a premium for processing costs to treat and refine the raw material (TC/RC). The prices of our copper products are also determined by reference to the price of copper on the LME, but generally have higher margins, depending on the type of product. If we do not agree on the price for the next contract year, our customers can buy the products from another supplier. There is no guarantee that our contracts with our major customers will be renewed or extended, that they will be closed on favorable terms to us or terminated in advance, or that we will continue to obtain equivalent revenue from our major customers in the future.

Any change in demand from one or more of our major customers, payment delays, difficulty in reaching a price agreement for a given year, or even judicial reorganization, bankruptcy or loss of any of these customers may have a material adverse effect on the Company.

f.3. If our customers win lawsuits against us for defects in our products, our operating results may be impacted and our reputation may be impaired.

We are subject to lawsuits and other claims if the use of any of our products result in personal injury, property damage or loss. Malfunctioning of any of our products could result in significant property damage, loss, personal injury and even death. The costs and resources required to defend ourselves against this type of process can be substantial. If the Company is found guilty, we may be held liable for paying some or all of the damages. In addition, publicity around that type of process may damage our reputation, regardless of whether such claims are true or not.

g. Risks related to the sectors of the economy in which we operate

g.1. The variation in TC/RC (Treatment Charge/Refining Charge), premiums on the LME price and processing premiums may affect our results.

The results of our operations are sensitive to the cyclical nature and fluctuations of (a) the treatment and refining charges (TC/RC) for the casting of copper concentrate in anode, as well as copper refining (copper with 99.99% purity), for processing into cathodes; (b) premiums on the LME price in the sale of our cathodes; and (c) premiums on the processing of cathodes into copper products such as bars and laminates.

The TC/RC are negotiated annually with our suppliers and are affected by several factors beyond our control, such as: the level of supply and demand in the market for a wide variety of products (e.g. copper concentrate, copper cathode and other copper products), the relative strength of some currencies such as the euro and the US dollar, interest rates, global and/or regional political and/or economic crises.

g.2. Global and domestic crises and subsequent economic slowdowns may adversely affect global and domestic demand. As a result, our financial condition and results of operations may be adversely affected.

Historically, the copper industry has been highly cyclical and strongly affected by overall economic conditions, such as worldwide production capacity and fluctuations in imports/exports of copper and their respective customs tariffs. The economic downturn and the turbulence of the global economy may negatively impact consumer markets, affecting the business environment in terms of reduction in international prices of metal commodities; falling international cathode volumes traded; and specific crises in consumer sectors.

A global and/or domestic crisis may result in a decrease in our sales and profitability.

g.3. Economic and political conditions and government policies for the economy and other areas in Brazil may adversely affect demand for our products, as well as our net revenue and overall financial performance. The Brazilian government makes interventions in the economy by changing monetary, tax, credit and tariff policies to influence the course of the Brazilian economy. Government actions to control inflation and implement other policies often included monetary and fiscal policies, wages and prices freezing, exchange rate policies, bank accounts freezing, capital controls and import restrictions.

Our operating results and financial condition may be adversely affected by the following factors and by the consequent reactions of the government to them:

• Interventions in the foreign exchange market;
• Interest rates;
• Inflation;
• Tax policies;
• Shortages or higher costs of electricity;
• Liquidity of domestic and foreign credit and capital markets;
• Other political, diplomatic, social and economic developments in or affecting Brazil.

The uncertainty on possible changes, by the Brazilian government, of policies and regulations affecting these or other factors may contribute to economic uncertainty in Brazil and increased volatility in the securities markets and the securities of Brazilian issuers in other countries. These and other developments of the Brazilian economy and government policies may adversely affect us and our business.

g.4. Government protectionism, including fiscal policies and incentives, anti-dumping rules, countervailing duties and safeguard measures may adversely affect our business.

The protectionist measures adopted by the governments of some of the leading metallurgical products markets, such as refined and semi-finished copper products and copper alloys, may adversely affect our exports. In response to increased production and exports of refined copper in several countries, anti-dumping rules, countervailing duties, taxes and other protective measures may be imposed by countries representing some of the major markets for the export of our products. These measures may cause an imbalance in the international copper metallurgy market, which could adversely affect our exports, and consequently, our financial condition and results of operations.

In addition, the adoption of policies and/or the granting of tax incentives to certain industries may negatively impact the competitiveness of our prices.

g.5. Our line of business is highly competitive and informal, and changes in the competitive scenario could reduce our revenues, margins and cash flow to maintain our competitiveness.

The competition in the metallurgy industry in relation to primary copper and semi-finished copper products in the domestic and international market is intense, a scenario that will not change in the future. We have competitors for each of our products and in all geographic markets in which we operate, a situation we expect to be maintained in the future, and pricing power is a key factor in the market. Therefore, our business prospects depend on our ability to maintain a competitive pricing structure, as well as our ability to meet changing customer needs, anticipate and respond to technological changes and develop close and competitive relationships with our customers and suppliers. If we fail to meet these requirements, or if our level of profitability is reduced due to price competition, our business and results may be adversely affected.

g.6. Changes in legislation or government regulations may affect our copper metallurgy activities, and may increase our operating costs, restrict our operations and/or result in operational delays.

Our copper metallurgy operations are subject to laws and regulations governing, among other matters, production, export, taxes, general labor standards, as well as occupational health and safety, waste disposal, environmental protection, toxic waste, and protection of endangered species and other issues.

Therefore, any changes in applicable laws, regulations, agreements, or in the exercise or interpretation of such laws, regulations and agreements may result in an increase in legal requirements or in terms of existing licenses and agreements applicable to us or our activities, which may have a material adverse impact on our planned development projects, properties, results of operations, financial condition and/or prospects.

Failure to comply with applicable laws, regulations and agreements could result in suspension or even termination of metallurgy operations or in significant fines, penalties or other liabilities that may have a material adverse effect on our business, properties, results of operations, financial condition and/or prospects.

g.7. The advent of new technologies or the increase in the price of our products can lead to their replacement by more modern and accessible products, restricting our operations and affecting our results.

In addition to our direct competition, depending on the applications of our products, manufactures of substitute products such as plastic, aluminum, graphite compounds, ceramics, glass, wood and concrete, are also our competitors.

A technological change resulting in the substitution of copper by other materials in all or part of its current applications could have a negative impact on our business and financial condition, as well as the results of our operations.

In addition to competing with other producers of copper products, we also indirectly compete with producers of substitutes for some of our products, such as plastic and aluminum. Any technological change resulting in the substitution of copper by other materials, in whole or in part of its current applications, may have an adverse impact on us.

g.8. Developments and the perception of risk in other countries, both developed and emerging economies, may influence the market price of Brazilian securities, including the shares issued by us.

The market value of securities of Brazilian companies is affected, at different scales, by economic and market conditions in other countries, including other Latin American countries and other emerging economies. The reaction of investors to developments in these other countries may have an adverse effect on the market value of securities of Brazilian issuers. Crises in other emerging market countries may diminish investor interest in securities of Brazilian issuers, including securities issued by us. This could adversely affect the market price of our shares, and difficult access to capital markets and financing of future operations on acceptable terms or under any conditions.

The Brazilian economy is also affected by general international economic and market conditions, especially in the United States. The price of shares traded on B3, for example, have been historically sensitive to fluctuations in US interest rates, as well as to variations of the main US stock indexes. Also, reductions in credit supply and the deterioration of economic conditions in other countries, including the financial crisis affecting some European Union countries, may adversely affect the market price of Brazilian securities.

g.9. Inflation and government measures to combat it can contribute significantly to economic uncertainty in Brazil and adversely affect our business.

Brazil has gone through periods of high inflation in the past. Since 2015, the Brazilian economy has been experiencing moments of instability and the inflation rate reached 10.67% in the same year, falling to 6.28% in 2016, further decreasing to 2.21% in 2017 and presenting an accumulated rate in the last 12 months to February 2019 of 3.89%, as measured by the IPCA. If Brazil experiences high levels of inflation again, there may be a slowdown in the country’s economic growth rate, which would lead to a lower demand for our products in Brazil. Inflation would likely also increase some of our costs and expenses that might not be able to be passed on to customers, leading to reduced profit margins and net revenue.

In addition, high inflation generally leads to higher domestic interest rates, which could lead to an increase in the cost of our debt denominated in reais. Inflation may also hinder access to capital markets, which could negatively impact our ability to refinance our debt. Inflationary pressures may also lead to the introduction of government policies to combat inflation, with possible adverse impacts on our business.

g.10. Our operations are subject to hazards and risks inherent to the copper metallurgy sector and its alloys.

Our operations are subject to all hazards and risks inherent to activities related to the smelters and the semi-finished copper and its alloys; to the use of natural resources and industrial operations in general, which may lead to interruptions in our processes, personal injuries or damage to our property and to the environment. These hazards and risks include, but are not limited to:

• Environmental risks;
• Shortages or higher costs of electricity;
• Industrial accidents;
• Loss of suppliers;
• Costs with transportation;
• Risks related to exchange rate variations;
• Labor disputes and port strikes;
• Unfavorable operating conditions; and
• Other fortuitous or unforeseeable events.

The materialization of any of these risks and hazards may affect our copper metallurgy operations and may result in (i) delays or interruption in the development and production of our products, (ii) damage or destruction of property or facilities, (iii) personal injury, death or our legal liability.

All of these hazards and risks may cause a material adverse effect on our financial condition, results of operations and cash flow.

g.11. Copper, gold, silver and metals used in copper alloys (zinc and tin) are actively traded on worldwide metal exchanges and their prices are subject to significant fluctuations.

Prices charged for copper and other metals used in alloys (zinc and tin) are based on prices for these metals on commodity exchanges such as the LME and Commodities Exchange (“COMEX”). Therefore, the prices of our products and revenue from these products are volatile. Global metal prices are subject to significant fluctuations and are affected by many factors, including macro-economic conditions and effective and expected global policies, supply and demand levels, availability and cost of substitutes, inventory levels maintained by producers and exchanges, commodity investment funds, and the actions of participants in commodity markets.

In addition, our copper metallurgy activities are subject to the effects of changes in copper prices on our working capital, that is, the variation in price that occurs between the moment of purchase of raw materials to the formation of inventories and the sale of our products, which may adversely affect our revenues.

h. Risks related to the regulation of the sectors in which we operate

h.1. Our operations are subject to complex and evolving laws, rules and regulations, and compliance with these laws, rules and regulations involves significant costs.

Our operations are subject to several local, state and federal laws, rules and regulations. Compliance with these laws, rules and regulations imposes charges and may cause delays in obtaining government permits, licenses and approvals. In addition, the costs incurred in complying with these laws and regulations, as well as voluntary policies and compliance programs, are significant and will continue to be in the future. Finally, the evolution of these laws, rules and regulations may result in increased litigation and/or increased costs, which may have a material adverse effect on us.

Compliance with the environmental legislation applicable to our activities is supervised by government agencies and bodies, which may impose administrative sanctions for possible non-compliance with legislation. These sanctions may include, among others, the imposition of financial penalties of up to R$50 million, suspension and cancellation of licenses, temporary or permanent suspension of the Company’s activities, and even the imposition of embargo and demolition of building works.

In addition, if the Company fails to comply with environmental protection legislation, it may also lead to the imposition of criminal sanctions, without prejudice to the civil obligation to repair any damages that may have been caused, or to the penalties applied in administrative proceedings. Criminal sanctions may include, but are not limited to, custodial sentences for those responsible, ban of activities, loss or restriction of fiscal incentives, and cancellation and suspension of financing lines with official credit institutions, as well as prohibition of contracting with the public power.

Furthermore, non-compliance with environmental legislation or obligations that the Company may assume through terms of adjustment of conduct, judicial and extrajudicial agreements, may have a material adverse impact on the Company’s image, revenues and operating results.

The issues mentioned above may adversely affect our business and results.

h.2. Our activities are subject to obtaining and/or renewing permits, concessions and licenses that may not be obtained and/or renewed.

Obtaining and/or renewing permits, concessions and licenses can be a complex and time-consuming process and we cannot guarantee that permits, concessions and licenses required for our operations will be obtained and/or renewed on acceptable terms, in a timely manner, or even if they will be granted. The costs, delays or failure to obtain and renew permits, concessions and licenses may temporarily and/or definitively prevent or significantly delay the development of our activities.

Failure to comply with applicable permits, concessions and licenses, may result in temporary and/or permanent suspension or termination of facilities and/or operations of metallurgy, exploration, development, mining and logistics, or in administrative and criminal penalties (of the Company and its directors), as well as the obligation to indemnify any damages caused to the environment and to third parties affected by its conduct. These factors may have a material adverse effect on our business, properties, results of operations, financial condition or prospects.

In addition, effective or potential political or social changes and changes in economic policy may undermine investor confidence, which could hinder investment, reducing economic growth and negatively affecting the economic and other conditions under which we operate, which may negatively and relevantly affect our business.

i. Risks related to foreign countries where we operate

i.1. Our activities are subject to obtaining and/or renewing permits, concessions and licenses that may not be obtained and/or renewed in many countries to which we export or import goods.

We have foreign subsidiaries with business purpose that are subject to applicable laws in the country where they are established (see section 9.1.c).

i.2. Variations in demand for refined copper from China could adversely and significantly affect our business.

China has become the largest consumer of refined copper in the world. Adverse changes in the Chinese government’s political, economic, legal and other policies may undermine China’s economic growth, which could negatively and significantly affect the demand for refined copper in that country.

The eventual slowdown in China’s economic growth could adversely affect the price and volume of our exports and consequently impact our operating performance and our financial results until this volume is eventually allocated to other markets.

i.3. Our exports are subject to risks that may adversely affect our business.

We export products to different regions of the world, subjecting us to some political and regulatory risks, including: exchange controls in the countries where we have accounts receivable; any formal or informal trade barriers, or political incentive or subsidy to producers in different regions.

Therefore, our future financial performance will depend on the economic and political conditions of our main export markets (e.g. China, Argentina, Singapore, Japan, Belgium, United Kingdom, among others). This way, factors that are beyond our control, such as imposing barriers or granting market incentives and changes in the economic policies of the countries to which we export, may adversely affect our export capacity and, consequently, our business and results.

j. Risks related to social and environmental issues

j.1. Our operations are subject to environmental risks that may cause material contingencies.

All our operations are subject to strict environmental laws and regulations that impose on us a wide range of obligations and responsibilities, including the need to obtain environmental licenses, which must be renewed periodically. The licenses, when issued, establish conditions of their respective licensing bodies that must be met by us. We are also subject to the preparation of environmental impact studies and the holding of public hearings before approving new activities. Future changes in laws and regulations or even the difficulty in complying with conditions and environmental measures that are too expensive can have a significant impact on our activities, leading to the re-evaluation, from an economic perspective, of these activities or even their suspension.

Our activities can generate environmental liabilities related to: (i) the quality of the soil and groundwater in the areas of our projects; (ii) suppression of vegetation; (iii) the disposal of solid waste; (iv) the disposal of effluents; (v) air emissions, among others (see item j.3). The occurrence of environmental liabilities can affect our image and give rise to the imposition of administrative sanctions such as fines and the suspension of activities, and even criminal sanctions such as the arrest of those responsible and the loss or restraint of tax incentives and benefits, as well as the cancellation and/or suspension of credit lines from official institutions regardless of the obligation to repair the damage caused to the environment and affected third parties. These sanctions may have an adverse effect on our operating results.

In addition, our general liability insurance may not cover the payment of the costs involved with the reorganization of these liabilities, which may cause the disruption or suspension of our activities.

We are also subject to the payment of environmental compensation according to the degree of impact of the relevant project, as characterized by the competent body in the environmental licensing process.

j.2. Disagreements with the local communities where we operate may have a negative impact on our business and reputation.

Disagreements or disputes with local groups in relation to our operations, projects and businesses may cause delays or disruptions in our activities, adversely affect our reputation or hinder our ability to conduct our operations. Protesters may act to disrupt our operations and projects, and may adversely affect our business.

j.3. We may incur significant costs to comply or address obligations under laws and regulations on health, safety and the environment.

Our facilities and our activities are subject to strict health, safety and environmental laws and regulations in Brazil. These laws govern, among other things, the disposal and treatment of effluents, use, storage and disposal of controlled substances, waste management, air emissions, water resources management, as well as issues related to the occupational health and safety of our employees and third parties. We are required to obtain and maintain the authorizations and licenses from several national, state and municipal government authorities for many of our operations.

The costs to comply with these requirements can be significant. In addition, failure to meet the applicable requirements, or to obtain permits and comply with the necessary licensing, could result in fines or other administrative or criminal penalties, claims for personal injury and property damage, obligations to remedy the contamination or damage to natural resources or to install pollution control equipment, cancellation or non-renewal of licenses, restrictions or suspension of our operations or the temporary or permanent closure of our production facilities. In addition, failure to comply with stricter foreign environmental laws and regulations may prevent us from seeking low-cost financing from organizations related to development or the government abroad, which may restrict the granting of funding to compliance with more rigorous laws and environmental regulations.

The discovery of soil and water contamination at our facilities or at third-party sites to which we send waste for storage or disposal could result in significant research and decontamination costs. Some environmental laws and regulations may impose liability on owners and/or current and former contaminated property operators, as well as third parties that dispose of hazardous waste at these sites, regardless of knowledge or culpability.

The enactment of new environmental laws and regulations, stricter interpretation, implementation of existing requirements or imposition of obligations under environmental legislation could force us to incur additional costs for compliance, updates or liabilities relating to indemnity claims and/or could limit our operations.

Notwithstanding, the Company’s financial planning for 2019 and subsequent years includes Opex and Capex values for the management of Occupational Safety and Environment activities.

j.4. We may incur air emissions of sulphur and concentration of SO2 in the air quality stations at our unit in Dias d’Ávila (BA).

The production of SO2 is an intrinsic feature of the process of transforming copper concentrate into anodic copper, and the emission of this gas into the atmosphere may occur during an emergency stop and/or through fugitive emissions of SO2 from our unit in Dias d’Ávila (BA). We continuously work on initiatives to mitigate these factors in line with corrective and preventive maintenance scheduled for the units, as well as investments made and planned to control such emissions.

k. Credit risk

Paranapanema is exposed to credit risk related to accounts receivable from customers, financial investments and derivative contracts. The Company limits the risks associated with these financial instruments by allocating them to financial institutions selected by criteria related to rating and maximum concentration percentage by counterparties. In addition, the Company relies on its Credit Committee composed of financial and commercial specialists, who evaluate and monitor customers’ risk, which is obtained through a careful analysis and selection of customers according to their ability to pay, debt ratio and balance sheet, and through the diversification of their accounts receivable from customers. The concentration of credit risk of accounts receivable is minimized due to the diversification of the customer portfolio and granting credit to customers with good financial and operating ratios.

l. Liquidity risk

The Company relies on certain tools necessary to maintain its liquidity level, such as cash management, lengthening of available bank liabilities, reduction of working capital items and sale of non-operating assets. Therefore, the continued credit contraction may compromise access to such tools and the Company’s cash flow performance, as well as its liquidity level.