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QUARTERLY MANAGEMENT REPORT. - Floresteca S/A - Calendar Year rd Quarter (Jul/17 to Sep/17)

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QUARTERLY MANAGEMENT REPORT - Floresteca S/A - Calendar Year rd Quarter (Jul/17 to Sep/17) TABLE OF CONTENTS 1. PROPERTY SUMMARY THINNING & HARVESTING THINNING ACTIVITIES HARVESTING ACTIVITIES FORESTRY MANAGEMENT PRUNING SPROUT CONTROL WEED CONTROL PLANNING AND FOREST DESCRIPTION LOG SALES LOG SALES AND HARVESTING COSTS COMPLIANCE & LEGAL ISSUES PARAISO FARM MUTUM FARM EXECUTIVE OFFICER CHANGE APPENDIX PLANTED AREA PER PROJECT AT END Pg.2 1. PROPERTY SUMMARY Floresteca S/A is located in the State of Mato Grosso, where it manages 17, hectares of Tectona Grandis (Teak), planted on 52, of leased land, and composed of 23 individual farms planted between 1994 and The management objective is to maximize the production of high quality teak round logs for hardwood markets. With the object of gaining long term cost-efficiency and flexibility and securing the highest standards of professionalism in teak plantation management, Floresteca S/A (FSA) has engaged Teak Resource Company S/A (TRC) to perform certain management services to FSA per the Management Services and Timber Purchase and Sale Agreement (MSA), put in effect in March of The information shown herein is on calendar year basis (January to December), although, the forestry activities run on an agricultural year basis (July to June). Pg.3 2. THINNING & HARVESTING This section segregates activities of thinning from final harvesting THINNING ACTIVITIES In accordance with the 2017 Management Plan the Mutum 2007 (MUT) and São José 2007 (SAJ) farms are to be thinned in Both areas have reached 18 m²/ha of basal area, which indicates they are reaching competition stage. This is the second thinning of these farms and the objective of the operation is to reduce the number of trees per hectare from 430 to 250. Due to operational constraints, the thinning operation in Mutum began one month earlier than planned, starting in December 2016, and was finished in mid-january of The map below presents the stands thinned in blue, totaling 220 hectares. It represents site class I areas, where growth is higher and, need to be thinned first. The operation on the remaining stands was postponed to the next year due to operational constraints. Map 1: YTD Thinning per stand, Mutum 2007 The thinning at the São José farm (map 2) started in February and were completed during 1S2017. Pg.4 Map 2: YTD Thinning per stand, São José 2007 All production from the thinning on these farms was sold as short logs (2.3m). Only logs above 18 cm at the small end have commercial value to be exported or processed in a sawmill. Below 18cm, the logs only have value as firewood, and are left on site, where they may be sold when dry, and depending on market demand for biomass energy. Production in both Mutum and São José are finalized for HARVESTING ACTIVITIES Floresteca started the final harvest on some of the oldest projects in June By the end of 2016, the Silas and K_8 projects had been harvested completely, while the operation at Pimental began in September This is the most important operation in the lifecycle of the project, as it is when the most valuable timber and most of the revenues are generated. The selection of which areas to be harvested is done through an optimization process, which considers the expected future growth and revenues for different harvesting age alternatives, while respecting important operational and market constraints. During this quarter, the operation in Pimental meant to be finalized and continuing in Buriti. Both projects are being harvested at the same time, generating a favorable product mix, coming from forests with distinct growth patterns. After finishing Pimental, which should happen in October, we will start harvesting Cocal. Pg.5 Map 3: YTD Final Cut per stand, Buriti 1994 The Pimental farm (map 4) had all hectares harvested this year. Map 4: YTD Final Cut per stand, Pimental 1996 The stands 001A, 001B, 002, 026, 027, 027A and 027C were performed in Pg.6 3. FORESTRY MANAGEMENT The maintenance and general management fees agreed between Floresteca S.A. and SATT are USD 4,500 for a 20-year rotation project and USD 6,375 for a 25 year rotation project (Agreed Fees) for all activities after year 8. Most of the maintenance and general management activities have been outsourced to TRC though the Management Services Agreement put in place in March 2017, to lower the per hectare costs for FSA, (TRC operates at a larger scale, as it also provides services to additional international clients, as well as possessing specialized know how in teak planation management). The combined costs for maintenance and general management by Floresteca S.A. and TRC are capped at the Agreed Fees level. The main groups of silvicultural activities are pruning, sprout control and weed control, which will be described hereunder. Table 1 below shows the activities performed and number of hectares on which they were performed for each individual farm until the 3 rd quarter of Table 1 YTD capital forestry activities, per forest. Pg.7 3.1. PRUNING Pruning aims to eliminate the branches of the trees that do not contribute to its growth, as well as to reduce the formation of knots. This activity is very important in the determination of future wood quality, and results in a better shape and marketability of the logs, The most relevant pruned areas this quarter were in Cacimba and Paraíso farms, finishing all stands, and the younger plantations (2005, 2006) in Duas Lagoas. Map 5: YTD Pruning per stand, Cacimba 2002 and Map 6: YTD Pruning per stand, Paraíso 1997 Pg.8 Map 7: YTD Pruning per stand, Duas Lagoas 2005 and SPROUT CONTROL With the opening of the canopy following thinning, the stumps of the removed trees tend to re-sprout and may result in competition with the remaining crop trees. Sprout control involves eliminating sprouts from thinned trees, allowing the remaining trees to grow without additional competition. The most relevant areas performed are shown below: Map 8: YTD Sprout Control per stand, Cacimba 2002 and 2003 Pg.9 Map 9: YTD Sprout Control per stand, Duas Lagoas The younger part of the farm (2005 and 2006), on the lower right part of the map, was done completely. On the older part (center of the map), this activity was performed only on the stands with high incidence of stumps sprouting, Map 10: YTD Sprout Control per stand, BAM 2000 So far, 4 stands in Bambu farm were finished. The operation will be completed, including 1999 stands on the last quarter of this year. Pg.10 3.3. WEED CONTROL Weed control consists in the prevention of infestations of invasive plants to avoid competition for resources, such as sunlight, nutrients and water. The activity is normally done manually, and can be chemical (with dorsal spray tanks) or mechanical (hoe and/or sickle). This operation can also be done to clear the understory to facilitate traffic for our field crews inside the forest prior to significant operations. All farms illustrated here below are cases of mowing to improve conditions for the harvesting team. The most relevant areas performed this quarter are presented in detail in the maps hereunder: Map 11: YTD Weed Control per stand, Pimental 1996 Stands were done prior to final harvesting. Map 12: YTD Weed Control per stand, Buriti 1994 Stands were done prior to final harvesting. Pg.11 Map 13: YTD Weed Control per stand, Cocal 1996 and 1998 Stands were done prior to final harvesting, which will begin on the coming quarter. Pg.12 4. PLANNING AND FOREST DESCRIPTION Intentionally left blank no changes from the Management Plan 2017 Pg.13 5. LOG SALES 5.1. LOG SALES AND HARVESTING COSTS The Year to Date sold volume equals to 47, m³ with a weighted average price (at roadside) of USD 111/m³. The time difference from forwarding to sales is at least of 30 days for drying and loading. Table 2 YTD Sales (volume & values) FC = Final Cut 2T = Second thinning FS = Phytosanitary Gross Revenues = revenues before applicable costs including: Harvesting costs FC (cutting, forwarding, making land root free) Agreed maintenance and general management fees; Incentive fee of 5% to FSA; Applicable local taxes. W.A. Price = Weighted Average for the price of sales, equals to the total revenue divided by the total volume sold. The considerable variation observed in the weighted average prices per m³ reflects both the mix and timing of the harvesting operations occurring year to date. In projects like SIL and PIM, for example, where final cuts are occurring, unit prices are higher, with a greater share of large diameter logs, whereas at MUT and SAJ, where second thinning are taking place, unit prices are lower, reflecting mostly smaller diameter logs. It should be also noted that the revenue and price figures shown here are partial and reflect activity in the current year only. Final gross revenue and average prices per project take into consideration all revenues over the life of each project. Log prices are determined based on roadside prices in Mato Grosso. As the market for teak logs is largely private and fragmented, Floresteca has contracted Consufor, an independent forestry services firm, to provide a benchmark roadside pricing report for teak log sales in the Mato Grosso region. The reports are done quarterly, the latest of which dated October All were based on based on a sample of respondents, most which are forest owners, but also included some sawmills and traders. Below we show the prices for all quarters (prevailing at the beginning of each period): Pg.14 Figure 1: CONSUFOR average Teak Prices in Mato Grosso (USD/m³) Prices of larger diameter logs (most of which represent later thinnings and final harvest logs, have remained steadier, with some appreciation in the largest diameter grades (following a drop in 2Q vs Q1 2017). Note that logs below 25 cms in diameter have experienced price compression over the course of This is large due to the fact that the logs are from thinnings (so have less heartwood, and are accordingly discounted) and compete with logs from Central America which have greater logistics advantages. Most of these logs are sold in the local market to sawmills, as their export would not be economic. Table 3 YTD harvesting costs (FX 3.168) Activity Actual cost BRL Actual cost USD Total 3,868,166 1,221,012 Volume Sold 47,261 47,261 Cost / m³ Pg.15 6. COMPLIANCE & LEGAL ISSUES 6.1. PARAISO FARM Issue 1: Floresteca has received a legal challenge by Mr. Antonio Frigieri, the owner of the Paraíso Farm ( plaintiff ), in a declaratory procedure, requesting the end of the usufruct rights with immediate effect. After being subpoenaed by the Mato Grosso State Court, which held that the plantation area was considered abandoned, the court issued a preliminary decision in August 2016 granting land possession to the plaintiff. However, the preliminary decision did not consider the Usufruct Agreement void, and Floresteca challenged the preliminary decision in the Mato Grosso Superior Court. In May 2017, the Superior Court reversed the initial decision in favor of Floresteca, who has been granted the right to continue with the Usufruct. Following the court decision and after a relatively short disturbance in the work planning, the maintenance teams of FSA were able to resume activities at Paraiso again MUTUM FARM Issue 1: Mutum farm was invaded by the MST Landless Movement -in The owner of the property (LHS) filed a court order to remove the squatters (in 2011). The judge ruled in favor of the LHS (in June, 27, 2011). The MST has repeatedly invaded the property over time, motivating the hiring of a private security guard. Issue 2: In 2012, the National Agrarian Reform Institute -INCRA, initiated an administrative process aimed at the expropriation of the property, alleging that the property was not being used productively. In (March 27, 2012) LHS filed for a withdrawal of the process in the Federal Court, Cáceres-MT. In (March, 28, 2012), the judge decided to suspend INCRA s administrative procedure. Subsequently, in (January 09, 2015) a technical opinion declared the property as productive. A Court Hearing is scheduled for November 9th, 2017, where FSA s testimonies will be heard to clarify the facts. After that, the judge will issue a final decision EXECUTIVE OFFICER CHANGE FSA has hired Glenn Peebles III as Vice-President since 1 st May, 2017 in substitution of Sylvio Coutinho Neto. The latter became member of the non-executive board. Pg.16 7. APPENDIX 7.1. PLANTED AREA PER PROJECT AT END 2016 Total Managed Project Area SATT 1994 BUR 592,29 592, K SIL COC 374,88 374, PIM 698,26 698, T EM 191,42 191, PAI 297,92 210, PAR 555,05 512, BOC 431,65 426, COC 133,84 133, PAI 93,95 93, CAN 44,62 44, ST J 26,76 26, SIL 24,41 24, VDO 351,68 351, ARA 98,88 78, BAM 549,07 400, BOC 108,18 108, CPB 507,87 507, CAS 88,49 84, SER 105,01 104, VDO 48,59 48, BAM 513,83 404, DLG 1527, , DLG 2136, , SMG 97,52 93, BAR 970,2 756, CMB 571,08 445, DLG 48,41 48, SMJ 1085, , SMG 5,71 4, BAR 12,95 10, CMB 10,19 8, ST F 2562, , SMJ 207,87 207, BAR , T ST 1143, , DLG 207,67 170, DLG 233,88 190, MUT 539,18 522, SAJ 301,3 290, SMJII 99,87 89,88 Total 18798, ,57 Pg.17
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