Before taking any investment decision, the potential investors should carefully consider all the information, financial or not, available in the website of the Brazilian securities commission (Comissão de Valores Imobiliários), or CVM, and in this website, especially the following factors. Lupatech’ business, financial condition, results of operations may be materially adversely affected by any of these risks, and as a result, the securities issued by the Company may also be negatively affected. The risks described below are those known by Lupatech, and are just examples. The company believes that in the case one any of them happens eventually, they may affect the Company relevantly. Additional risks, not known today by Lupatech or irrelevant risks may also affect its business.
Risk factors that may influence the investment decision
a. Related to the Company
- Our revenues depend largely on the investments and operating expenses of exploration and production companies (E & P), the largest portion of which is concentrated in Petrobras, which accounts for a significant portion of our revenues. Expenses and requests from E & P companies may be delayed, reduced or canceled, which could have a material adverse effect on our business.
We are a manufacturing and service company mainly for the oil and gas sector, with direct exposure to the development and production phases. The development stage is the construction of the infrastructure, which, when completed, will allow the production of oil and gas, and the production of the oil and gas extraction stage, for which we provide infrastructure maintenance services, as well as the sale of spare parts. A significant part of our sales is tied to the projects of a major client, Petrobras, directly or through companies that provide services to it. If E & P companies, especially Petrobras, reduce their expenses and investments or cancel, reduce or delay our orders, our ability to generate revenues could be compromised, resulting in significant adverse effects.
- We produce high technology and highly customized manufactures, and for this reason, we are subject to operational risks related to the use of our manufactures with critical applications of high operational risk, as well as risks related to large accidents or casual losses and limits of our insurance coverage, which may adversely affect our results.
Some manufactures and services offered by us, by reason of their nature, carry an inherent and significant risk of civil liability for damages to third parties. For example, our valves are used on oil production platforms and production lines of companies. Failure to operate these valves can result in major losses, such as large accidents or casual losses, and the corresponding obligation to compensate for the damages caused. A significant contingency associated with a failure in one of our manufactures may adversely affect us.
In addition, we may not be able to obtain insurance for all risks involved in our operations because of the lack of coverage available in the market or because of the high cost of such coverage.
We maintain insurance contracts in different modalities, required or not by law, such as civil liability policies and damages caused by fires, explosions or lightning strikes. However, the occurrence of losses or other liabilities that may not be covered by such policies or that exceed their limits may entail significant additional costs, which may not adversely affect us.
- Our growth strategy provides for capital investments that will require financial resources that we may not have access to, which may adversely affect us.
Our growth strategy may require significant capital expenditures in our business and operations. If we do not earn sufficient revenue, cash and cash generation from our operations and require financing, we may have limited capacity to obtain the capital needed to support our future operations.
We can not assure you that sources of funds will be available, in acceptable terms or in any terms, to us in the future, and when necessary. If access to the limited or the cost of financing increases, our operations may be adversely affected.
Future financing, if available, may result in increased interest and amortization expenses, increased leverage levels, and reduced available resources to finance our growth. If we are unable to generate or obtain additional capital in the future, we may be forced to reduce or delay our capital outlays, sell our assets or restructure our indebtedness, any of which may adversely affect our business and our financial condition.
- Our overall level of indebtedness is significant. and the Company has been in Judicial Recovery since May 2015, where the reversal of this situation depends on the success of the Company's and its Subsidiaries' restructuring plans, as well as compliance with the judicial recovery plan.
Our level of indebtedness is due to the financing obtained for the execution of a growth strategy, either through acquisitions or expansion of industrial capacity, favored by an international credit context fed at very low rates, before the international crisis of 2008, where the digestion of so many acquisitions proved harder than anticipated.
Predicted synergies did not materialize, resulting in lower than expected profitability, while interest rates began to rise, the Real depreciated, and the price of oil fell.
Together, our main client Petrobras also faced its own difficulties, greatly reducing its level of offshore and offshore activity, and in this way we began to face difficulties in honoring financial commitments, culminating in Judicial Recovery.
In order to reorganize and honor liabilities, we will need to comply with the proposal for a judicial reorganization plan, where, among the transformations, we mainly require the sale or demobilization of oil services activities and activities abroad, through a more economical alternative than market conditions allow, and concentration of activities in manufacturing, accelerating the activity of our manufacturing plants in Brazil.
- We depend on our ability to update ourselves and develop technological improvements to successfully meet the needs of the segments in which we operate.
The segments in which we operate are subject to rapid and constant technological advances. Our positive results depend on our ability to continue to develop improvements in our processes and products and provide customers with innovative solutions that respond to rapid changes in technology standards and market expectations in general. If we are not able to develop technological improvements and new technological standards or we are not successful in acquiring new technologies, either due to inability to obtain resources, closing partnerships or retaining and hiring qualified personnel, in a timely and affordable manner, we may lose market share and be adversely affected.
- We may not be able to maintain or hire a sufficient number of qualified personnel for the development of our business, which may adversely affect our results.
Given the high technology content coupled with our manufacturing and services, and the importance of our business relationships with our key customers, our ability to become productive and profitable will depend significantly on our ability to attract, train and retain qualified executives and employees development of our business. The demand for skilled workers is high and supply is extremely limited in Brazil, especially during periods of high activity in the oil and gas sector. The increase in wages paid by our competitors may reduce our labor or increase the labor costs to be paid by us, or both. In addition, the lack of skilled labor could adversely affect the development of our activities, including technological improvements and new technological standards. Turning away or losing strategic people services and the inability to attract, train and retain a sufficient number of qualified personnel can have a significant adverse impact on our business.
- We can be hampered by the absence of financial protection policies.
The nature of our operations exposes us to fluctuations in various currencies. However, we do not use financial instruments and physical delivery contracts to protect our exposure to such risks. With the non-use of hedge operations, we are more susceptible to currency volatility and commodity prices than our competitors who engage in hedge transactions.
Such risks may have a material adverse effect on the results of our operations and on our financial condition. Our inability to pass on these unplanned increases or operating costs to our customers may materially and adversely affect the results of our operations and our financial condition.
- We are and can be part of judicial, administrative and arbitration proceedings that, depending on the results, may adversely affect us.
We are, and may in the future, be party to various proceedings at the judicial and administrative levels, including civil, labor, tax, environmental and / or criminal proceedings, as well as arbitration proceedings. We can not guarantee that the results of these proceedings will be favorable, or even that it will have provision, partial or total, for all liabilities arising from these processes. Decisions contrary to us that eventually achieve substantial values or impede the conduct of our business may adversely affect us.
- The calculation method of our EBITDA (Adjusted EBITDA) may not represent our financial performance.
EBITDA (Adjusted EBITDA) is not a measure of financial performance and should not be considered as an alternative to net income (loss), as an indicator of operating performance, as an alternative to operating cash flow, or as an indicator of liquidity.
We calculate EBITDA as net income before income tax and social contribution, financial income (expenses) and depreciation and amortization (Adjusted EBITDA as adjusted EBITDA for extraordinary and non-recurring expenses or revenues or non-operating). Because our EBITDA calculation does not consider income tax and social contribution, financial income (expenses), depreciation and amortization (and in the case of Adjusted EBITDA, we also do not consider expenses and extraordinary or non-recurring income or non-operating expenses ), EBITDA (Adjusted EBITDA) is characterized as an indicator of our overall operating economic performance, which is not affected by changes in income tax and social contribution rates, fluctuations in interest rates or depreciation and amortization levels.
Also, our independent auditors do not review, approve or issue any opinion on how to calculate our EBITDA (Adjusted EBITDA). Therefore, our EBITDA (Adjusted EBITDA) should be read in conjunction with the other financial information, financial statements and the explanatory notes contained in this Reference Form.
For more information on our EBITDA (Adjusted EBITDA), see section 3.2. of the Reference Form.
- Exposure to obligations and contingencies of acquired companies
The acquisitions present a risk of exposure to the obligations and contingencies of the companies or assets acquired, due to previous acts of management and liability previously incurred. The process of duediligence. In the event of significant contingencies arising from acquisitions that have not been identified or which, even identified, lead to losses in amounts higher than those obtained in the debt settlement process, these may adversely affect our activities and results.
- The combination of certain risks led our auditors to raise doubts about the continuity of our operations.
The risks mentioned above, especially those that address the difficulty in generating cash, coupled with the fact that we have generated recurring losses and the fact that the Company and its subsidiaries have entered the judicial recovery process, led our independent auditors to include in the report on audit of the financial statements a paragraph of emphasis indicating the existence of significant uncertainty that may raise doubts as to the Company's ability to continue operating.
- Delays in the mobilization of contracts can negatively impact on fines, penalties and / or cancellation of contracts applied by clients.
The risks mentioned above may cause the Company's inability to mobilize the equipment and contracts won together to its clients, generating significant negative impacts of fines, penalties and / or cancellation of the contracts to be applied by the customers.
- The lack of certifications or certificates related to our companies or industrial units may prevent the supply of goods and products to important customers
Some of our customers require their own or third party certifications to purchase our products or services. Such certifications may involve diverse and constantly changing aspects, from production, legal, financial or taxation. Notoriously, Petrobras certifies its suppliers according to several of these aspects and requires that not only its direct purchases, but also those of its subcontractors, be made to certified suppliers.
The various certifications can be canceled for a variety of reasons and the company may be unable to provide substantial volumes, materially affecting its result and business plan. We do not always have control over the events that may lead to the eventual suspension of certificates, and the rectification or mitigation of problems can lead to materially relevant times.
- Constriction of assets or resources by third parties may affect our ability to operate or the continuity of our business
The company has a large number of administrative and judicial disputes in the civil, labor and tax areas. Judicial Recovery offers certain protections against the possibility of constriction of assets or financial resources, but these protections are often ignored by certain courts that, for example, block property values and assets. When these determinations confront legal order, we are led to take legal action that may take a long time to produce the necessary effects, and we may not have the desired successes. The extent, proportionality and duration of such measures is unpredictable and may have significant impacts on the company. and in their operations.
b. Related to our controller, direct or indirect, or control group
Not applicable, since we have diffuse control, not having controlling shareholder or control group.
c. Related to our shareholders
- We may not pay dividends or interest on shareholders' equity to our shareholders.
In accordance with our by-laws, we must pay our shareholders 25% of adjusted annual net income, calculated and adjusted pursuant to Law 6404/76, as amended ("Brazilian Corporate Law"), in the form of a dividend or interest on capital. For more information, see item 3.4 of this Reference Form. Net income may be capitalized, used to offset impairment, if any, or retained, as provided for in the Brazilian Corporation Law, and may not be made available for the payment of dividends or interest on shareholders' equity.
Pursuant to the Brazilian Corporation Law, dividends may not be paid to shareholders in any fiscal year if our Board of Directors decides that such payment would be inadvisable in view of our financial situation. Should this occur, the holders of our shares may not receive dividends or interest on capital.
- The relative volatility and limited liquidity of the Brazilian securities market may substantially limit the ability of investors to trade in our shares.
Investment in securities traded in emerging markets, such as Brazil, is often more risky compared to other global markets, and such investments are generally considered to be more speculative. The Brazilian securities market is substantially smaller, less liquid and more concentrated, and may be more volatile than the major global securities markets, including the United States and Europe.
These market characteristics may substantially restrict investors' ability to trade in our shares at the price and at the time they wish, which may adversely affect our shareholders.
- We may need resources in the future, which may not be available. Obtaining additional funds, as well as the conversion of the convertible debentures into shares already issued, may dilute the investor's interest in our capital stock.
We may need additional capital in the future, which may not be available on favorable terms or under any condition. We may have to raise additional funds in the future through operations of public or private issuance of shares or securities convertible into or exchangeable for shares. Any fund raising through the public distribution of shares or securities convertible into shares may be carried out to the exclusion of the preemptive right of our shareholders, which may result in dilution of the shareholding of the current shareholders.
d. Related to our subsidiaries and affiliates
- Losses in civil, labor and tax lawsuits related to San Antonio
With the acquisition of the San Antonio Companies the Lupatech group was victimized by hundreds of civil, labor and tax lawsuits. Such actions may result in losses to the company. which we may not be able to recover, either partially or in full, from the former shareholders of the San Antonio group.
- Loss on sales of assets used in service operations
When we discontinued our oil service activities, the equipment used was idle and was made available for sale. We can realize losses with these assets from the most diverse causes, for example and without limitation to:
• Deterioration due to lack of use and maintenance
• Theft or depredation of the equipment by the invasion of the places where they are stored
• Costs and fines for non-compliance with temporary admission regimes
• Costs for import, re-export or destruction of obsolete equipment
• Inexistence of stakeholders in the acquisition of equipment
• Costs for storing and storing equipment
e. Related to our suppliers
We can depend on suppliers for obtaining parts, equipment and raw materials that are fundamental to our business. Any problems related to the provision of these items could adversely affect our business.
We rely on suppliers to obtain essential parts, equipment and raw materials for our business units, which are mostly certified by competent entities or by our own final customers. These suppliers may encounter difficulties in supplying such materials due to various factors such as unanticipated demand from other customers, equipment malfunction and quality or yield problems, delaying or impeding demand satisfaction. Still, the price of the raw materials used by our suppliers could increase, generating the need to increase the prices of our products as well. If we are not able to pass on the increase in these prices, our business could be adversely affected.
Our business may be significantly and adversely affected if one or more of the suppliers are also significantly interrupted in our operations, affecting the quality, availability or timely delivery of parts and equipment. Due to the dependence of certain suppliers, we may not be able to get the parts or equipment you need in our operations in sufficient quantity, with good quality and on reasonable terms. Difficulties with suppliers can also cause loss of revenue, extra manufacturing costs and delays, adversely affecting our business.
Due to the financial difficulties and the Judicial Recovery situation, many of our suppliers have been harmed and will only receive their credits through the regulations and compliance with the judicial recovery plan, which may weaken our business relationship and lead to a disruption in the regular supply or cancellation of sales.
f. Related to our customers
- Cancellation or reduction of orders by our largest customer, as well as our inability to provide manufacturing and services to our customers, may adversely affect us.
Our business, for the most part, assumes long-term relationship with customers and continuous participation in the development of new manufacturing and services. Our manufacturing and services have important characteristics such as extensive specifications and development, investment maturity and operational cycle. The competitiveness we are subject to is based on the ability to offer manufacturing and services with cost, quality and deadlines compatible with customer demand. For this reason, if some competitor is able to offer products in more competitive or higher quality conditions than our manufactures and services, we may have difficulties in finding new markets in a short enough time to avoid an adverse effect.
g. Related to the sectors of the economy
- The sectors in which we operate, mainly oil and gas and industry in general, both internationally and in Brazil, may face downswing periods, which could adversely affect our business.
The sectors in which we operate, mainly oil and gas and industry in general, both internationally and in Brazil, are historically characterized by periods of contraction of available supply, price increases and high margins alternated with periods of excess capacity, declining prices, and low margins Historically, these industries have faced downswing periods, which usually leads to a reduction in planned investments and postponement of expansion projects.
The oil and gas sector depends on investments that are linked to the financial capacity of oil and gas companies, which take into account economic, political and environmental conditions, as well as variables such as the price of a barrel of oil.
Industry in general depends on the national and global economic situation, which enables the investments in capacity expansion and maintenance of industrial parks, which benefit us.
A shrinkage in the international or Brazilian economies, especially in the oil and gas sectors, of industry in general, could negatively affect the demand and sales of our manufacturing and services, causing a decrease of our current production and the development of new manufactures and services , which could adversely affect us.
- Changes in environmental, safety, and health laws and regulations may adversely affect us.
Our activities are subject to strict environmental legislation at the federal, state and municipal levels regarding, among other things, the disposal of solid waste and discards of liquid, industrial and sanitary effluents, and require authorizations and licenses from governmental agencies. In the event of violation or non-compliance with such laws, regulations, licenses and authorizations, we may be subject to administrative sanctions, such as fines, revocation of authorizations and licenses, temporary or permanent ban, or we may be subject to criminal sanctions (including our administrators), which, like administrative sanctions, may be aggravated by recidivism, irrespective of the obligation to repair or indemnify, in the civil sphere, damages caused to the environment and to affected third parties. We may also be required to bear substantial corrective environmental expenditures. In accordance with applicable Brazilian law, there is no limitation on the amount of compensation due in relation to environmental liability.
In addition, environmental legislation imposes objective civil liability in the event of degradation to the environment. In this way, we can be held liable, regardless of guilt or fraud, for any damages caused to the environment in the exercise of our activities - even if the person directly responsible for the execution of the activity is outsourced - or in an earlier period - in the case of an environmental liability concerning the place of accomplishment of the activities.
In addition, government agencies or other authorities may also edit new stricter rules or seek more restrictive interpretations of existing laws and regulations, which may force us to spend additional resources on environmental suitability. Any action in this direction by government agencies may adversely affect us.
- Our business will depend on the development and production activities of the oil and gas sector in Brazil, which is significantly affected, among other factors, by the volatility of oil and gas prices.
Lowering these prices may reduce demand for our manufacturing and services and adversely affect our business.
Our business depends significantly on the level of activity of the oil and gas sector, particularly in Brazil, particularly the investments of oil and gas companies in offshore exploration, development and production operations. The level of investment generally depends on future oil and gas prices, which are influenced by a number of factors that affect the supply and demand for oil and gas, including but not limited to:
Lower oil and natural gas prices, or estimates of price reductions, may cause oil and gas exploration and production companies to cancel or reduce their activities. In addition, there are several other factors that may affect investment decisions, including unsuccessful exploration activities. As oil and gas prices decline, the exploration and production of E & P companies, the demand for the manufactures and services we intend to offer may decrease, causing a material adverse impact on our activities.
- Strong competition in our sectors may reduce our future profitability and weaken our financial situation.
We estimate the entry of new competitors due to the recent discoveries in the pre-salt area and due to the governmental incentives for the development of the sector. In this way, we expect to operate in the future in a highly competitive environment. We estimate to compete in terms of price, quality of services provided and availability of manufactures and services. Significant changes in the incentives to concentrate investments for the exploration, development and production of oil and gas in Brazil, as determined by the ANP in promoting the local content policy may increase the competition in the future before we are able to obtain levels of productivity. This competition may force the price reduction of our manufacturing and services, which may negatively impact revenues and profitability. If we are not able to face such competition, our profitability may be reduced, which would have an adverse effect on our business.
- Cheaper imports from other countries can adversely affect our business and our market share.
Cheaper imports from other countries, especially China and India, can adversely affect our business and our market share. Competition from foreign producers is a threat and may increase due to the domestic premium over the international price. Any changes in customs tariffs or protectionist measures may result in a higher level of imports into Brazil, resulting in domestic price pressures that could adversely affect our business.
h. Related to the regulation of the sectors of activity
The market in which we operate is not regulated, but we provide manufacturing and services to customers operating in sectors that are regulated by the ANP.
Changes in the regulations of our operating sectors may adversely affect our business. The regulation of the oil and gas sector by the ANP, if changed, for example, in relation to the Minimum Local Content requirements required for manufacturing and services provided for this industry, may affect our business with exposure to this sector.
i. Related to foreign countries
We have operations in Colombia through a joint subsidiary, where changes in tax rules, sector regulation, exchange rate, import and / or export rules, capital repatriation laws, competition conditions, among others may affect our business in this country, and also to us as a whole.
In addition, uncertainty regarding the effective implementation of changes in the policies or standards mentioned above can generate economic insecurity and, consequently, adversely affect us.
If one or more of the risks described above materializes, we may suffer loss of assets, rights or contracts in the affected country, which may also adversely affect us.
Risk factors related to Colombia
Changes in current or future policies, as well as changes in economic policy, may undermine investor confidence and undermine investment, reduce economic growth, and have a concrete negative effect on the Company's business.
- The Company is subject to social, political and economic risks related to its operations in Colombia.
The Company has operations in Colombia through one of its indirect subsidiaries. Thus, its operating results and financial position may be adversely affected by fluctuations in the economy, political instability and local government actions, as well as other risks, including:
• The imposition of exchange controls and prices;
• The imposition of restrictions on exports and imports of natural resources;
• The local currency oscillates against the real and the US dollar.
Macroeconomic Risks
The Federal Government has exercised and continues to exercise significant influence over the Brazilian economy. The political and economic conditions in Brazil have a direct impact on our business, financial condition, results of operations, as well as our outlook on the trading price of our shares. Changes in governments as well as significant changes in monetary, fiscal, credit and other policies and regulations may affect our business.
Inflation
Inflation and certain measures taken by the Federal Government to contain it have historically caused adverse effects on the Brazilian economy and on the Brazilian capital market. High levels of inflation in the future may adversely affect us, especially with regard to raw materials and labor costs, as well as the cost of financing with inflation-linked interest rates.
Perception of Risk
Developments and the perception of risk in other countries, especially in emerging countries, may adversely affect the market value of Brazilian securities and the price of our shares.
Foreign exchange
Exchange rate instability and the appreciation of the real against the Euro, US Dollar and other currencies could have an adverse effect on us. The Brazilian currency has undergone significant variations in relation to the North American Dollar and other strong currencies over the last four decades, due to several pressures. Economic plans were implemented and were based on different exchange rate policies, which resulted in significant variations in the exchange rate between the Real and the US Dollar, for example.
We operate internationally and are exposed to currency risks arising from the exposure of certain currencies, mainly in relation to the US Dollar and the Colombian Peso.
Foreign exchange risk arises from commercial and financial operations, recognized assets and liabilities and net investments in foreign operations. We have certain investments in foreign operations whose net assets are exposed to foreign exchange risk.
Currently, we do not have hedges contracted for our foreign currency exposure, mainly for our indebtedness (loans and financing, convertible debentures, perpetual bonds and derivative losses, current and noncurrent), which at December 31, 2018 was 7.2% (11.5% in 2017 and 14.1% in 2016) denominated in foreign currency. In fact, because they are long-term obligations, the cost of exchange protection is not feasible.
Several exchange protection instruments for shorter-term events require credit limits with financial institutions. Because we do not have such limits, we may not be able to hire the necessary protections even at times where they are necessary or desirable.
Interest Rates
The variation in interest rates may also adversely affect us, as well as adversely affect the trading value of our shares.
Our interest rate risk stems from long-term loans. Loans raised at floating rates expose us to interest rate and cash flow risk. Our variable rate loans are mainly denominated in Reais and are indexed to TR - Referential Rate.
Our interest rate risk is significant only to the extent that it may cause us to increase the cost of our financing. As of December 31, 2018, we had R $ 23.7 million of indebtedness with variable interest rates (R$ 19.11 in 2017 and R$ 15.31 in 2016).
Considering the profile of the Group's indebtedness as of December 31, 2017, the impact on income after the calculation of income tax and social contribution, with a variation of around 0.25 percentage points in variable interest rates, considering that all other variables were kept constant, would correspond to an approximate increase of R $ 32 thousand in the year of interest expense.
Credit Risks
Credit risk arises from cash and cash equivalents, derivative financial instruments, deposits with banks and financial institutions, as well as exposures to credit to customers. Significant changes in the credit conditions related to the aforementioned items may affect us materially, such as the cash and cash equivalents position being reduced by customer default, impairment of funds to financial institutions that could be used to finance our operations, inability to honor commitments related to derivative financial instruments, among others.