U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR (G)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission file number 1-14878
GERDAU S.A.
(Exact Name of Registrant as Specified in its Charter)
Federative Republic of Brazil
(Jurisdiction of Incorporation or Organization)
N/A
(Translation of Registrant's name into English)
Av. Farrapos 1811
Porto Alegre, Rio Grande do Sul - Brazil CEP 90220-005
(Address of principal executive offices) (Zip code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange in
Title of Each Class Which Registered
------------------- ------------------------
Preferred Shares, no par value per share,
each represented by American Depositary Shares New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Securities for which there is a reporting obligation
pursuant to Section 15(d) of the Act:
None
The total number of issued shares of each class of stock of GERDAU S.A.
as of December 31, 2003 was:
51,468,224 Common Shares, no par value per share
96,885,787 Preferred Shares, no par value per share
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark which financial statement item the Registrant
has elected to follow Item 17 Item 18 X.
TABLE OF CONTENTS
Page
INTRODUCTION.............................................................................................. 3
PART I.................................................................................................... 4
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS.................................... 4
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE.................................................. 4
ITEM 3. KEY INFORMATION.......................................................................... 4
ITEM 4. INFORMATION ON THE COMPANY............................................................... 8
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS............................................. 30
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES............................................... 42
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS........................................ 49
ITEM 8. FINANCIAL INFORMATION.................................................................... 51
ITEM 9. THE OFFER AND LISTING.................................................................... 57
ITEM 10. ADDITIONAL INFORMATION.................................................................. 62
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............................. 74
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.................................. 76
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES........................................ 76
PART II................................................................................................... 77
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS............ 77
ITEM 15. CONTROLS AND PROCEDURES................................................................. 77
ITEM 16. AUDIT COMMITTEE FINANCIAL EXPERT........................................................ 77
PART III.................................................................................................. 80
ITEM 17. FINANCIAL STATEMENTS.................................................................... 80
ITEM 18. FINANCIAL STATEMENTS.................................................................... 80
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS....................................................... 80
CERTIFICATION OF CEO AND CFO
INTRODUCTION
Unless otherwise indicated, all references herein (i) to the "Company"
or to "Gerdau" are references to Gerdau S.A., a corporation organized under the
laws of the Federative Republic of Brazil ("Brazil") and its consolidated
subsidiaries, (ii) to "Acominas" are to Aco Minas Gerais S.A. - Acominas prior
to November 2003 when the same company underwent a corporate reorganization,
receiving all of Gerdau's Brazilian operating assets and liabilities and being
renamed Gerdau Acominas S.A., (iii) to "Gerdau Acominas" are to Gerdau Acominas
S.A. after November 2003 and to Acominas before such date, (iii) to "Preferred
Shares" and "Common Shares" refer to the Company's authorized and outstanding
preferred stock and common stock, designated as acoes preferenciais and acoes
ordinarias, respectively, all without par value. All references herein to the
"real", "reais" or "R$" are to the Brazilian real, the official currency of
Brazil. All references to (i) "U.S.", "dollars", "U.S.$" or "$" are to United
States dollars, (ii) "Canadian dollars" or "Cdn$" are to Canadian dollars (iii)
"billions" are to thousands of millions, (iii) "km" are to kilometers, and (iv)
"tons" are to metric tons.
The Company has prepared the consolidated financial statements included
herein in accordance with accounting principles generally accepted in the United
States ("U.S. GAAP"). The investments in Sipar Aceros S.A. in Argentina (in
which a 38% stake is held), in Gallatin Steel Co., Bradley Steel Processor and
MRM Guide Rail in the United States, of which Gerdau Ameristeel holds 50% of the
total capital, the investments in Armacero Industrial y Comercial Limitada, in
Chile, in which the Company holds a 50% stake and the investment in Dona
Francisca Energetica S.A, in Brazil, in which the Company holds a 51.82% stake,
are consolidated using the equity method of accounting.
Unless otherwise indicated, all information in this Annual Report is
stated as of December 31, 2003. Subsequent developments are discussed in Item 8
- Significant Changes.
CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING STATEMENTS
Statements made in this Annual Report with respect to the Company's
current plans, estimates, strategies, beliefs and other statements that are not
historical facts are forward-looking statements about the Company's future
performance. Forward-looking statements include but are not limited to those
using words such as "believe", "expect", "plans", "strategy", "prospects",
"forecast", "estimate", "project", "anticipate", "may" or "might" and words of
similar meaning in connection with a discussion of future operations or
financial performance. From time to time, oral or written forward-looking
statements may also be included in other materials released to the public. These
statements are based on management's assumptions and beliefs in light of the
information currently available to it. The Company cautions potential investors
that a number of important risks and uncertainties could cause actual results to
differ materially from those discussed in the forward-looking statements, so
that you should not place undue reliance on them. Potential investors should not
rely on any obligation on the part of the Company to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise, with the Company disclaiming any such obligation. Risks and
uncertainties that might affect the Company include, but are not limited to: (i)
general economic conditions in the Company's markets, particularly levels of
spending; (ii) exchange rates, particularly between the real and the U.S.
dollar, and other currencies in which the Company realizes significant sales or
in which its assets and liabilities are denominated; and (iii) the outcome of
contingencies.
3
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable, as the Company is filing this Form 20-F as an annual
report.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable, as the Company is filing this Form 20-F as an annual
report.
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
U.S. GAAP PRESENTATION
The selected financial information for the Company included in the
following table should be read in conjunction with, and is qualified in its
entirety by, the U.S. GAAP financial statements of the Company and "Operating
and Financial Review and Prospects" appearing elsewhere herein. The consolidated
financial data for the Company as of December 31, 2003, 2002, 2001, 2000 and
1999 are derived from the U.S. GAAP financial statements.
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
INCOME STATEMENT 2003 2002 2001 2000 1999
--------------- ---------------- ---------------- ---------------- ----------------
Net sales 4,530,969 3,264,926 2,401,138 2,771,376 1,760,693
Cost of sales (3,445,564) (2,349,636) (1,722,228) (2,059,015) (1,141,076)
--------------- ---------------- ---------------- ---------------- ----------------
Gross profit 1,085,405 915,290 678,910 712,361 619,617
Sales and marketing expenses (146,388) (112,645) (105,801) (112,195) (86,007)
General and administrative expenses (241,854) (221,895) (181,108) (213,143) (157,755)
--------------- ---------------- ---------------- ---------------- ----------------
Operating income 697,163 580,750 392,001 387,023 375,855
Interest expense and exchange (gain) loss, (254,763) (424,147) (238,269) (243,477) (222,414)
net
Interest income 62,036 100,350 55,002 57,324 64,166
Other non-operating income (expense) (824) (18,178) (7,853) 2,165 5,196
Equity in earnings (losses) of 22,062 (10,057) 18,324 33,962 (4,903)
unconsolidated companies, net
--------------- ---------------- ---------------- ---------------- ----------------
Income before income taxes and minority 525,674 228,718 219,205 236,997 217,900
interest
Income taxes benefit (expense)
Current (87,812) (27,065) (40,981) (36,725) (17,456)
Deferred 121,925 20,507 (13,666) (8,899) (3,080)
--------------- ---------------- ---------------- ---------------- ----------------
Income before minority interest 559,787 222,160 164,558 191,373 197,364
Minority interest (49,623) 9,667 2,795 (2,815) 328
--------------- ---------------- ---------------- ---------------- ----------------
Net income available to common and
preferred shareholders 510,164 231,827 167,353 188,558 197,692
=============== ================ ================ ================ ================
Basic income per share (i)
Common 1.72 0.78 0.53 0.60 0.64
Preferred 1.72 0.78 0.59 0.66 0.69
Diluted income per share (i)
Common 1.72 0.78 0.53 0.60 0.64
Preferred 1.72 0.78 0.59 0.65 0.68
Cash dividends declared per share (i)
Common 0.40 0.26 0.23 0.21 0.18
Preferred 0.40 0.26 0.25 0.23 0.19
Number of common shares outstanding at
year end (ii) 102,936,448 102,936,448 102,393,253 102,393,253 102,393,253
=============== ================ ================ ================ ================
Number of preferred shares outstanding at
year end (ii) 193,771,574 193,771,574 193,685,184 193,685,184 193,685,184
=============== ================ ================ ================ ================
(i) Per share information has been retroactively restated to reflect
for all periods the effect of: (a) the 2 for 1 stock split
approved in April 2000, (b) the stock bonus of 10 shares for 3
shares held, approved in April
4
2003, (c) the reverse stock split of 1 share for 1,000 shares held, as
approved in April 2003, and (d) the stock bonus of 1 share for every share
held approved in April 2004;
(ii) The information on numbers of shares presented above relates to
the end of each year, and is retroactively restated to reflect
changes in numbers of shares due to the transactions described in
(i) above.
AS OF DECEMBER 31,
----------------------------------------------------------------------------
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
BALANCE SHEET 2003 2002 2001 2000 1999
-------------- ------------- ------------- -------------- -------------
Cash 92,504 40,457 27,832 12,433 9,570
Restricted cash 1,935 15,001 - - -
Short-term investments 236,137 367,748 306,065 290,449 364,492
Net working capital (1) 300,670 (63,579) 250,636 196,596 235,993
Property, plant and equipment 2,304,158 2,084,895 1,384,463 1,542,609 1,568,051
Total assets 4,770,834 4,000,301 2,952,677 3,231,758 3,215,542
Short term debt 798,496 1,104,793 567,491 688,586 655,551
Long term debt, less current portion 1,132,429 794,571 630,636 717,830 739,315
Long term parent company - - 461 77 49,511
Debentures - short term 1,048 - 2,018 2,413 2,505
Debentures - long term 155,420 200,766 94,204 113,349 81,613
Shareholders' equity 1,403,063 865,010 1,032,720 1,065,659 1,022,744
Capital 982,601 843,959 838,214 838,214 836,551
(1) Total current assets less total current liabilities
DIVIDENDS
The Company's total authorized capital stock is composed of Common and
Preferred Shares. As of December 31, 2003, the Company had 51,468,224 Common
Shares and 96,885,787 Preferred Shares issued and outstanding.
The following table details dividends paid to holders of Common Shares
and Preferred Shares since 1999. The figures are expressed in reais and
converted to U.S. dollars on the date of payment. Dividend per share figures
have been retroactively adjusted for all periods to reflect: (a) a 2-for-1 share
split for each share held, approved in 2000, (b) a bonus issue of 3 shares for
each share held, approved in April 2003, (c) a reverse stock split of 1 share
for each 1,000 shares held, approved in April 2003 and (d) a bonus issue of 1
share for each share held, approved in April 2004.
DATE OF R$ PER SHARE (2) R$ PER SHARE (2) $ PER SHARE (2) $ PER SHARE (2)
PERIOD PAYMENT COMMON SHARES PREFERRED SHARES COMMON SHARES PREFERRED SHARES
1st Half 1999 (1) Aug. 03, 1999 0.1212 0.1333 0.0636 0.0729
2nd Half 1999 (1) Feb. 29, 2000 0.1906 0.2096 0.1078 0.1185
1st Half 2000 (1) Aug. 15, 2000 0.1435 0.1578 0.0795 0.0874
2nd Half 2000 (1) Feb. 15, 2001 0.2546 0.2801 0.1285 0.1414
1st Half 2001 (1) Aug. 15, 2001 0.1531 0.1684 0.0612 0.0673
2nd Half 2001(1) Feb. 19, 2002 0.3692 0.4062 0.1523 0.1675
1st Half 2002 (1) Aug. 15, 2002 0.2692 0.2692 0.0844 0.0844
2nd Half 2002 (1) Feb. 18, 2003 0.6269 0.6269 0.1747 0.1747
1st Quarter 2003 (1) May 15, 2003 0.2500 0.2500 0.0853 0.0853
2nd Quarter 2003 (1) Aug. 14, 2003 0.1700 0.1700 0.0564 0.0564
3rd Quarter 2003 (1) Nov. 18, 2003 0.2550 0.2555 0.0867 0.0867
4th Quarter 2003 (1) Feb. 17, 2004 0.5100 0.5100 0.1751 0.1751
1st Quarter 2004 (1) May. 18, 2004 0.3200 0.3200 0.1027 0.1027
(1) Corresponds to payment of interest on shareholders' equity.
(2) From April 2003 onwards, and as result of the reverse stock split of 1
share for 1,000 shares held, approved in April 2003, dividends are quoted
on a per share basis (rather than a per thousand shares basis, as was the
case prior to this date)
5
Law No. 9,249, of December 1995 establishes that a company may, at its
sole discretion, pay interest on stockholders' equity in addition to or instead
of dividends (See "Item 8 - Interest on Stockholders' Equity"). A Brazilian
corporation is entitled to pay its shareholders (considering such payment as
part of the Mandatory Dividend for each fiscal year) interest on stockholders'
equity up to the limit calculated as the TJLP rate (Long-Term Interest Rate) on
its stockholders' equity or 50% of the income for the fiscal year, whichever is
greater. The payment of interest on stockholders' equity as described herein is
subject to a 15% withholding income tax. See "Item 10 - Taxation"
B. CAPITALIZATION AND DEBT
Not required.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not required.
D. RISK FACTORS
The steel industry is cyclical and has experienced a series of crises
over the last few years. In the United States, where a significant portion of
Gerdau's productive assets are located, the steel sector has undergone an
extensive process of reorganization, including buyouts, bankruptcies and Chapter
11 filings. In Brazil, this cyclicality is less pronounced, with risks in that
country relating to domestic market conditions and government decisions.
The relevant risk factors for Gerdau S.A.'s operations relate to scrap,
iron ore, energy and imports, where these exist, as well as Gerdau Ameristeel's
efforts (in North America) to incorporate the productive assets of the former
Co-Steel. There are also political risks.
RISK FACTORS RELATING TO THE COMPANY AND THE STEEL SECTOR
CHANGES IN STEEL SCRAP PRICES AND A REDUCTION IN SUPPLY WOULD AFFECT
THE COMPANY'S PRODUCTION COSTS AND OPERATING MARGINS
The main metallic input for Gerdau's mini-mills is the scrap used in
electric arc furnaces, corresponding to 67.7% of total crude steel output in
2003. Other important raw materials include pig iron, iron ore (used in blast
furnaces and in the DRI plant), and ferroalloys. Brazilian mills normally use a
mixture of scrap and pig iron due to the lower yield of steel scrap in Brazil.
In North America, by contrast, mini-mills normally use 100% steel scrap.
Although international steel scrap prices are essentially determined by
the U.S. domestic market (since the United States is the main exporter of scrap)
scrap prices in the Brazilian market are determined by internal supply and
demand. The price of steel scrap in Brazil varies from region to region, and
reflects regional demand and transportation costs. Gerdau Acominas is the
largest consumer of steel scrap in Brazil, sourcing it from more than 4,000
suppliers. An increase in steel scrap prices and the consequent reduction in the
supply of scrap to Gerdau's units would affect the Company's production costs
and reduce its operating margins. "See Item 4 - Business Overview".
AN INCREASE IN IRON ORE PRICES AND A SUPPLY SHORTAGE IN THE DOMESTIC
MARKET WOULD ADVERSELY AFFECT THE COMPANY'S INTEGRATED PROCESS UNITS
Gerdau Acominas uses iron ore to produce pig iron at its Barao de
Cocais and Divinopolis units, in the state of Minas Gerais. Iron ore is also
used to produce sponge iron at its Gerdau Usiba unit, in the state of Bahia.
These three units represent 12.1% of total crude steel output by Gerdau S.A. and
20% of total production by its Brazilian units.
By contrast, the Ouro Branco mill uses iron ore as its main metallic
input for the production of steel, accounting for 25.3% of total crude steel
output by Gerdau Acominas S.A. The iron ore used is of fine grain quality, and
is transformed into sinter in a sintering unit. An increase in prices and a
shortage of iron ore in the domestic market would adversely affect the steel
producing capacity of Gerdau Acominas' integrated process units and could reduce
profit
6
margins. "See Item 4 - Business Overview".
AN INTERRUPTION IN THE SUPPLY OR SHORTAGE OF ELECTRICAL POWER WOULD
SERIOUSLY AFFECT THE PRODUCTION PROCESS IN THE COMPANY'S ELECTRIC ARC FURNACE
MELT SHOPS
Steel production is an energy-intensive process, especially in melt
shops with electric arc furnaces. For these, electricity represents a
significant cost component, as does natural gas, which is used in certain mills
mainly for reheating prior to the rolling process. The interruption or the
rationing of the supply of electrical power would have a seriously adverse
impact on the production process in the electric arc furnace melt shops, as
these have no alternative energy source. This could cause a reduction in output
until such time as the power supply returned to its normal levels. "See Item 4 -
Business Overview".
RESTRICTIVE MEASURES ON TRADE IN STEEL PRODUCTS MAY AFFECT GERDAU'S
BUSINESS
Gerdau Acominas is a steel producer that supplies both the domestic and
the international markets, exporting to many countries and thus facing
competition from other steel producers, as well as certain periodic restrictions
imposed by importing countries, such as quotas, ad valorem taxes or increases in
import duty, any of which could adversely affect the Company's exports.
In North America, despite the increase in freight costs associated with
the transport of steel bar products, Gerdau Ameristeel and other North American
steel producers have experienced significant competition from cheap foreign
imports. In some cases, these competitors have sold steel products at a
significant discount, with this perceived as unfair competition that has
adversely affected the Company's results. The U.S. Administration has responded
to this disequilibrium situation with administrative measures aimed at restoring
an economic balance and allowing the U.S. steel industry to recover. Future
changes in or the elimination of the same measures may adversely affect the
operations of our subsidiaries in North America.
The U.S. dollar has recently devalued relative to certain European and
Asian currencies. This has acted as a deterrent to what were previously cheap
imports.
THE COMPANY MAY EXPERIENCE DIFFICULTIES IN INTEGRATING ACQUIRED
COMPANIES
During the last few years Gerdau S.A. has expanded through significant
acquisitions, buying Ameristeel in 1999, the Cartersville mill in 2001, a
controlling interest in Acominas in 2002 and completing a reverse takeover, at
the end of 2002, of Co-Steel of Canada, an operation that was limited to an
exchange of shares.
The integration of these businesses and their associated opportunities
also carry risks, including problems in integrating the same businesses, their
management, operations, products, and services with the Company's existing
businesses, as well as related costs which may include unplanned expenses that
are necessary for the achievement of such integration. The completion of these
transactions and the integration process are making significant demands on
management's time. The diversion of management's attention from existing
businesses, as well as problems that may arise in connection with the
integration of the same operations, may have an impact on the revenues and
results of the operations mentioned above.
COMPLIANCE COSTS RELATED TO ENVIRONMENTAL REGULATION MAY INCREASE IF
REQUIREMENTS BECOME MORE STRINGENT
The Company's industrial plants are required to comply with a number of
laws and regulations regarding the environment and the operation of mills at
federal, state and municipal levels in all the countries in which it operates.
If legislation becomes more demanding in the future, expenditure on fixed assets
and the costs of compliance may rise, adversely affecting the Company's
financial condition and the steel sector as a whole. All of Gerdau's units are
currently in compliance with local legislation.
INCREASES IN BRAZILIAN INTEREST RATES AND INFLATION MAY AFFECT THE
COMPANY'S OPERATING RESULTS
Within Brazil, the economic variables that most significantly impact
the Company's financial results are interest rates and inflation. In an
environment of single digit inflation and steadily declining interest rates,
economic risks to its
7
operations are reduced, whereas high levels of interest rates or inflation have
an adverse impact on the same operations, due to the increased cost of servicing
the debt of its Brazilian operating subsidiaries and the likely reduction in
economic activity arising from higher interest rates and inflation. To date, the
government has succeeded in meeting its inflation targets.
CHANGES IN TAX POLICIES, MARKET REGULATION AND THE POLITICAL
ENVIRONMENT MAY AFFECT THE COMPANY'S OPERATIONS
Changes in the tariff policies of utilities, exchange controls,
regulatory policies and taxation in the countries where the Company operates
could adversely affect the Company's business and financial results, as could
inflation, devaluation, social instability and other political, economic or
diplomatic developments. "See Item 10 D - Exchange Controls"
ITEM 4. COMPANY INFORMATION
A. HISTORY AND DEVELOPMENT
Gerdau S.A. is a Brazilian company that was incorporated on November
11, 1961. Its main executive office is located at Av. Farrapos, 1811, Porto
Alegre RS - Brazil, with telephone number: 00-55 (51) 3323 2000.
Gerdau began operating in 1901, with the Pontas de Paris nail factory
in Porto Alegre, Brazil. In 1969, the company changed its name to Metalurgica
Gerdau S.A., and is today a holding company that controls Gerdau S.A. In 103
years of activity, the Gerdau Group has made a seminal contribution to Brazilian
industry.
IMPORTANT EVENTS IN THE DEVELOPMENT OF THE COMPANY'S BUSINESS
In order to compensate for the potential shortage of raw material
immediately after the end of World War II, Gerdau acquired Siderurgica
Riograndense S.A., a steel producer also located in Porto Alegre. In February
1948, the Gerdau Group initiated its steel operations, which foreshadowed the
successful mini-mill model of producing steel in electric arc furnaces (EAF),
using steel scrap as its main raw material. The Company also adopted a regional
sales strategy to ensure more competitive operating costs. Growth in its markets
led the Company to install a second Riograndense unit in the city of Sapucaia do
Sul (in the state of Rio Grande do Sul) in 1957, consolidating the Group's
vocation for producing steel. In 1962, steady growth in the production of nails
led to the construction of a larger and more advanced factory in Passo Fundo (in
the state of Rio Grande do Sul). Gerdau is currently the world's largest nail
manufacturer, with more than 1,000 items available to customers through 100,000
sales outlets.
In 1967, the Company expanded into the state of Sao Paulo, in the
Southeast of Brazil, purchasing Fabrica de Arames Sao Judas Tadeu, a producer of
nails and wires. It was later renamed Comercial Gerdau and became the Brazilian
distribution channel for the Company's steel products, with 68 branches and 5
flat steel service centers strategically located throughout the country.
In June 1969, Gerdau expanded into the Northeast of Brazil, producing
steel at Siderurgica Aconorte in the state of Pernambuco. In 1971 it began to
build the Cosigua mill in Rio de Janeiro, initially as a joint venture with the
German group, August Thyssen Huette. Eight years later, Gerdau became the major
shareholder of Cosigua, which currently operates the largest mini-mill in Latin
America. In December 1971, Gerdau acquired control of Siderurgica Guaira, a
pioneer steel producer in the state of Parana. It also established a new
company, Seiva S.A. Florestas e Industrias, to produce lumber on a sustainable
basis for the furniture, cellulose and steel industries. Since then, Gerdau has
expanded throughout Brazil with a series of acquisitions and new operations,
currently owning 10 steel mills within the country.
In addition to its industrial units and warehouses, Gerdau operates 11
rebar fabricating facilities in Brazil. In January 2003, the Group became the
major shareholder in the Dona Francisca hydroelectric plant (in the state of Rio
Grande do Sul) taking a 51.8% stake in the overall capital of Dona Francisca
Energetica S.A.
8
Gerdau began to expand internationally in 1980, with the acquisition of
the Laisa mill in Uruguay, continuing in 1989 with the acquisition of the
Canadian company, Gerdau Ameristeel Cambridge (formerly Courtice Steel), located
in Cambridge, Ontario. In 1992, Gerdau acquired control of Indac and AZA, in
Chile, merging these into a single company, Gerdau AZA, shortly afterwards. Over
time, Gerdau increased its international presence by acquiring units in
Argentina and most notably, in North America - Gerdau Ameristeel MRM Special
Sections and Ameristeel. In October 2002, Gerdau carried out a reverse takeover,
merging its North American assets with those of the Canadian Co-Steel to create
Gerdau Ameristeel, which is currently the second largest long steel producer in
North America.
After this merger between Gerdau's North American assets and Co-Steel,
the business names of the companies in that region were changed.
On November 28, 2003, Gerdau S.A. transferred its directly and
indirectly controlled operations in Brazil to Acominas, which was renamed Gerdau
Acominas S.A., albeit while maintaining its headquarters in Ouro Branco (in the
state of Minas Gerais). As of the above date, all Gerdau Group steel activities
within Brazil were carried out by Gerdau Acominas, which remains a privately
held company. Gerdau S.A remains a publicly traded company with a controlling
stake in Gerdau Acominas, Gerdau Ameristeel, the two subsidiaries in Uruguay and
Chile, and a 38% stake in the Argentine company, Sipar.
Also in 2003, via its subsidiary Gerdau Acominas S.A., Gerdau S.A.
signed an agreement to acquire the entire capital stock of Margusa - Maranhao
Gusa S.A., located in Bacabeira (in the state of Maranhao), which has an
installed capacity of 200,000 metric tons of pig iron. The acquisition is part
of Gerdau's strategy for supplying pig iron to its mills in the Northeast of
Brazil and exporting any excess output to its North American units. This
investment provides Gerdau with a presence in the important iron ore production
center of Carajas, a strategic source of pig iron with excellent logistics for
supplying both its domestic and its export markets.
Gerdau also owns 11 manufacturing plants in Brazil (Armafer), 6
downstream operations and 8 scrap yards. In South America it owns 3 fabricating
plants in Chile and Uruguay and has a minority interest in a plant in Argentina.
In North America, it has 14 rebar fabricating plants, as well as 12 units that
manufacture higher value-added products and special sections such as super light
beams, elevator guide rails and epoxy coated steel. It also operates 13 steel
scrap recycling operations in North America.
Gerdau began a corporate restructuring in 1995, which it completed in
1997. In this process, the 28 Gerdau group companies were merged, with its six
publicly listed companies consolidated into two: Gerdau S.A. and Metalurgica
Gerdau S.A., resulting in greater stock market transparency.
Gerdau S.A. has been a publicly listed company in Brazil since 1980,
listing its ADRs on the New York Stock Exchange (NYSE) in March 1999. In June
2001, Gerdau joined the Sao Paulo Stock Exchange's Corporate Governance Program
(Level 1). In December of 2002 it was listed on the Latibex section of the
Madrid Stock Exchange devoted to Latin American companies, with its stock traded
in Euros. Gerdau Ameristeel is listed in Canada on the Toronto Stock Exchange.
This steady growth process, which began in Brazil in 1901, has made the
Gerdau Group the 14th largest steel producer in the world in 2003 (according to
Metal Bulletin).
PRINCIPAL CAPITAL EXPENDITURES SINCE 2001
2001 - TOTAL CAPITAL EXPENDITURES: U.S.$ 244.0 MILLION
MAIN INVESTMENTS
The Group's presence in the United States was strengthened with the
purchase of a fifth mill, entailing investments of $ 48.8 million. This plant is
located in Cartersville, Georgia, and has production capacity of 725,000 metric
tons of steel per year, complementing Gerdau Ameristeel's product line. Gerdau
Ameristeel has also increased its range of services to the manufacturing
industry by acquiring an 80% stake in a new downstream unit, Ameristeel Bright
Bar, in Orrville, Ohio, investing some $ 10 million in this acquisition.
9
Gerdau also constructed three new rebar fabricating plants, at the cost
of $ 6.3 million, enlarging a system that adds value to and increases the
productivity of civil construction.
The main highlights in the field of information technology were the
development of global data consolidation systems, and the e-procurement website
for suppliers. A pilot Management Execution System (MES) was installed at the
Cosigua mill for the management of production processes.
The Company's investments in reforestation activities, through its
affiliate Seiva S.A. Florestas e Industrias and its subsidiaries, amounted to $
11.9 million.
MODERNIZATION AND UPGRADING OF INDUSTRIAL PLANTS
Investment in the modernization of industrial plants, which
concentrated on improving melt shops and rolling mills and upgrading
environmental management equipment, amounted to $ 171 million during this year.
Of this total, the Company invested $ 130.8 million in its Brazilian
subsidiaries, and $ 40.2 million in its foreign subsidiaries, mainly those in
the United States and Canada.
BRAZIL
Gerdau Cosigua has carried out a series of investments in order to
complete its product line, including improvements to the continuous casting
system to permit the production of 160 x 160 mm billets rather than 130 x 130 mm
billets, a new exit for wire rod coils on rolling mill number 2, the addition of
equipment to rolling mill number 3 for the production of light profiles and the
installation of a new small profile rolling mill. These improvements at Gerdau
Cosigua represented total investments of $ 20 million.
Other capital expenditures by the Company included the upgrading of the
Gerdau Aconorte rolling mill, at a cost of some $ 10 million, aiding to improve
the performance of the same and reducing its operating costs, investments of $
8.5 million in improving Gerdau Riograndense's melt shop and rolling mill in
order to improve operating safety, reduce metal loss and increase productivity,
as well as the construction of a new rolling mill for Gerdau Acos Finos
Piratini, at a cost of $ 7 million. In addition, investments in its sales
network amounted to $ 5.2 million in 2001. Other domestic capital expenditures
related to improvements in other Brazilian mills.
CHILE AND URUGUAY
At Gerdau AZA's plant in Chile, a new ladle furnace was added to the
melt shop. The profile rolling mill was also modernized in order to broaden its
product line, standardize the use of 130 x 130 mm billets and reduce operating
costs. In Uruguay, Gerdau Laisa installed a Thermex controlled bar cooling
system to add value to its rolled products. Investments in Chilean, Uruguayan
and Argentine subsidiaries amounted to approximately $ 9 million.
CANADA AND THE UNITED STATES
In addition to the investments in the United States mentioned before,
the Jacksonville mill completed improvements to its cooling bed and installed
equipment to improve the quality of its wire rod coils. At the Company's West
Tennessee unit, principal investments included the expansion of the melt shop
water cooling system, new rolling mill equipment and the expansion of the
warehouse. Investments in industrial units in the United States amounted to
approximately $ 24 million.
In Canada, Gerdau Ameristeel Cambridge's rolling mill increased its
range of products, initiating production of 2 1/2 inch channels, aimed at the
manufacturing and construction industries. Gerdau Ameristeel MRM Special
Sections installed a new de-scaling system. Investments in Canadian subsidiaries
during the year amounted to $ 7 million.
2002 - TOTAL CAPITAL EXPENDITURES: U.S.$ 598.0 MILLION
MAIN INVESTMENTS
Gerdau's investment policy has mainly consisted of expanding through
the acquisition of financially distressed companies, albeit with quality
operations. The merger of its North American operations with the former Co-Steel
Corp.
10
in 2002, reflected this policy and resulted in the creation of the new company,
Gerdau Ameristeel, which is the second largest long steel producer in the
region.
In 2002, the Group invested a total of $ 598.0 million, of which 68.9%
in acquisitions of holdings and 31.1% in the modernization of units and the
acquisition of new permanent assets.
The Group became the majority shareholder in Acominas by acquiring
sufficient voting shares to command a qualified majority under the terms of the
stockholders' agreement. At an auction realized in February by Central Bank of
Brazil, the Company purchased a 16.12% stake in the capital of Agropecuaria
Senhor do Bonfim, a company controlled by Banco Economico, for a consideration
of $ 179.0 million. In the same month, The Company concluded an agreement with
Natsteel, a corporate member of the controlling block of Acominas, to purchase
an additional 24.8% stake for $ 226.7 million, which it paid in October. With
these two investments, the Group's stake in Acominas increased to 78.9%, giving
Gerdau important competitive advantages due to operating flexibility and the
privileged location of the mill in Ouro Branco (in the state of Minas Gerais).
The Company also invested in the energy sector, acquiring a 22%
minority stake in the company Dona Francisca Energetica S.A. in December 2002
for approximately $ 6 million. Dona Francisca Energetica S.A. owns the Dona
Francisca hydroelectric plant, which started operations in 2001. Located in the
municipalities of Agudo and Nova Palma in the state of Rio Grande do Sul, it has
power generating capacity of 125 MW.
In order to service the civil construction market, the Group has
invested in the expansion of technologies for boosting on-site productivity,
expanding rebar fabrication services in Brazil, Uruguay and Chile, where it also
began to produce welded wire mesh.
Through its affiliate Seiva S.A. Florestas e Industrias and its
subsidiaries, the Company invested a total of $ 7.8 million in reforestation
activities.
MODERNIZATION AND UPGRADING OF INDUSTRIAL PLANTS
BRAZIL
A rolling mill for heavy structural shapes with an annual capacity of
440,000 metric tons was installed at the Gerdau Acominas Ouro Branco mill, where
the Company also completed the installation of a turbo-generator that will use
the excess gases from the blast furnace production process to generate energy.
In 2002, investments at Gerdau Acominas Ouro Branco mill amounted to $ 66.3
million.
At Gerdau Acos Finos Piratini, the modernization of rolling mill 1 was
concluded at a cost of $ 13.1 million, increasing the surface and the
dimensional quality of medium and heavy bars with gauges over 45 mm and
exceeding the requirements of the German DIN standard.
The improvements at Gerdau Riograndense's rolling mills, entailing
investments of $ 8.2 million, resulted in increased metallic yield and
efficiency of equipment.
Gerdau Cosigua increased its range of products with the manufacture of
light structural shapes for steel structures and roofing. In addition, new exits
were installed in rolling mills 1 and 2 to increase both productivity and
product quality. Galvanization output was also expanded in order to increase
production of agricultural products. Capital expenditures at Gerdau Cosigua
amounted to $20.8 million.
At Gerdau Divinopolis, the drive and electronic control system for the
medium bar rolling mill was upgraded at a cost of $ 2.2 million, improving
equipment performance from 2003 onwards.
In the Northeast of Brazil, the Company invested in (i) the
installation of new equipment at Gerdau Aconorte, upgrading the technology of
its welded mesh factory in order to increase installed capacity and
productivity, and (ii) the installation of a new continuous casting unit at
Gerdau Usiba, to be completed in 2004. This unit is expected to increase the
installed capacity of the melt shop by 20%, as well as improving product quality
and reducing operating costs. Investment in the two units during 2002 amounted
to $ 9.4 million.
11
CHILE AND URUGUAY
In Chile, investments in Gerdau AZA were primarily aimed at optimizing
the productivity of rolling mills, reducing costs and improving product quality.
Improvements in warehouses and product loading ramps optimized operations and
improved customer service. Capital expenditures in Chile during 2002 amounted to
$ 8.4 million.
In Uruguay, investments in Gerdau Laisa, included the refurbishing of
the continuous casting unit, at a cost of $ 2.4 million, to produce larger
section billets (100 X 100 mm to 120 X 120 mm) and improve the productivity of
the melt shop and rolling mill.
CANADA AND THE UNITED STATES
In 2002, capital investment in Gerdau Ameristeel amounted to $29.5
million, relating principally to the improvement of its mills. The most
significant investments in its United States units were (i) in the Cartersville
mill, where the new automated packaging and rolled products inventory area
improved logistics; (ii) in the Charlotte and Knoxville units, where the
implementation of new drive and electronic control systems improved both
productivity and product quality; and (iii) at the Jackson mill, where the
complete refurbishing of the continuous casting unit reduced losses and improved
product quality.
In the Canadian units of Gerdau Ameristeel, the most significant
investment was the installation of a new gantry crane at the Cambridge unit,
which expanded the operating performance of the melt shop.
2003 - TOTAL CAPITAL EXPENDITURES: U.S.$ 312.5 MILLION
MAIN INVESTMENTS
The Company initiated new programs for upgrading technology to meet
domestic demand, most notably at Gerdau Riograndense, Gerdau Acos Finos Piratini
(both in the state of Rio Grande do Sul) and Gerdau Usiba (state of Bahia). Over
the next four years, such investments will boost the production capacity of
Gerdau Acos Finos Piratini from 300,000 to 500,000 metric tons per year. By
2007, Gerdau Usiba will expand its steel production capacity by 20% to 600,000
metric tons per year, and its rolled products capacity by 25% to 500,000 metric
tons per year. Production of sponge iron, one of the main raw materials in the
steelmaking process, will be increased by 33% to 600,000 metric tons per year.
The Company is upgrading data processing systems at its Brazilian
plants by adding several new functions. This new technology should improve
reliability and service for its customers and suppliers, as well as access to
data such as inventory levels and shipping schedules along the whole of the
supply chain.
In the United States, Gerdau Ameristeel increased its output of higher
value added products during the fourth quarter of 2003. It also acquired the
assets of Potter Form & Tie Co., a leading supplier of fabricated rebar and
other materials to the reinforced concrete industry in its region for over
thirty years. This investment adds six units to Gerdau Ameristeel in the United
States: in Belvidere, Urbana and Decatur (Illinois), Madison and Appleton
(Wisconsin) and Eldridge (Iowa).
In January 2003, Gerdau acquired an additional interest in Dona
Francisca Energetica S.A. (DFESA), for a consideration of $ 5.7 million,
increasing its total stake in this company to 51.8%.
MODERNIZATION AND UPGRADING OF INDUSTRIAL PLANTS
BRAZIL
In addition to its wire rod rolling mill, the Gerdau Acominas Ouro
Branco mill also invested in the production of high quality steel: the KR plant,
which reduces sulfur levels in pig iron, reached full capacity in 2003,
improving quality and reducing costs. The Company is also implementing its
dephosphorization project to reduce the level of phosphorus in its steel
products. At the primary rolling mill, the Company is close to completing the
new billet inspection line, which aims to guarantee surface quality. Investments
during 2003 at the Ouro Branco mill amounted to $ 80 million.
Other investments by Gerdau Acominas in its units, which amounted to
$151.9 million, included the following:
12
- Gerdau Acos Finos Piratini concluded the modernization of its medium
and heavy bar rolling mill, increasing quality and exceeding the most
demanding standards of the market. The modernization of the electric
arc furnace in the melt shop, which started in 2003, was completed
early in 2004.
- Gerdau Cosigua invested in improving the efficiency of the mill's
electric arc furnace, increasing its production by 10%.
- Gerdau Divinopolis initiated the construction of a new blast furnace
which will have annual production capacity of 190,000 metric tons and
will replace one of the existing older blast furnaces. The new
equipment is scheduled to begin operating in 2005.
- The Company completed the upgrading of the main equipment of Gerdau
Riograndense's melt shop and bar rolling mill. It also began upgrading
technology at the drawing mill and wire galvanizing areas with a view
to improving product quality even further.
- In the Sao Jose dos Campos unit, the new welded wire mesh factory began
operating in the first quarter of 2004, to service the civil
construction sector. The expansion of the welding products factory will
also be completed at the start of 2004, with improvements in technology
and increased output of MIG wire.
CHILE AND URUGUAY
At the Renca unit of its Chilean subsidiary, the Company is extending
the automation of industrial processes to the profile finishing area. A new
stock and loading warehouse will also optimize product delivery during 2004. The
paving of the scrap yard at the Colina unit has significantly improved the
performance of trucks and equipment, with a consequent reduction in raw material
unloading times. Rebar storage conditions were also improved, maintaining
product quality, reducing costs and increasing loading speed. Investments in
Chilean and Uruguayan subsidiaries amounted to $ 6.9 million.
CANADA AND THE UNITED STATES
Investments in Gerdau's North American subsidiaries amounted $ 59
million in 2003. The most significant investments in North America were:
- Installation of new automated lubrication system for Gerdau Ameristeel
Cambridge's rolling mill guides, leading to increased productivity and
reduced losses in the production process.
- Completion of the first phase of the replacement of the high voltage
system at Gerdau Ameristeel MRM Special Sections and the installation
of a new scrap shearing press.
- At the Cartersville mill, new technologies were installed in the melt
shop: electricity conductor arms and improvements to the injection
system that boosted the performance of the electric arc furnace.
Another important initiative was the implementation of a new stock and
packaging area, improving logistics and customer service.
- Installation of rolling mill drives and control systems at Charlotte,
Knoxville and Whitby units, to increase equipment performance.
- Improvements in the melt shop at the Jackson unit, reducing costs by
expanding the casting area. Investments in backup rolling mill stands
increased equipment efficiency.
- At the Jacksonville unit, investments were made in the carbon and
oxygen injection system, the replacement of the dome roof of the
electric arc furnace in the melt shop and the construction of a new
administrative building.
- The modernization of the continuous casting process at the Perth Amboy
plant, starting in 2003, to improve melt shop operating performance.
- Improvements in the Cartersville rolling mill reheating furnace
improved productivity and product quality.
PRINCIPAL CAPITAL EXPENDITURE CURRENTLY IN PROGRESS
As part of the Gerdau Group's long-term strategy to ensure the growth
of its Brazilian subsidiary, Gerdau Acominas has signed an agreement with the
Votorantim Group, whereby Gerdau Acominas will purchase the real estate and
mining rights of Companhia Paraibuna de Metais, a company with mines in the
state of Minas Gerais. The assets involved in this transaction include 15
extraction concessions located over a total area of 7,000 hectares. According to
partial surveys, these mineral reserves should guarantee the supply of iron ore
to the Ouro Branco steel mill at currently planned production rates for
approximately 100 years. The mines have a privileged location within the iron
belt of Minas Gerais, are close to the Ouro Branco mill and will contribute to
the consolidation of the unit's long-term competitive position. This purchase
should not alter current supply structure, which relies on more than ten
regional iron ore
13
suppliers. The agreed price for the purchase of the real estate and mineral
rights described above is $ 30 million, with $ 7.5 million paid at the signing
of the agreement, 25% paid upon completion of the due diligence process
concluded in May and the remaining 50% due in July 2004.
B. BUSINESS OVERVIEW
Comments in this section are structured in the following order: Brazil,
South America and North America.
Gerdau's strategy concentrates on the decentralized production of long
steel using electric arc furnace (EAF) mini-mills that employ continuous casting
technology. Gerdau Acominas also has four integrated mills. Plants are sized and
located to meet the needs of local markets and provide efficient access to
customers. This strategy is a response to the geographical dimensions of Brazil
and the United States, in the light of high transportation and freight costs.
Gerdau is thus in a position to supply its customers and source raw materials
locally. From 1970 to 1990, Gerdau concentrated on increasing its market share
in Brazil by increasing its installed capacity and by acquiring existing mills,
typically seeking mills with management problems where the Company's main
contribution would be management skills rather than capital. Gerdau Acominas is
currently the third largest crude steel producer in Brazil, accordingly to the
IBS (Brazilian Steel Institute).
Outside Brazil, and notably in North America, Gerdau Ameristeel has
increased its market share by acquiring mills which, like their Brazilian
counterparts, required administrative adjustments rather than capital. Gerdau
has progressively increased its share of the North American market and is
currently the second largest North American long steel producer with nominal
capacities of 5.9 million tons of crude steel per year and 5.5 million tons of
rolled products per year, according to Company statistics. Gerdau's industrial
units are distributed across North America to supply local markets along the
East Coast of the United States. and the East and Center of Canada. Following
the merger with Co-Steel, completed in October 2002, Gerdau Ameristeel has 10
long steel units.
Gerdau also owns three mills in Argentina, Uruguay and Chile. Of
these, the Argentine mill is a joint venture that does not produce crude steel,
in which Gerdau holds a minority stake. The other two mills in Chile and Uruguay
have a combined output of 510,000 tons of crude steel per year. Although these
units make only a minor contribution to consolidated results, they are highly
profitable and efficient.
MAIN CATEGORIES OF PRODUCTS
Gerdau provides its customers with a wide range of products within the
following major lines:
SLABS, BLOOMS AND BILLETS
Products such as billets, blooms and slabs have relatively low added
value. Billets are Gerdau Acominas' main products, with blooms and slabs
produced in smaller quantities.
Billets: Billets are square section, long steel bars which serve as
inputs for the production of wire rod, rebars, merchant bars, shapes,
etc.
Blooms: Blooms, which are also square in shape, are wider but shorter
than billets, and are used to manufacture products such as springs,
forged parts, shapes and seamless tubes.
Slabs: Slabs are short, narrow bars, similar to billets in length that
are used to produce hot and cold coils, heavy slabs, profiling and
oxy-cutting, etc.
These products may be cast using different processes, such as
continuous casting, mechanical cutting or oxy-cutting, or may be cooled
in molds using a conventional casting system that employs cooling beds.
Although this conventional system is not widely used in Brazil, it is
still employed at Gerdau Acominas' Ouro Branco mill. This may represent
a competitive advantage, since Gerdau Acominas is the only company
manufacturing these products and thus has captive customers.
14
COMMON LONG ROLLED PRODUCTS
Rolled products represent a major portion of Gerdau's production. In
2003, common steel rolled products accounted for 66.4% of the Group's
consolidated sales (41.5% by non-Brazilian companies and the remaining 24.9% by
Gerdau Acominas, with 16.0% going to the domestic market and 8.9% to exports).
The main rolled products include rebars, merchant bars and profiles.
DRAWN PRODUCTS
Drawn items represent higher added value products with higher margins.
Drawn products include barbed and barbless fence wires, galvanized wires,
fences, concrete reinforcing wire mesh, nails and clamps. Drawn products account
for 5.8% of the Company's consolidated sales. These products are not exported
and are usually sold to the industrial, civil construction and agricultural
sectors.
SPECIALTY STEEL
Specialty or high-alloy steel requires advanced manufacturing processes
and normally includes some degree of customization. Gerdau produces specialty
and stainless steel used in tools and machinery (e.g. cold, hot and high-speed
steels), chains, fasteners, railroad spikes and special coil steel at its Gerdau
Acos Finos Piratini plant.
In the United States, Gerdau Ameristeel MRM Special Sections produces
special section profiles such as grader blades, smelter bars, light rails, super
light I-beams and elevator guide rails with direct applications in the
production line of its clients at lower operating costs.
FLAT PRODUCTS
The Gerdau Acominas Ouro Branco mill (formerly Acominas) produces
slabs, the input for flat steel coils, and other flat steel products. In 2003,
flat steel products accounted for 7.5% of this mill's total production. Gerdau
Acominas' retail division, Comercial Gerdau, resells flat steel products
manufactured by other Brazilian steel producers, also adding value through
additional processing for flat steel clients at its 5 flat steel service
centers.
With the incorporation of the former Co-Steel mills and its joint
venture (Gallatin, Kentucky), Gerdau Ameristeel acquired the ability to supply
flat steel to its customers. The Gallatin mill is a 50%-50% joint venture with
Dofasco, Canada, a leading flat steel producer, and has nominal installed
capacity of 1.4 million metric tons of flat steel per year.
LIST OF PRODUCTS
CIVIL CONSTRUCTION
GG-50, CA-60 and CA-25 concrete reinforcing bars (rebar) Annealed wire
Ribbed reinforced concrete Transfer bars POP prefabricated light
columns and meshes Truss reinforcing for concrete beams Stirrups
Fabricated rebar Prefabricated footing
INDUSTRIAL PRODUCTS Hot rolled flat, round and square bars
Cold drawn round, square and hexagonal bars
Blooms
Angles
Channel, I-beams, T-Shapes and W-beams
Ribbed T profile
Elevator guide rails
15
Star profiles
Slabs
Tribar
Wire rod
Billets
Prefabricated warehouse
Structural shapes
SPECIAL SECTION PROFILES (MANUFACTURED IN CANADA)
Grader blades
Smelter bars
Light rails
Superlight I-beams
Elevator guide rails
METALLURGY
Complete line of wires for industrial applications, welding
and wire ropes
AGRICULTURAL PRODUCTS
Oval-shaped wire and barbed wire
Gripple joiner and tensioner
Staples for fences
Cercafix post-spacing wire
Wire and posts for electrified fences
Wire rope for corrals Wire and wire rope for agricultural products
Galvanized wire
Plastic-coated galvanized wire
Arcorfix and tutor - products for fruit crops
Steel post
Nails
Bulk nails - construction
Bulk nails - carpentry
Bulk nails - packaging
SPECIALTY STEEL
Round and square rolled bars
Wire rod
Forged bars
Cold-finished products
With or without heat treatment
Tools Steel
Forged bars and blooms
Round, square and flat rolled bars
STAINLESS STEELS
Round and square rolled bars
Wire rod
Forged bars
Cold-finished
PRINCIPAL MARKETS IN WHICH THE COMPANY COMPETES
The three main markets in which Gerdau operates are: (i) construction,
to which it supplies rebars, merchant bars, nails and meshes; (ii)
manufacturing, to which it supplies products for machinery and agricultural
implements, tools and other industrial products; and (iii) other markets, to
which it supplies wires and posts for agricultural facilities and reforestation
projects. In North America, Gerdau Ameristeel MRM Special Sections also supplies
customers with special
16
sections, including elevator guide rails and super light beams. Gerdau provides
its customers with higher added value products at 28 rebar fabricating
facilities (11 Armafer service centers in Brazil, 3 in South America and 14
Fabshops in North America) and flat steel service centers (5 in Brazil).
SEASONALITY OF THE COMPANY'S MAIN BUSINESS
The Company's sales are not subject to significant seasonal variation.
Its performance is more dependent on the development of the segments that
compose the Gross Domestic Product of countries in which Gerdau operates. Within
Brazil, second and third quarter shipments tend to be stronger than those in the
other two quarters. In North America, demand is influenced by the winter, when
consumption of electricity and other energy sources (i.e. natural gas) for
heating increases and may be exacerbated by adverse weather conditions,
contributing to increased costs, decreased construction activity and hence lower
Company sales.
SOURCES AND AVAILABILITY
Gerdau's production processes are mainly based on the mini-mill
concept, with mills equipped with electric arc furnaces that can melt steel
scrap and adapt the same to the specifications of the required steel product.
The principal raw material used at these mills is essentially steel scrap (100%
in the US) and a mixture of pig iron and steel scrap in the Company's Brazilian
mills that may be varied in accordance with price and availability at the time
of production so as to optimize raw material costs. In this way, the ratio of
steel scrap to pig iron may be varied from 60%-40% to 90%-10%.
As mentioned above, The Company's mills in the United States use 100%
steel scrap. With steel scrap prices exceeding acceptable levels however, these
mills are seeking alternative sources of inputs. One of these is the pig iron
from the recently acquired Margusa, a pig iron producer in the Northeast of
Brazil located close to the coast and the local sea port with installed plant
capacity of 200,000 metric tons of pig iron per year. Gerdau intends to use
Margusa's output to supply its plants in the Northeast of Brazil, with the
balance to be exported to Gerdau Ameristeel plants in the United States.
The Company's Brazilian mills use scrap and pig iron purchased from
local suppliers. The Company believes that this strategy minimizes
transportation costs. Gerdau Acominas has a network of 4,000 scrap suppliers
that deliver their materials to the Company's yards and believes that it is the
largest buyer of scrap in Brazil. The pig iron used in the electric arc furnaces
is produced at Gerdau Acominas's pig iron mill, located in Contagem, in the
state of Minas Gerais, part of which is sourced from other companies. In 2003,
Gerdau Acominas produced 32% of its pig iron requirements internally.
Due to the nature of the raw materials employed, Gerdau Acominas does
not use long term supplier contracts. Its mini-mills purchase their scrap
directly on a demand basis using mainly obsolescence scrap. Scrap and other raw
materials are priced in reais so that input prices are not directly affected by
currency fluctuations.
Due to its size, Gerdau Acominas' Ouro Branco mill has a different
strategy for sourcing raw materials, establishing long-term contracts to ensure
supply. The unit's main raw materials include: (i) coal, imported from Canada,
Australia and the United States; (ii) ferroalloys, of which at least 90% is
purchased in the domestic market; and (iii) iron ore, the most strategic raw
material, which is sourced both from large mining companies and from small and
medium suppliers strategically located close to the plant. These three inputs
account for more than 60% of all purchases by the plant.
In South America, Gerdau AZA, like Gerdau's other mills in Brazil, does
not maintain long-term contracts with suppliers and is thus exposed to market
fluctuations. There are approximately 300 steel scrap suppliers in Chile. In
Uruguay, Laisa purchases all of its steel scrap in the domestic market, and is
the only significant buyer of steel scrap in Uruguay, purchasing 48,000 tons of
scrap in 2003.
Gerdau Ameristeel has consistently obtained adequate supplies of raw
materials at competitive market prices, permitting efficient mill operations.
Gerdau Ameristeel is not dependent on any one supplier as a source for any
particular material and believes there are adequate alternate suppliers in the
marketplace, in the event that it needs to replace an existing one. Gerdau
Ameristeel operations also include 13 scrap recycling operations that provide
flexibility in sourcing scrap.
17
METALLIC INPUTS
Gerdau's main metallic input is steel scrap, which is used in electric
arc furnaces. Pig iron, iron ore (used in blast furnaces and in one DRI plant),
and ferroalloys are also important. Its Brazilian mills use a mixture of scrap
and pig iron, due to the low yield of steel scrap in Brazil. In North America,
by contrast, mini-mills normally use 100% steel scrap.
Although international steel scrap prices are determined by the U.S.
domestic market (as the United States is the main exporter of scrap), the price
of steel scrap in Brazil varies from region to region and is influenced by
regional demand and transportation costs. Gerdau Acominas is the largest
consumer of steel scrap in Brazil with over 4,000 scrap suppliers.
SCRAP
There are two broad categories of steel scrap: (i) obsolescence scrap
representing steel from various sources, ranging from tin foil cans to car
bodies and white goods and (ii) industrial scrap representing factory steel
cookie cutouts, steel turnings, and even scrap generated by the Company's own
production processes. Gerdau Acominas mainly uses obsolescence scrap. By
contrast, North American plants use mainly industrial scrap.
In Brazil, the highest proportion of the steel scrap consumed by Gerdau
Acominas is sourced in the state of Sao Paulo, the balance being evenly
distributed among the other areas in which the Company mills are located.
Obsolescence scrap is delivered directly to mills by scrap suppliers. In regions
where it does not have a steel mill, the Company has yards where scrap is
collected and compacted for transportation by third parties. The price of scrap
in Brazil varies by region, depending upon local supply and demand and
transportation costs. Each month, on the basis of market conditions, the
Company's purchasing officer sets the maximum price for scrap (by type of scrap
and region) to be paid by Company representatives. Due to the large number of
consumers and thus fierce strong competition between them, prices tend to be
higher in the Southeast, the most industrialized region of Brazil. Given that
the Company's facilities are evenly distributed throughout Brazil, however,
Gerdau Acominas is able to take advantage of lower prices in other regions
without incurring high transportation costs.
A leader in steel scrap recycling in Latin America, Gerdau Metalicos,
the business unit that collects and supplies scrap to industrial units,
reutilizes millions of tons of Brazilian scrap every year, accounting for
significant gains through process optimization, reduced energy consumption,
increased productivity and increasingly competitive operating costs. It should
be noted that a ton of steel produced from scrap requires only one third of the
power needed to generate one ton of steel from iron ore. Gerdau Metalicos
purchases scrap directly from companies across Brazil, through a network of over
4,000 suppliers that generates thousands of jobs. Gerdau Metalicos has stowage
yards (collection points) for scrap in strategic locations throughout Brazil and
uses several moving presses that travel around Brazil, preparing scrap for
transportation to its mills. Every Gerdau Metalicos industrial unit has a
recycling yard with state-of-the-art equipment to process scrap using presses
and stationary and mobile shears. The Company also has two shredders, including
the megashredder at Gerdau Cosigua, in Rio de Janeiro, capable of processing 300
cars per hour.
The price of scrap in Chile varies according to demand, transportation
costs and by region. Gerdau AZA is the largest scrap consumer in Chile, using
some 70% of the scrap generated in the country. The scrap used by Gerdau Laisa
in Uruguay is 90% obsolescence scrap delivered to the mill by scrap dealers.
Steel scrap is Gerdau Ameristeel's primary raw material and represents
around 40% of its cost of sales, depending on the mill and product mix. Scrap is
a commodity whose availability varies with price, and is a major constraint on
the company's operations. Gerdau Ameristeel's Jackson and Jacksonville mills
both have on-site dedicated scrap processing facilities that supply a
significant proportion of their requirements. Gerdau Ameristeel MRM Special
Sections receives a significant amount of its scrap from the Mandak and Porter
scrap collection and processing yards. Gerdau Ameristeel has a total of 13 scrap
recycling locations, although since not all of the scrap that it consumes is
sourced from its own scrap yards, it buys its residual requirements in the
market either directly or through dealers who source and aggregate scrap.
All of Gerdau Ameristeel's production facilities in North America are
mini-mills whose operating results are closely linked to the cost of steel scrap
and scrap substitutes, the primary input for the mini-mill facilities. Steel
scrap prices are relatively higher during winter months due to the impact of
weather on collection and supply efforts. Realized selling prices for end
products cannot always be adjusted on a short-term basis to recover the cost of
increases in steel scrap prices, but generally reflect increases or decreases in
these prices. Approximately half of all steel products in North America are
currently made in electric arc furnaces using steel scrap. The increasing rate
of steel scrap consumption has
18
placed upward pressure on the price of steel scrap. The availability and prices
of scrap are subject to market forces and government regulation that are largely
beyond the company's control, including demand from North American and
international steel producers.
PIG IRON AND SPONGE IRON
Brazil is a net exporter of pig iron. Most Brazilian pig iron is
produced in the state of Minas Gerais by a large number of small producers. Pig
iron is a natural substitute for scrap, and in Brazil, is mixed with scrap due
to the low quality of the existing scrap supply. Mills in the U.S. operate with
100% scrap loads. In Brazil, the price of pig iron is related to the cost of
charcoal, an important input and the most volatile cost item in the production
of pig iron. When the price of charcoal is seasonally high, coking coal can be
used as a substitute which, although more expensive, provides a higher yield in
pig iron production. Iron ore, the main component of pig iron, is widely
available in Brazil, which is among the world's leading producers and exporters
of iron ore. Approximately 68% of Gerdau Acominas' pig iron requirements for the
electric arc furnaces (EAF) are purchased from other companies, with the Company
seeking to preserve the flexibility resulting from a large number of suppliers
in order to avoid excessive dependence on a small number of large suppliers.
The Company produces sponge iron at its industrial plant in the state
of Bahia (Gerdau Usiba), whose entire production is used internally to
manufacture steel products.
The Company does not have any Brazilian contracts for the supply of pig
iron, negotiating directly in the spot market to agree amounts and delivery
conditions. The price of pig iron may fluctuate in line with its international
market price, given that approximately 60% of production is exported.
In Chile, Gerdau AZA sources pig iron from Compania Siderurgica
Huachipato, located 550 km to the south of Santiago, in accordance with its
needs and the specifications of the steel to be produced.
IRON ORE
Gerdau Acominas uses iron ore to produce pig iron at its Barao de
Cocais and Divinopolis mills, in the state of Minas Gerais, and sponge iron at
its Gerdau Usiba mill, in Bahia.
By contrast, its Ouro Branco mill uses fine grain quality iron ore as
its main metallic input for steel production, transforming this ore into sinter
at a sintering unit. Ore lump is directly loaded into the blast furnace and
pre-reduced iron ore pellets are added to increase productivity. These raw
materials are purchased from suppliers located close to the mill to reduce
transportation and stowage costs. In 2003, the consumption of these three inputs
(sinter, ore lump and pellets) amounted to 1.6 tons per ton of pig iron
produced. The molten pig iron produced in the blast furnace was the main raw
material used in the melt shop in 2003, representing 84 % of metallic inputs,
with steel scrap representing 11% of inputs, and cold pig iron 5 %.
OTHER INPUTS
In addition to scrap, pig iron, sponge iron and iron ore, Gerdau
Acominas uses other inputs in steel production, such as ferroalloys, electrodes,
furnace refracting materials, oxygen, nitrogen and other industrial gases and
limestone, albeit in smaller amounts. All of these inputs are readily available
in Brazil. Additional inputs associated with the production of pig iron are
charcoal, used at blast furnace mills, and natural gas, used at the DRI unit.
At the Ouro Branco mill, important raw materials and inputs also
include coal, iron ore and pellets. Coal is employed in the production of coking
coal, the main agent in the reduction of sinter, which is injected directly into
the blast furnace in powdered form to reduce consumption of the same and
consequently the cost of pig iron production. Iron ore and pellets are also
employed in pig iron production.
Ferroalloys are used to produce steel with special properties for use
in specific applications. Oxygen, nitrogen, and argon are also used in some
production processes and are sourced from an on-site supplier. In addition,
gases generated in the production of coking coal, pig iron, and steel are
cleaned and used to generate electric power at the Ouro Branco mill.
19
In Chile, some inputs, such as electrodes, refractories, ferroalloys
and limestone are imported, mainly from Brazil and Argentina. Other materials,
such as oxygen, nitrogen and natural gas are purchased in the local market.
The Company's North American operations also use additional inputs.
Various domestic and foreign firms supply other important raw materials or
operating supplies required for the business, including refractories,
ferroalloys and carbon electrodes that are readily available in the open market.
In the past, Gerdau Ameristeel has obtained adequate quantities of these raw
materials and supplies at competitive market prices that have permitted
efficient mill operations. The company is not dependent on any one supplier as a
source for any particular material and believes there are adequate alternative
suppliers available in the marketplace if the need arises to replace an existing
one.
ENERGY
Steel production is an energy intensive process, especially in EAF
mills. Power and the natural gas used in some mills is a significant component
of steel production costs.
With the exception of the Ouro Branco mill, Gerdau Acominas' mills
purchase power and natural gas through long term supply contracts between each
of the 9 units in Brazil and the authorized public utility in their respective
regions, of which they are captive customers. Demand and consumption is agreed
by the parties on an annual basis. The Brazilian Federal Government, through its
agency ANEEL (National Electric Energy Agency), determines the tariffs that each
authorized public utility company may charge, which vary according to consumer
class (commercial, industrial, residential) and level of demand (tension and
volume). Following the passage of Law No. 9,074 on July 7, 1995, consumers with
demand levels that exceed 3,000 KW (kilowatts) and tensions of over 69 KV
(kilovolt) may buy electric power from concessionaires in other regions. Any
interruption in the supply of electricity to Gerdau may have a negative impact
on the Company's business.
In the event electricity is interrupted, no alternate energy options
are available at most Gerdau mills due to the high volume and tension required
for the operation of these plants. In such cases (as occurred in 2001 in Brazil,
when consumption targets were defined by the federal government), the events and
their consequences are discussed with the respective energy concessionaires,
with operating capacity kept at emergency levels to protect staff and equipment.
In the event of rationing, decisions and norms will be implemented by
the Government's regulatory agency and may have a materially adverse impact on
the Company's results, with a consequent reduction in production in accordance
with the availability of electricity and readjustments in the delivery schedule.
Although these problems are not common in Brazil, some small units of Gerdau
Acominas may choose, as an alternative, to use generators to compensate for the
energy shortage. In 2001, during the period of electric power rationing, Gerdau
overcame the crisis by reallocating production among several industrial units,
and by rationalizing the use of electricity. These measures resulted in
efficiency and productivity gains, and were incorporated into the production
process even after the end of the critical period.
By contrast, Gerdau's Ouro Branco mill is practically self-sufficient
in power, with internal generation, including the output of its three
turbo-generators and the blast furnace's top rotor shaft, supplying 76% of the
power requirements of the unit.
In Chile, Chilectra Metropolitana S.A. is the current supplier of
Gerdau AZA on a long-term contract basis. In 2003, electricity accounted for
approximately 12% of production costs. Another important energy input is the
natural gas supplied by Metrogas S.A., also on the basis of long-term contracts.
In Uruguay there is only one power supplier, and since Gerdau Laisa is the
largest consumer in that country it is able to negotiate fair prices for the
energy it purchases. In 2004 Gerdau Laisa will replace fuel oil with natural
gas.
Electricity and natural gas together represented approximately 20% of
Gerdau Ameristeel's conversion costs (excluding raw material expenses). Free
access to competitively priced electric power and natural gas represents an
important competitive cost advantage to a mini mill. Although deregulation of
both natural gas and wholesale electricity may provide opportunities for lower
costs resulting from competitive market forces, the prices of both of these
energy inputs have recently become more volatile and may remain so.
20
INFORMATION ON THE EXTENT OF THE COMPANY'S DEPENDENCE
The Company is not dependent on patents or licenses, industrial,
commercial or financial contracts (including contracts with customers or
suppliers) or new manufacturing processes that are material to the Company's
business or profitability.
The Company has a policy of diversifying its suppliers, so that it can
replace these in the event of breach of contract without affecting the Company's
operations.
Gerdau S.A. holds contracts with a series of electricity suppliers
and is not dependent on any single contract. (Regarding energy supply, see Item
4B - Business Overview). In addition, all of Gerdau's industrial units in
Brazil, have energy supply contracts in which they qualify as "Captive
Consumers" including them within the "Energy Regulation Mechanism" which, in
event of a supply shortage by the original supplier, provides for supply by
other utilities included in the "Brazilian Interconnected System" without any
extra charges to the consumer.
MARKETING CHANNELS
Gerdau S.A. sells its products in various markets, including construction,
manufacturing industry and other products. Sales by its Brazilian operations
include both domestic and export sales. Most of the sales by its business
operations in North and South America are aimed at their respective local
markets.
CONSOLIDATED NET SALES REVENUE BY MARKET
In thousands of U.S. Dollars
------------------------------------------------------------------------------
2003 2002 2001
------------------------------------------------------------------------------
CONSTRUCTION 1,539,278 1,469,217 1,137,081
MANUFACTURING INDUSTRY 2,911,496 1,567,164 1,065,753
OTHER 80,195 228,545 198,304
TOTAL 4,530,969 3,264,926 2,401,138
------------------------------------------------------------------------------
CONSOLIDATED SHIPMENTS BY REGION
In thousands of tons
------------------------------------------------------------------------------
2003 2002 2001
------------------------------------------------------------------------------
TOTAL 11,453 8,971 6,839
BRAZIL 6,639 5,778 4,206
Domestic 3,376 3,874 3,416
Exports 3,263 1,904 790
NORTH AMERICA 4,466 2,884 2,294
SOUTH AMERICA 348 309 339
BRAZILIAN OPERATIONS
In 2003, the Company's Brazilian operations through Gerdau Acominas,
accounted for 58% of overall group shipments. Brazilian sales amounted to 6.6
million tons, of which 3.4 million tons to the domestic market and 3.2 million
tons to the export market.
The Company's segment operations in Brazil consist of: Long Steel,
Gerdau Acominas and Specialty Steel. Each segment operation is divided into
Business Units, which are defined by product line or market characteristics,
with the aim of establishing commercial strategies for the domestic market. Its
Brazilian Long Steel operation consists of the following Business Units:
GERDAU CONSTRUCAO CIVIL (GC) - CIVIL CONSTRUCTION
GERDAU INDUSTRIA (GI) - INDUSTRIAL
GERDAU PRODUTOS AGROPECUARIOS (GPA) - AGRICULTURAL PRODUCTS
GERDAU PREGOS (GP) - NAILS
GERDAU PRODUTOS METALURGICOS (GPM) - METALLURGICAL PRODUCTS
GERDAU EXPORTACAO (GEX) - EXPORTS
COMERCIAL GERDAU (CG) - RETAIL
21
Each Business Unit (Area de Negocios) has national coverage with a
unified sales policy and local execution. Business Units with the most sales to
a particular customer are allocated responsibility for Company relations with
that customer. Approximately 25% of the production negotiated by Business Units
is distributed through Comercial Gerdau, its largest distribution channel with
68 stores all over Brazil, which serviced 135,000 customers in 2003. This
network is also supported by 6,000 independent distributors, resulting in
comprehensive national coverage. Sales through its distribution network and to
final industrial and construction consumers are channeled through Company
employees and authorized representatives working on a commission basis. The
Company provides these representatives with product catalogs and computer
terminals linked to Gerdau's information system (Internet and SAP R/3), as well
as fax and telephone equipment.
In order to minimize delays, Gerdau Acominas delivers its products
directly to customers, through third-party companies under the supervision of
the Gerdau team. Sales trends in both the domestic and export markets are
forecast monthly on the basis of historical data for the three preceding months.
Gerdau Acominas uses its own information system to remain informed of market
developments so that it can respond swiftly to fluctuations in demand. Gerdau
considers its flexibility in shifting between markets and its ability to monitor
and adapt to changes in demand, so as to maintain minimum inventory levels, as
keys to its success.
The Ouro Branco mill has some specific characteristics relating to its
operations that arise from the fact that its products are normally sold to
rolling mills and other companies that use slabs, blooms and billets as raw
material for manufacturing finished products such as springs, structural and
forge products. Clients of this unit are thus larger than other customers
serviced by Gerdau Acominas units, except for those of Gerdau Acos Finos
Piratini. The Ouro Branco mill delivers its products directly to its costumers.
The Specialty Steel segment represents the operations of the Gerdau
Acos Finos Piratini mill, whose sales and production are independent of the
Brazilian Long Steel operation. The segment concentrates on specialty steel for
mechanical construction, tools and stainless steel products. 80% of its output
is used in the automotive segment. In order to meet the continuous need for
innovation, Gerdau Acos Finos Piratini is constantly developing new products in
partnership with its customers, such as high cleanliness steels for application
in bearings, steel for off-shore cables, and stampable steel for screws.
Within the Brazilian market, 49.4% of sales were made to the Southeast,
including the most economically developed states of Sao Paulo and Rio de
Janeiro. The South of Brazil, where Gerdau Riograndense and Gerdau Acos Finos
Piratini are located, accounted for 28.7% of Gerdau Acominas' domestic sales in
2003. Sales to the South, Southeast and Northeast represented 91.4% of domestic
sales by the Group's Brazilian operations.
RETAIL
Through Comercial Gerdau, and its network of 68 stores and 5 flat steel
service centers, Gerdau Acominas sells its products throughout Brazil. In
addition to Gerdau products, Comercial Gerdau resells flat products of
third-party producers. In 2003, domestic market sales of flat steel products
amounted to 322,600 tons.
EXPORTS
In the past, Gerdau has only exported its surplus output, on the basis
of its policy of giving priority to local markets. Since 2003, due to the
consolidation of its Brazilian operations and a decline in the domestic market
together with better international prices, this has changed. Last year, exports
accounted for 49% of Gerdau Acominas' total shipments. The Company's export
marketing activities are coordinated by the Business Unit responsible for
selling the Company's exportable products and are conducted (i) primarily on a
FOB (Free on Board) basis, (ii) on a cash basis against letters of credit from
customers in more than 30 countries and (iii) directly to clients in neighboring
countries and indirectly through trading companies.
Although Gerdau Acominas deals primarily in commodity products such as
rebars, it is aware of the importance of quality control. In order to ensure the
satisfaction of final users around the world with products purchased indirectly
from Gerdau Acominas, the Company's technicians visit clients on an occasional
basis to check the quality of the products that it ships.
22
Due to its emphasis on exports, Gerdau Acominas Ouro Branco mill sells
its output in the form of billets, blooms and slabs and since 2002, heavy
structural shapes. Billet sales in 2003 amounted to 1,888,000 tons, while slab
sales amounted to 179,600 tons, bloom sales to 92,300 tons and structural
products to 33,300 tons. A significant portion of the output of the Ouro Branco
mill is assigned to Asian markets. Even after the temporary imposition of
tariffs on steel imports as a safeguard measure under Section 201, the Company
continued to supply the U.S. market, since no tariffs were imposed on the import
of billets and the quotas established for flat steel were sufficient to ensure
the maintenance of supply. Most of Gerdau Acominas' Ouro Branco mill sales to
foreign markets are made directly (approximately 80% of overall shipments by
this unit).
FOREIGN OPERATIONS
Within South America, Gerdau AZA sold 292,600 tons of finished products
in 2003, representing a 10.2% increase compared to 2002. In the merchant bar
segment, Gerdau AZA has a market share of more than 50%. Rebar sales to the
construction sector increased in 2003, with the Company holding a 50% share of
this market. In 2003, rebar demand increased by 7.4%, due to important
investments in infrastructure. Since the end of 2000, Gerdau AZA has had a
business unit known as AZAonLine, which services customers in Chile through the
Internet. This was the first e-commerce initiative in the steel sector in Chile.
Customers can now follow their orders on the Internet, together with product
inventories, credit and payment status. They can also access their purchase
records, generate quality certificates and place orders.
Gerdau Laisa, in Uruguay, has 300 registered customers that may be
classified as retail, wholesale and consumers, which distribute Laisa's products
all over the country. Uruguayan customers may also use an e-business channel.
Among Gerdau's South American subsidiaries, Gerdau AZA in Chile uses a
network of 150 independent distributors to sell its products. Gerdau Laisa, in
Uruguay, sells its products directly to small-consumers at varying retail
prices.
Gerdau's foreign operations are intended to supply their respective
domestic markets, with the exception of the Canadian operations, which sell most
of their production in the United States.
In general, employees of the Tampa sales office centralize and process
sales of mill-finished products to U.S. customers, while employees in the Whitby
sales office centralize and process sales to Canadian customers. Gerdau
Ameristeel also has sales offices in Perth Amboy, which process sales of rods,
and Selkirk, which process sales of special sections.
The relevant sales offices are responsible for booking orders, mill
scheduling and inventory management. Gerdau Ameristeel has about 50 employees
dedicated to marketing and sales, a quarter of which are located in the field,
near its customers. Every Gerdau Ameristeel sales representative has immediate
access to inventory and production schedules at all mills, enabling them to
provide customers with `one-stop shopping', as well as to service the needs of
customers from the most convenient and/or cost effective source within the
company.
In general, sales representatives at the relevant facilities of Gerdau
Ameristeel process sales of cold drawn, rod and super light beam products. The
fabricated rebar and elevator guide rails are sold through a bidding process in
which employees at the facilities work closely with each customer to establish
their product requirements, shipping schedule and price.
TERMS OF SALES
Gerdau Acominas' Brazilian domestic sales are usually made for 21-day
settlement, on a CIF (Cost Insurance and Freight) basis. Domestic customers
making purchases in excess of a certain monthly limit are subject to a
centralized credit approval process. As a result of these policies, the
Company's bad debt write-offs (which are made after 12 months) are an
insignificant percentage of its consolidated accounts receivable. At Gerdau
Acominas Ouro Branco mill, payment of domestic purchases is on a cash basis (or
within 7 days) on account of its specific business characteristics. Deferred
payment through bank draft is also accepted. Sales to foreign markets are
settled using letters of credit.
Gerdau Ameristeel's credit terms to customers are generally based on
market conditions and customary practices. Gerdau Ameristeel's business is
seasonal with orders in the June and September quarters tending to be stronger
23
than those of the March and December quarters, due primarily to weather-related
slowdowns in construction activity.
All Gerdau companies (in Brazil and abroad) accept both immediate and
deferred payment for purchases of their products, the latter in accordance with
ordinary commercial terms used in each region, determined on a seasonal basis.
COMPETITIVE POSITION
Shipping, freight and demurrage costs are a major barrier to
imports, and since Gerdau Acominas operates primarily in the common long rolled
product business where profit margins are relatively small, the incentive for
foreign competitors to enter the Brazilian market is low. In the domestic
market, no single company competes against Gerdau Acominas across all its
product range. Gerdau Acominas believes that its business diversification and
decentralization provide a competitive edge over its major competitors whose
operations are more centralized.
Gerdau is the largest Brazilian long steel producer with a 49.6% share
of the market, according to the IBS (Brazilian Steel Institute). Belgo Mineira
is the second largest producer in Brazil. Belgo Mineira was originally an
integrated steel company, but now it also has mini-mill plants. Gerdau Acominas'
strategy focuses on the decentralized production of long steel using electric
arc furnace (EAF) mini-mills that employ continuous casting technology. Gerdau
Acominas also has four integrated mills located near steel scrap suppliers, port
facilities, and the markets they serve, which thus have low freight costs.
By contrast, Gerdau Acominas Ouro Branco mill supplies blooms and
billets almost exclusively to a well-defined domestic market and a loyal
customer base. The slab market is more competitive due to the presence of CST
(Companhia Siderurgica de Tubarao), and more recently, of Cosipa (Companhia
Siderurgica Paulista). In foreign markets, the Ouro Branco mill faces strong
competition in high quality products from Eastern European suppliers (mainly
from Russia and Ukraine), Italy and Japan. The Company's unit is nevertheless
highly competitive due to its long experience and high product quality, its
guaranteed delivery schedules and technical assistance to customers. The Ouro
Branco mill thus has a diversified client list, relying on traditional customers
in all of markets in which it operates.
In South America, the main barriers faced by Gerdau AZA sales are
freight and transportation costs and the availability of products relative to
imports. Gerdau AZA has a 50% share of the Chilean domestic construction market
and CAP - Compania Acero Del Pacifico a 45% share, with imports accounting for
the remaining 5% of total sales.
In Uruguay, Gerdau Laisa's main competitors are two local rolling
mills, in addition to imports from Brazil, Argentina and Eastern Europe.
Gerdau Ameristeel's geographic market covers the eastern half of Canada
and the United States, predominantly the Eastern Seaboard, the Southeast and the
Midwest. Gerdau Ameristeel has encountered substantial competition in each of
its product lines from numerous competitors in its markets. Rebar, merchant
bars, and structural shapes are commodity steel products for which price is the
primary competitive factor. Due to the high cost of freight relative to the
value of steel products, competition from non-regional producers is limited.
Proximity of product inventories to customers, together with competitive freight
costs and low-cost manufacturing processes, are key factors in maintaining
margins on rebar and merchant bar products. Rebar deliveries are generally
concentrated within a 350 mile radius of mills and merchant bar deliveries
within a 500 mile radius. Some products, such as special sections produced by
the Selkirk mill, are shipped over greater distances, or even exported.
Except in unusual circumstances, the customer's delivery costs are
limited to freight charges from the nearest competitive mill, with the supplier
absorbing any incremental freight charges.
Gerdau Ameristeel believes that its principal competitors in Canada
include Ispat Sidbec Inc., Stelco Inc. and Ivaco Inc.; and in the United States,
Bayou Steel Corporation, Commercial Metals Corporation, Marion Steel Company,
NorthStar Steel Company, Nucor Corporation, Roanoke Electric Steel Corporation,
Sheffield Steel Corporation, and Steel Dynamics Inc. The Gallatin joint venture
competes with numerous other integrated and mini-mill flat steel producers.
Despite the commodity characteristics of the rebar, merchant bar and
structural markets, the Company believes that it distinguishes itself from
competitors by its large product range, product quality, consistent delivery
performance, capacity to service large orders and ability to fill most orders
quickly from inventory. Gerdau Ameristeel believes that it produces one of the
largest ranges of bar products and shapes east of the Mississippi River. Product
diversity is an
24
important competitive advantage in a market in which the customers are looking
to fulfill most of their requirements from a few key suppliers.
MATERIAL EFFECTS OF GOVERNMENT REGULATIONS
Besides government regulations that apply to industry in general, the
Company's business is not subject to any specific regulation.
C. ORGANIZATIONAL STRUCTURE
GERDAU GROUP
Gerdau S.A. is a non-operational holding company (since November, 2003
when Gerdau S.A. integrated its assets in Brazil with Acominas, creating Gerdau
Acominas S.A.) controlled by a holding Company, Metalurgica Gerdau S.A. Gerdau
S.A. consolidates the results of 5 operating companies: Seiva S.A., Gerdau
Acominas S.A., Gerdau Ameristeel Corp, and the operations of Gerdau AZA in Chile
and Gerdau Laisa in Uruguay.
The Company's investments in Sipar Aceros S.A. in Argentina (in which
it holds a 38% stake), those in Gallatin Steel Co., Bradley Steel Processor and
MRM Guide Rail in the United States, in which Gerdau Ameristeel holds a 50%
stake in the total capital, the investments in Armacero Industrial Y Comercial
Limitada in Chile, in which the Company owns a 50% stake, and the investment in
Dona Francisca Energetica S.A., in which the Company owns a 51.82% stake, are
consolidated in the Company's financial statements using the equity method of
accounting.
DISTRIBUTION OF SHARES
(% stake in total capital as of April 30, 2004)
----------------------------------------------------------------------------------------------------------
SHAREHOLDER ORDINARY SHARES PREFERRED SHARES TOTAL
SHARES
Metalurgica Gerdau and other Gerdau Companies 90.78% 30.46% 51.39%
Brazilian Institutional Investors 0.05% 15.26% 9.98%
Foreign Institutional Investors 0.27% 32.67% 21.43%
Public 8.90% 20.80% 16.67%
Treasury Stock - 0.81% 0.53%
----------------------------------------------------------------------------------------------------------
The above table presents the distribution of shares in Gerdau S.A. as
of April 30, 2004. Of the Company's total equity, 31.4% was held by
institutional investors, of which 10.0% were Brazilian investors. Foreign
institutional investors held a 21.4% stake and small investors, 16.7%. Gerdau
S.A. is controlled by the Gerdau family through the holding company Metalurgica
Gerdau S.A. and other companies. In April 2004, Metalurgica Gerdau S.A. held
44.1% of Gerdau S.A., while Santa Felicidade Comercio, Importacao e Exportacao
de Produtos Siderurgicos Ltda. and other Gerdau companies held the remaining
7.3% of the 51.4% controlling block.
SIGNIFICANT SUBSIDIARIES
The table below shows the main companies and investments maintained
directly or indirectly by Gerdau as of December 31, 2003:
-----------------------------------------------------------------------------------------------------------------------------------
COMPANY COUNTRY STAKE IN VOTING CAPITAL STAKE IN TOTAL CAPITAL
Aceros COX S.A. Chile 100% 100%
Armafer Servicos de Construcao Ltda. Brazil 100% 100%
Gerdau Ameristeel Corp. and subsidiaries Canada 69% 69%
Ameristeel Bright Bar Inc. USA 69% 69%
Gerdau Ameristeel MRM Special Sections Inc. Canada 69% 69%
Gerdau Ameristeel Perth Ameboy Inc. USA 69% 69%
Gerdau Ameristeel Sayreville Inc. USA 69% 69%
Gerdau Ameristeel US Inc. (a) USA 69% 69%
Gerdau Acominas S.A. (b) Brazil 92% 92%
Gerdau AZA S.A. Chile 100% 100%
Gerdau Internacional Empreendimentos Ltda. and its Brazil 100% 100%
subsidiary,
25
Gerdau GTL Spain S.L. and subsidiaries Spain (GTL)
Gerdau Laisa S.A. Uruguay 100% 100%
Seiva S.A. - Florestas e Industrias and subsidiaries Brazil 97% 97%
(a) Formerly AmeriSteel Corp.
(b) As described on Note 4.1, Gerdau Acominas
was formerly known as Aco Minas Gerais S.A. ("Acominas")
Gerdau S.A. is a non-operating company that consolidates the results of
various operating companies, or accounts for its investments using the equity
method. The most important operating companies that are fully consolidated or
consolidated on an equity basis in the financial statements of Gerdau S.A. are
described below:
GERDAU ACOMINAS S.A.
Gerdau Acominas has 10 mills in Brazil, distributed throughout the
country. In the state of Rio Grande do Sul, Gerdau owns the Gerdau Acos Finos
Piratini and the Gerdau Riograndense units. In the state of Parana, Gerdau owns
Gerdau Guaira; in the state of Rio de Janeiro, Gerdau Cosigua; in the state of
Minas Gerais, the units of Barao de Cocais, Divinopolis and the Ouro Branco
mill; in the state of Bahia, Gerdau Usiba; in the state of Pernambuco, Gerdau
Aconorte; and in the state of Ceara, Gerdau Cearense. In addition to the
industrial units, Gerdau also owns Comercial Gerdau, a network that distributes
its steel products and resells flat products from other manufacturers. Comercial
Gerdau has 68 stores and 5 flat steel service centers. Gerdau also has 11
Armafer rebar fabricating facilities and 6 downstream operations.
ARMAFER
Armafer Servicos de Construcao Ltda. was acquired in March 1993 and is
currently a subsidiary of Gerdau Acominas S.A., providing cutting and bending
services for long steel products for the civil construction sector. It has 11
branches throughout the country.
GERDAU LAISA
In 1980, the Company acquired the Laisa mini-mill, in Uruguay. Gerdau
Laisa has been profitable in past years, and is the only long steel producer in
Uruguay. Gerdau Laisa has annual production capacity of 70,000 tons of crude
steel and 72,000 thousand tons of rolled products. Production statistics are
based on Gerdau Laisa's sales plus Uruguayan imports. Gerdau Laisa claims to
supply 93% of rebar demand in Uruguay.
GERDAU AZA
In 1992, the Company acquired the AZA mini-mill in Chile, with Gerdau
AZA's second mill beginning operations in January 1999. The two units, Renca and
Colina, have combined annual production capacity of 440,000 tons of crude steel
and 465,000 tons of rolled steel. The difference in the output of crude steel
and long rolled products is due to the fact that Gerdau AZA still operates an
old profile rolling mill equipment at the Renca unit, which was not
decommissioned following the start-up of the new plant in 1999. Although no
official statistics are available in Chile, Gerdau AZA believes its share of the
domestic long steel market of rebars to be around 50%.
SIPAR
In December 1997, Gerdau entered the Argentinean market through Sipsa,
a rolling mill with production capacity of 68,700 tons per year. In May 1998,
Gerdau signed an agreement to acquire one third of the total equity of Sipar,
another Argentinean rolling mill, in exchange for one third of Sipsa's capital
stock. Gerdau has two rolling mills in Argentina, holding a 71.8% stake in Sipsa
and a 38.2% stake in Sipar. More recently, Gerdau carried out a financial and
corporate restructuring of its operations in Argentina to adapt these to the new
economic environment in that country. Gerdau currently holds a 38.2% stake in
Sipar, of which Sipsa is now a full subsidiary. The Company expects that these
measures will maximize business opportunities, improve results and minimize the
impact of the fluctuation of the Argentine peso against other currencies.
GERDAU AMERISTEEL
In September 1999 Gerdau acquired 75% of Ameristeel (Florida) from
Kyoei Steel Ltd. of Japan. At that point, Ameristeel operated 4 mills on the
East Coast: one unit in Florida, two in Tennessee, and one in North Carolina. In
2000,
26
Gerdau acquired an additional 12% stake from Kyoei, increasing its stake in
Ameristeel to 87%. In December 2001, Ameristeel acquired a steel mill located in
Cartersville, Georgia.
In October 2002 Gerdau merged its North American assets, i.e.
Ameristeel and its two Canadian units with Co-Steel, to create Gerdau
Ameristeel.
Gerdau Ameristeel has nominal annual capacity of 5.9 million tons of
crude steel and 5.5 million tons of rolled products and is the second largest
producer of long steel in North America. Since the completion of the operation,
Gerdau Ameristeel's shares have been traded on the Toronto Stock Exchange under
the ticker symbol GNA.TO. This transaction combined complementary operations,
resulting in an improved product mix and a consistent growth platform that
allows the Company to compete for a leading position in the North American steel
industry.
OTHER BUSINESSES
SEIVA S.A. - FLORESTAS E INDUSTRIAS
Seiva was incorporated on December 29, 1971 to implement reforestation
projects in accordance with Decree No. 1,134/70. Seiva's 55 employees (as of
December 2003) carry out the development, implementation, and maintenance of
reforestation projects. The Company also owns pine forests.
DONA FRANCISCA ENERGETICA S.A.
Dona Francisca Energetica S.A. (DFESA) consists of an operational
hydroelectric power station with nominal capacity of 125 MW, located in the
center of the state of Rio Grande do Sul.
DFESA aims to meet the demands of Dona Francisca shareholders with
regard to the operation, maintenance and optimal use of energy potential of the
Dona Francisca Hydroelectric Plant.
Together with the state utility Companhia Estadual de Energia Eletrica
- CEEE, Dona Francisca shareholders participate in a consortium (Consorcio Dona
Francisca) formed in accordance with the contract CEEE/9700295 of March 13,
1997. Following Gerdau S.A.'s acquisition of an additional stake in early 2003,
Dona Francisca Energetica S.A. has the following shareholders: Gerdau S.A.
(51.8%), Companhia Paranaense de Energia - COPEL (23.0%), Celesc (23.0%), and
Engevix (2.2%).
BRADLEY STEEL PROCESSORS INC.
A 50% joint venture with Buhler Industries Inc., which processes super
light beams.
SSS/MRM GUIDE RAIL
A 50% joint venture with Monteferro S.p.A., which processes MRM's guide
rail sections for elevator manufacturers.
GALLATIN STEEL
Gallatin Steel's plant is located in Gallatin County, Kentucky, 40
miles southwest of Cincinnati, on a fully-owned 1,000-acre site that is
conveniently located for barge, rail, and highway transportation. Gallatin
operates a direct current twin-shell electric arc furnace with a ladle arc
refining unit, a thin slab caster, a high-speed tandem rolling mill and a
cut-to-length operation. Gallatin is a 50% joint venture with Canadian steel
maker Dofasco, and is the only Gerdau Ameristeel mill that produces flat rolled
sheet, used in the construction, automotive, appliance, machinery, equipment and
packaging industries.
MINING RIGHTS
The acquisition of the land and mining rights of Companhia Paraibuna de
Metais by Gerdau Acominas has added 15 mining concessions covering 7,000
hectares. These mines are located at Miguel Bournier, Varzea do Lopes and Gongo
Soco, in the state of Minas Gerais. According to preliminary survey results,
these mineral reserves hold an estimate 500 million tons of ore. The mines in
question are intended to supply the Ouro Branco mill, with reserves
27
representing at least 100 years of potential supply of iron ore. The privileged
location of these mines within the iron belt in the state of Minas Gerais, in
the vicinity of the Ouro Branco mill, are expected to contribute to the
long-term competitiveness of this unit.
MARGUSA
Margusa - Maranhao Gusa S.A. has installed capacity of 200,000 metric
tons of pig iron. The mill is located 50 km from Sao Luis and 48 km from a
coastal port. The acquisition forms part of the Company's strategy for ensuring
the supply of pig iron to its mills in the Northeast of Brazil and for exporting
any excess output to the North American units. This investment has guaranteed
Gerdau's presence in the important iron ore production center of Carajas, a
strategic pig iron source with excellent logistics for supplying both domestic
and export markets.
D. PROPERTY, PLANT AND EQUIPMENT
MATERIAL PLANS TO CONSTRUCT, EXPAND OR IMPROVE FACILITIES
GERDAU SAO PAULO PLANT
In February 2001, Gerdau announced plans to build a 1 million metric
ton greenfield project in the state of Sao Paulo, to be built in two 500,000 ton
modules.
Conceived as a supplier to the markets of Sao Paulo, Mato Grosso do Sul
and Parana, the Sao Paulo plant, will be installed in the municipality of
Aracariguama, at Km 54 on the Castelo Branco Highway. A project with the
features of a market mill - a plant that purchases raw material in the same
region where it sells its products, Gerdau Sao Paulo will make the state of Sao
Paulo self-sufficient in steel, in addition to servicing the States of Mato
Grosso do Sul and Parana.
Total capital expenditures (including the amount already invested) for
the project are budgeted at R$ 420 million in the first phase, and R$ 400
million in the second phase. Half of these resources should be provided from
internally generated funds, with the remaining 50% expected to be financed by
suppliers' credits and by the BNDES/Finame (Development Bank of Brazil and its
dedicated equipment financing division).
It is expected that the 32,000 m2 plant will create 3,300 new direct
and indirect jobs, with a projected increase in annual production capacity of
1.1 million tons of crude steel and 1 million tons of rolled products.
The Company acquired the land and some existing steel production
equipment from the original owner, a cement company. In February 2001, the
Company announced that it would continue work to complete the construction of
the mill, but halted construction due to electricity rationing in 2002 and the
consequent downturn of the economy. The Company plans to announce the resumption
of the project sometime this year.
ENVIRONMENTAL ISSUES
Gerdau S.A is in compliance with governmental regulations on
environmental issues. The Company believes that there are no environmental
issues that might affect its utilization of the fixed assets described below.
MATERIAL TANGIBLE FIXED ASSETS
The principal properties of Gerdau consist of installations for the
production of steel, rolled products and drawn products. The following is a list
identifying the location, capacity and type of installation, as well as the
types of products manufactured:
28
LOCATION OF PLANTS, CAPACITY, EQUIPMENT AND PRODUCTS
(thousand tons/year)
------------------------------------------------------------------------------------------------------------------------------------
CAPACITY FOR CAPACITY CAPACITY CAPACITY FOR
LOCATION OF PLANTS PIG IRON AND FOR CRUDE FOR ROLLED DRAWN
SPONGE IRON STEEL PRODUCTS PRODUCTS EQUIPMENT
------------------------------------------------------------------------------------------------------------------------------------
Aconorte - 250 240 85 EAF mini-mill, rolling mill, drawing mill, nail
and clamp factory
Agua Funda 215 - Rolling Mill
Barao de Cocais (1) 330 350 200 - Integrated/blast furnace, LD converter and
rolling mill
Cearense - 130 110 - EAF mini-mill, rolling mill
Cosigua - 1,400 1,320 290 EAF mini-mill, rolling mill, drawing mill, nail
and clamp factory
Divinopolis (1) 360 600 550 - Integrated/blast furnace, EOF converter and
rolling mill
Guaira - 510 130 - EAF mini-mill, rolling mill
Gerdau Acominas (1) 2,800 3,000 655 - Integrated with blast furnace
(Ouro Branco)
Piratini - 375 390 - EAF mini-mill, rolling mill
Riograndense - 440 400 130 EAF mini-mill, rolling mill, drawing mill, nail
and clamp factory
Usiba (1) 450 520 430 30 Integrated with DRI, EAF mini-mill, rolling
mill, drawing mill
Contagem 240 - - - Blast furnace
Margusa 200 - - - Blast furnace
Cotia - - - 55 Drawing mill
Cumbica - - - 100 Mesh factory and drawing mill
Sao Jose dos Campos - - - 140 Drawing mill
BRAZIL 4,380 7,575 4,640 830 -
AZA - 440 465 - EAF mini-mill, rolling mill
Laisa - 70 72 - EAF mini-mill, rolling mill
SOUTH AMERICA - 510 537 - -
Whitby - 871 998 - EAF mini-mill, rolling mill
Cambridge - 327 295 - EAF mini-mill, rolling mill
MRM Special Sections - 349 299 - EAF mini-mill, rolling mill
Cartersville - 780 544 - EAF mini-mill, rolling mill
Charlotte - 417 363 - EAF mini-mill, rolling mill
Jackson - 608 544 - EAF mini-mill, rolling mill
Jacksonville - 581 558 - EAF mini-mill, rolling mill
Knoxville - 413 454 - EAF mini-mill, rolling mill
Perth Amboy - 816 907 - EAF mini-mill, rolling mill
Sayerville - 726 544 - EAF mini-mill, rolling mill
NORTH AMERICA - 5,888 5,506 - -
GERDAU TOTAL 4,380 13,973 10,683 830 -
-----------------------------------------------------------------------------------------------------------------------------------
Table Continued
--------------------------------------------------------------------------------
LOCATION OF PLANTS PRODUCTS
--------------------------------------------------------------------------------
Aconorte Rebar, merchant bars, wire rod, drawn products
and nails
Agua Funda Rebar and merchant bars.
Barao de Cocais (1) Rebar, merchant bar
Cearense Rebar, merchant bar
Cosigua Rebar, merchant bars, wire rod, drawn products
and nails
Divinopolis (1) Rebar, merchant bar
Guaira Billet, rebar, merchant bar
Gerdau Acominas (1) Billets, blooms, slabs, rebar, merchant bars and
(Ouro Branco) heavy structural shapes
Piratini Specialty steels
Riograndense Rebar, merchant bars, wire rod, drawn products
and nails
Usiba (1) Rebar, merchant bars, wire rod, drawn products
Contagem Pig iron
Margusa Pig iron
Cotia Wire
Cumbica Welded mesh and wire
Sao Jose dos Campos Wire
BRAZIL -
AZA Rebar, merchant bar
Laisa Rebar, merchant bar
SOUTH AMERICA -
Whitby Rebar, merchant bar and profiles
Cambridge Rebar, merchant bar
MRM Special Sections Special sections
Carterville Merchant bar
Charlotte Rebar, merchant bar
Jackson Rebar, merchant bar
Jacksonville Rebar and wire rod
Knoxville Rebar
Perth Amboy Wire rod products
Sayerville Rebar, merchant bar
NORTH AMERICA -
GERDAU TOTAL -
Notes: EAF: Electric arc furnace - electric arc furnace mills produce crude
steel from raw materials such as steel scrap or pig iron
(1) a mill with a blast furnace or "DRI" (direct reduction iron) is also capable
of producing pig iron or sponge iron for use in the production of crude steel,
using iron ore and natural gas as the main raw materials.
29
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A .OPERATING RESULTS
SIGNIFICANT FACTORS MATERIALLY AFFECTING THE COMPANY'S RESULTS
MATERIAL CHANGES IN FINANCIAL STATEMENTS
During 2003 the results of operations of Gerdau were positively
impacted by a series of events that resulted in an improvement in net income for
the year relative to 2002. Some of the most relevant events are:
- The consolidation of the former Co-Steel Inc. operations for the full
year 2003 compared to the consolidation of results in 2002 for only
that part of the year subsequent to October 22, 2002, when the
operations were acquired in conjunction with the integration of the
Gerdau units in North America with those of former Co-Steel Inc.,
Canada.
- The consolidation of Gerdau Acominas for the full year 2003 compared
to the consolidation of results in 2002 for only that part of the year
subsequent to the acquisition in February 2002 of shares that provided
the Company with a controlling interest.
- The Ouro Branco Mill operated at full capacity throughout the year of
2003, achieving total output of 3.1 million metric tons of liquid
steel. In 2002, production suffered a temporary interruption due to an
accident in one of its three air re-heaters (calpers) at the end of
March, and did not return to normal levels until September, 2002.
- Increases in international market prices and demand for steel
products that allowed Gerdau to establish a new tonnage record for
exports in 2003, when exports from Brazil through Gerdau Acominas
amounted to 3.2 million metric tons (+69.9%), and generated revenues of
some $ 787.3 million (+125.0%), representing an increase of 30.9% in
the average export price.
- The provision for income tax and social contribution in fiscal year
2003 represented a credit of $ 34.1 million due to the recognition of
$137.3 million in fiscal credits arising from tax losses generated in
previous years.
IMPACT OF INFLATION AND FLUCTUATIONS IN EXCHANGE RATES
Gerdau's results and its financial condition depend on Brazil's general
economic situation, most notably on (i) economic growth and its impact on steel
demand, (ii) financing costs and the availability of financing, and (iii)
exchange rates between Brazilian and foreign currencies.
For many years, Brazil experienced high rates of inflation that
progressively eroded the purchasing power of the vast majority of the Brazilian
population. During periods of high inflation, effective salaries and wages tend
to fall because the frequency and size of salary and wage adjustments for
inflation usually do not offset the actual rate of inflation. Since the
introduction of the real in July 1994, the inflation rate in Brazil has
decreased dramatically. In addition, there has been economic growth after the
implementation of the Real Plan with Brazilian GDP increasing by 0.8% in 1999,
4.4% in 2000, 1.4% in 2001, 1.5% in 2002 and decreasing by 0.2% in 2003.
The following table presents Brazilian inflation and the devaluation of
Brazilian currency against the U.S. dollar for the periods shown. For a
discussion of the Central Bank's decision, in January 1999, to allow the real to
float freely in the foreign exchange markets and its subsequent devaluation, see
"Item 10.D. Exchange Controls - Exchange Rates."
30
January Year ended December 31
to May
2004 2003 2002 2001 2000 1999
Inflation (INPC base)* 2.63% 10.38% 14.74% 9.44% 5.27% 8.43%
Inflation (IGP-M) 5.33% 8.69% 25.30% 10.37% 9.96% 20.10%
Foreign Exchange Rate (R$ vs. US$) 7.82% -18.23% 52.27% 18.67% 9.30% 48.01%
The appreciation of the real against the U.S. dollar throughout 2003
resulted from the positive domestic economic environment, some social
improvements in addition to the reform of the social security system, tax reform
and consistent monetary and fiscal policies. These measures have led to a
significant improvement in the perception of Brazil's country risk and a gradual
reduction in interest rates.
At the end of 2002 and beginning of 2003, higher levels of inflation
generated a divergence in frequencies and sizes of adjustment factors between
prices and wages, resulting in an erosion of purchasing power. This gap was
significantly reduced by the recent low inflation indices and increased consumer
demand.
A portion of Gerdau S.A.'s trade accounts receivable, trade accounts
payable and debt is denominated in foreign currencies, mainly in U.S. dollars,
causing the Company's financial position and operating results to be affected by
changes in exchange rates. In 2003, Gerdau's operating results were strongly
affected by the appreciation of the Brazilian real versus the U.S. dollar,
generating losses in its U.S. dollar-denominated trade accounts receivable from
exports, which rose significantly relative to 2002, and generating gains on the
U.S. dollar denominated trade accounts payable and on debt balances denominated
in foreign currencies, which remained stable relative to 2002. The significant
appreciation of the real, together with the increase in the balances of trade
accounts receivable and trade accounts payable and the maintenance of debt
balances at similar levels to 2002, generated the foreign exchange gains
recorded in the income statement. The financial statements of Gerdau are also
presented in U.S. dollars with transactions in currencies other than the U.S.
dollar translated into U.S. dollars in accordance with the criteria established
in SFAS No. 52 "Foreign Currency Translations". Changes in the exchange rate
between the functional currency of the Company's operations, such as the
Brazilian real, and the U.S. dollar, affect the reported amounts of revenues and
expenses in its consolidated statements, translated into U.S. dollars. For
instance, a devaluation of the Brazilian real from one period to another causes
the same amount of revenue expressed in Brazilian reais to represent a smaller
amount in U.S. dollars when translated into the latter currency.
OPERATING RESULTS
The table below contains U.S. GAAP information for various income statement
items, expressed as a percentage of net sales for the following years:
--------------------------------------------------------------------------------------------------------------
Fiscal year ending December 31,
2003 2002 2001
--------------------------------------------------------------------------------------------------------------
Net Sales 100.0% 100.0% 100.0%
Cost of Sales (76.0%) (71.9%) (71.7%)
Gross Profit 23.9% 28.0% 28.3%
Sales and Marketing Expenses (3.2%) (3.5%) (4.4%)
General and Administrative Expenses (5.3%) (6.8%) (7.5%)
Operating Income 15.4% 17.8% 16.3%
Net Income 11.3% 7.1% 7.0%
--------------------------------------------------------------------------------------------------------------
31
The following table shows cost of goods sold, excluding freight costs,
in 2002, 2001 and 2000 expressed as a percentage of net sales revenue:
Breakdown of Costs of Goods Sold
2003 2002 2001
------------------------------------------------------------------------------------------------------------
Raw materials 60% 53% 51%
Direct labor costs 9% 13% 14%
---------------------------------------------------------
Total direct costs 69% 66% 65%
Indirect labor costs 3% 5% 5%
Third party services 4% 7% 7%
Depreciation 7% 9% 9%
Power and electricity 9% 10% 9%
Other 8% 3% 5%
---------------------------------------------------------
Total indirect costs 31% 34% 35%
---------------------------------------------------------
Total costs 100% 100% 100%
------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED DECEMBER 31, 2003 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
2002
Results for the year 2003 reflect the consolidation of Acominas and of
the Co-Steel for the full year, whereas in 2002 the results of Acominas were
only consolidated from February 2002 onwards, and Co-Steel from October 2002
onwards. Other factors that contributed to the performance during the year were
the improved level of activity at Ouro Branco mill, following the accident in
March 2002 which disrupted production until September 2002, and the increase in
international prices and demand.
NET SALES
Net sales in 2003 amounted to $ 4,530.9 million ($ 3,264.9 million in
2002), representing an increase of 38.8% relative to 2002, mainly due to the
Company's strong export performance, with export revenues of $ 787.3 million
(+125% over the previous year), the merging of the nine North American units in
October 2002, and the utilization of full production capacity at Gerdau
Acominas. The average net price was $ 395.6/ton, which increased from $
363.9/ton in 2002.
Of total net sales, Brazilian operations accounted for $ 2,433.5
million, a 12.8% increase relative to the fiscal year 2002. Sales by South
American operations increased by 49.7% to $ 169.6 million, while the net
revenues of the Gerdau Ameristeel operation increased by 94% from $ 994 million
to $ 1,927.8 million over the same period, as the result of the full
consolidation of its nine North American operations, a significant increase in
regional prices and an improvement in market conditions.
COST OF SALES AND GROSS PROFIT
Cost of sales as percentage of net revenues increased to 76.0%, in 2003
from 71.9% in 2002, representing an increase of 46.6% in absolute terms against
a 38.8% increase in net revenues, which caused a decline in gross margin for
2003 to 23.9% from 28.0% in the previous year, due, in particular, to the
increased cost of scrap and pig iron in Brazil, and of scrap, electricity and
natural gas in the United States. In 2003, gross profit rose 18.6% in 2003 to $
1,085.4 million.
OPERATING INCOME
Operating expenses (sales, general and administrative expenses) rose
16.1% in 2003 to $ 388.2 million. Even with this increase, however, operating
expenses fell as a percentage of net sales to 8.5% in 2003, from 10.2% in 2002.
In 2003, operating income rose 20.0% relative to the preceding year, to $ 697.2
32
million, although the increase in cost of sales led to a fall in operating
margin over the same period from 17.8% to 15.4%.
FINANCIAL EXPENSES AND FINANCIAL INCOME
In 2003, net financial expenses amounted to $ 192.7 million, a figure
40.5% below that of the previous year. This figure represents financial expenses
of $ 417.0 million, a positive foreign exchange adjustment of $ 162.2 million
and financial income of $ 62.0 million. The reduction in net financial expenses
in 2003 was principally due to the foreign exchange adjustment that arose from
the appreciation of the Brazilian real against the U.S. dollar, affecting the
balance of trade accounts receivable, which were also heavily influenced by
increased exports. The appreciation of the real also affected the balances of
debt and trade accounts payable in foreign currencies.
EQUITY INCOME (LOSSES) FROM UNCONSOLIDATED COMPANIES, NET
Equity income of $ 22.1 million in 2003 resulted from earnings of
unconsolidated companies in Argentina, Chile, the United States and Brazil. Most
of this figure was due to Gallatin Steel and Dona Francisca Energetica S.A. In
2003, equity income included Gallatin Steel's net income for the full period of
12 months, whereas in 2002, equity income for these operations was only
calculated for a two month period following the integration of the Company's
North American operations. Dona Francisca Energetica S.A., generated losses in
2002, with a material effect on the equity income for that year, while in 2003
its operations generated net income.
PROVISION FOR INCOME TAX
Income tax payable is calculated separately for Gerdau and each of its
subsidiaries, as required by the tax laws of the countries in which Gerdau and
its subsidiaries operate. The Company recognized a credit of $ 34.1 million for
the year due to the reversal of a valuation allowance of $ 137.3 million in the
light of the improvement in profitability following its corporate reorganization
in November 2003. This figure relates to tax losses generated in prior years at
the former Acominas plant that the company was permitted to set against taxable
income generated by its Brazilian steel operations, including those formerly
owned by Gerdau S.A. and transferred to Gerdau Acominas.
NET INCOME
Due to higher sales, lower operating expenses, lower net financial
expenses and the income tax credit, 2003 net income amounted to $ 510.2 million
in 2003, increasing 120.1% relative to the previous year. Net margin rose to
11.3% from 7.1% in 2002.
FISCAL YEAR ENDED DECEMBER 31, 2002 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
2001
Results for 2002 reflected the consolidation of Gerdau Acominas and the
Co-Steel operations from their respective dates of acquisition onwards. Other
factors that contributed to the performance for the year were the improved level
of activity at Acominas after the accident in March that disrupted production
until September, improved conditions in the Chilean market and increased
exports.
NET SALES
Net consolidated sales in 2002 amounted to $ 3,264.9 million against $
2,401.1 million in 2001, representing growth of 35.9%, and resulted from an
increase of 37.7% in physical sales and a decrease of 1.8% in average prices.
The Company's average net sales price was $ 363.9/ton in 2002, which rose from $
351.1/ton in 2001. Around 66% of net revenue derived from the Company's
Brazilian operations and 34% from its foreign operations. The consolidation of
Acominas and Co-steel represented 22.6% of consolidated sales volume.
33
COST OF SALES AND GROSS PROFITS
The Company's efforts to cut costs and improve productivity offset
increases in the prices of certain raw materials during the year, most notably
scrap and pig iron. This resulted in 2002 gross margins of 28.0%, compared to
28.3% in 2001. Gross profit rose to $ 915.3 million in 2002 from $ 678.9 million
in 2001, an increase of 34.8%. During 2002, some North American subsidiaries
reassessed the useful life of certain assets, reducing depreciation expenses by
approximately $ 3.2 million.
OPERATING INCOME
Lower operating expenses (sales and marketing expenses, general and
administrative expenses) resulted in operating income for 2002 of $ 580.8
million, a figure 48.2% higher than that of 2001. Over the same period,
operating margin rose to 17.8% from 16.3%.
FINANCIAL EXPENSES AND FINANCIAL REVENUE
Net financial expenses increased 76.7% to $ 323.7 million, due to the
higher net foreign exchange loss for the period ($ 131.7 million in 2002 against
$ 71.8 million in 2001), due principally to the sharp devaluation of the real,
as well as higher debt levels arising from the consolidation of the Co-Steel
operations and the purchase of a stake in Acominas.
EQUITY IN EARNINGS (LOSSES) OF UNCONSOLIDATED COMPANIES, NET
Negative equity income of $ 10.1 million in 2002 was largely due to losses in
Dona Francisca Energetica S.A. and Sipar Aceros S.A.
PROVISION FOR INCOME TAX
In 2002, the income tax provision of $ 6.6 million represents a
reduction of $ 48.1 million with respect to the loss recorded in 2001, mainly as
a result of increased tax benefits from the distribution of interest on
stockholders' equity, the recognition of deferred tax income through the
reversal of a valuation allowance at Acominas and higher levels of non-taxable
income.
NET INCOME
2002 consolidated net income amounted to $ 231.8 million, a 38.5%
increase relative to the previous year, with a corresponding increase in net
margin to 7.10% from 6.96% in 2001. It should be noted that the Company's
Brazilian operations accounted for $ 209.7 million of this figure, its North
American operations for $ 11.1 million and its South American operations for $
11.0 million.
B. LIQUIDITY AND CAPITAL RESOURCES
Net cash generated by operating activities amounted to $ 395.4 million,
$ 350.5 million and $ 468.5 million for the years ended December 31, 2001, 2002
and 2003 respectively, giving a cumulative total for the three years of $
1,214.4 million. Net cash generated by operating activities was one of the main
sources of liquidity utilized by the Company. Cumulative short and long-term
financing agreements amounted to $ 3,561.7 million for the period, providing $
377.6 million in 2001, $ 1,186.1 million in 2002 and $ 1,998 million in 2003,
toward the Company's liquidity needs. Disposals of fixed assets generated
cumulative proceeds of $ 19.8 million for the years 2001, 2002 and 2003.
In 2003, the main uses of capital resources were: $ 297.8 million for
investment in fixed assets, $ 2,126.5 million for short and long-term debt
payments and $ 122.3 million for payment of dividends. In 2002, the main uses of
capital resources were: $ 185.9 million for investment in fixed assets, $ 824.9
million for short and long-term debt payments and $ 74.3 million for payment of
dividends. In 2001, the main uses of capital resources were: $ 244.0 million for
investment in fixed assets, $ 436.6 million for short and long-term
34
debt payments and $ 64.4 million for payment of dividends. Resources invested in
fixed assets from 2001 to 2003 ($ 727.7 million) were used to modernize the
Company's industrial plants and subsidiaries and to upgrade their technology.
Between December 31, 2002 and December 31, 2003, net working capital
(current assets less current liabilities) increased by $ 364.2 million, from ($
63.6) million in 2002 to $ 300.7 million in 2003. Between December 31, 2001 and
December 31, 2002 net working capital decreased by $ 314.2 million, from $ 250.6
million in 2001 to ($ 63.6) million in 2002. The increase in 2003 was primarily
due to a reduction in current liabilities, mainly in short-term debt due to the
lengthening of the debt profile of Gerdau Ameristeel and Gerdau Acominas.
DEBT AND FINANCIAL STRATEGY
The Company's borrowings are intended to finance investments in fixed
assets, both in the modernization and technological upgrading of its plants and
in the expansion of installed capacity, as well as working capital, the purchase
of stakes in other companies, and, depending on market conditions, short-term
financial investments.
The Company's loan balance (total debt less debentures and parent
company) stood at $ 1,930.9 million and $1,899.4 million as of December 31, 2003
and 2002, respectively. On the same dates, balances of short-term financial
investments and cash stood at $ 330.6 million and $ 423.2 million, respectively.
Total debt amounted to $ 2,088.6 million in 2003, down from $ 2,100.1
million in 2002. Net debt increased from $ 1,667.2 million in 2002, to $ 1,758.0
million in 2003 due to a reduction in short-term financial investments and cash.
In 2003 and 2002, net financial expenses amounted to $ 192.7 million
and $ 323.8 million, respectively. The reduction in net financial expenses
principally reflected the foreign exchange gain in 2003 that resulted from the
appreciation of the Brazilian real, which affected U.S. dollar denominated
assets and liabilities, most notably trade accounts receivable, debt and trade
accounts payable.
The following table profiles the Company's debt as of December 31, 2003 and 2002
(in thousands of U.S. dollars):
2003 2002
SHORT TERM:
SHORT-TERM DEBT:
Debt denominated in reais 29,527 42,974
Debt denominated in foreign currency 450,059 664,404
TOTAL SHORT TERM DEBT 479,586 707,378
CURRENT PORTION OF LONG-TERM DEBT:
Debt denominated in reais 49,470 84,569
Debt denominated in foreign currency 269,440 312,846
TOTAL CURRENT PORTION OF LONG-TERM DEBT 318,910 397,415
Debentures(a) 1,048 -
Short-term debt, parent company(a) 1,173 277
SHORT-TERM DEBT PLUS CURRENT PORTION OF LONG-TERM DEBT, DEBENTURES AND PARENT COMPANY 800,717 1,105,070
LONG TERM:
LONG-TERM DEBT, LESS CURRENT PORTION:
Debt denominated in reais 160,500 118,248
Debt denominated in foreign currency 971,929 676,323
TOTAL LONG TERM DEBT 1,132,429 794,571
Debentures 155,420 200,766
LONG-TERM DEBT PLUS DEBENTURES 1,287,849 995,337
TOTAL DEBT PLUS DEBENTURES, CURRENT PORTION OF LONG-TERM DEBT AND PARENT COMPANY 2,088,566 2,100,407
Short-term investments, restricted cash and cash 330,576 423,206
NET DEBT PLUS DEBENTURES, CURRENT PORTION OF LONG-TERM DEBT AND PARENT COMPANY 1,757,990 1,667,201
35
(a) Recorded under "other current liabilities".
On December 31, 2003 the Company's debt was subject to the following terms and
conditions:
On December 31, 2003, the Company's total debt plus debentures, current
portion of long term debt and parent company amounted to $ 2,088.6 million. Of
this balance, $ 318.9 million (15.3%) was denominated in Brazilian reais and $
1,769.7 million (84.7%) in U.S. dollars.
SHORT TERM
As of December 31, 2003, the Company's short-term debt amounted to $
479.6 million. Of this total, $ 29.5 million related to financing in reais and $
450.1 million to financing in foreign currencies. The current portion of the
Company's long-term debt and debentures amounted to $ 318.9 million, of which $
49.5 million in reais and $ 269.4 million in foreign currencies. In 2003,
short-term debt plus the current portion of long-term debt, debentures and
financing with the parent company amounted to $ 800.7 million, representing a
reduction of 27.5% relative to 2002, due to the lengthening of debt profile by
Gerdau Ameristeel and Gerdau Acominas.
The main sources of short-term financing used by Gerdau are trade
finance credit lines, commercial paper (in U.S. dollars and Euros), suppliers'
credits and specific credit lines provided by the Brazilian Development Bank
(BNDES).
LONG TERM
Long-term debt including debentures amounted to $ 1,287.8 million as of
December 31, 2003. Of this total, $ 1,132.4 represented loans from financial
institutions, of which $ 160.5 million denominated in reais and $ 971.9 million
in foreign currency. Of total long-term debt, $ 155.4 million represents
debentures, of which $ 77.2 million denominated in U.S. dollars and $ 78.2
million in reais.
Of the $1,691.4 million of loans denominated in foreign currency,
approximately 46.0% were contracted by the Company and its Brazilian
subsidiaries and 54.0% by the Company's foreign subsidiaries.
Information about the terms of long-term debt cost is presented in Note
14 to the Financial Statements - `Long-term debt and debentures'. For additional
information, see Item 11 - Quantitative and qualitative disclosures about market
risks.
In January 1999, the Company assumed $ 130.0 million of debt relating
to the Eurobonds issued by Metalurgica Gerdau maturing on May 26, 2004 that were
partially redeemed on May 26, 1999 and fully retired at maturity in May 2004.
The Company is subject to limitations on debt levels, the granting of
encumbrances on its properties and the payment of dividends under certain
circumstances, in accordance with the terms of its debentures, its loans from
the Banco Nacional de Desenvolvimento Economico e Social - BNDES ("BNDES"), and
the refinancing agreement for Gerdau Ameristeel.
With the exception of the 13th debenture issue, the terms of the
Company's public debentures prohibit the payment of dividends in excess of 30%
of net profit, if such distributions cause the Company's long-term liabilities
to exceed its net worth by a factor of more than 50% and its current assets to
fall below its current liabilities.
The 13th debenture issue limits the Company's consolidated financial
debt to no more than four times Earnings before Interest, Taxes, Depreciation
and Amortization (EBITDA of the last twelve months, defined as gross profit
minus general, sales and administrative expenses plus depreciation and
amortization). This instrument also requires consolidated EBITDA to be more than
double net interest expenses for the last twelve months, excluding monetary and
foreign exchange variations.
36
The terms of the Company's BNDES debt require that the current
liquidity ratio (consisting of current assets divided by current liabilities) is
least 1.3 and that financial debt divided by Earnings before Interest, Taxes,
Depreciation and Amortization (EBITDA defined as gross profit minus general,
sales and marketing and administrative expenses plus depreciation and
amortization) is less than 5. These agreements also contain negative covenants,
subject to customary exceptions.
The Gerdau Ameristeel Senior Secured Credit Facility contains
restrictive covenants that limit the Company's ability to engage in specified
types of transactions without the consent of the lenders. Limitations apply to
incurring additional debt, issuing redeemable stock and preferred stock, paying
dividends on its common shares, selling or otherwise disposing of certain assets
and entering into mergers or consolidations. The indenture governing the Senior
Notes permits Gerdau Ameristeel and its restricted subsidiaries to incur
additional indebtedness, including secured indebtedness, subject to certain
limitations.
The Company agrees to furnish a copy of the debt instruments described
herein to the Securities and Exchange Commission upon request.
All covenants described above are based on (i) the financial statements
prepared according to Brazilian Corporate Law for the operations contracted by
the companies in Brazil and (ii) financial statements prepared in accordance
with U.S. GAAP for Gerdau Ameristeel. As of December 31, 2003, management
believes that the Company was in full compliance regarding such debt covenants
and other conditions of the debt described above.
In order to protect itself from fluctuations in the Brazilian currency
against the U.S. dollar and changes in interest rates on its foreign currency
debt incurred in Brazil, Gerdau entered into cross-currency interest rate swaps
through which it receives U.S. dollars, generally accruing interest at fixed
rates, and pays Brazilian reais accruing interest at rates based on the CDI
(Brazilian Interbank deposit rates). As of December 2003, the total amount
swapped was $ 555.3 million (notional amount) of which $ 95.6 million has been
treated, pursuant to EITF No. 02-02 on a combined basis as if the loans had been
originally denominated in reais. Part of the Company's cash flow from operations
is denominated in Brazilian reais and part in U.S. dollars. See Note 20 to the
financial statements - Derivatives Instruments. Such cash flows from operations
may be utilized to service this debt. There can, however, be no assurance that
cash flows from operations will be sufficient to service foreign currency debt
obligations, denominated principally in U.S. dollars. It is thus possible that
exchange rate fluctuations may have a material adverse effect on the Company's
business, financial condition and results of operations. See Item 10.D -
Exchange Controls.
The Company's long-term debt with financial institutions, including
debentures, will be amortized as follows:
$ million
---------
2005 191.9
2006 136.2
2007 153.7
2008 175.7
2009 and thereafter 630.3
---- -----
TOTAL 1,287.8
=======
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENCES, ETC.
Due to its specialized business, Gerdau Acos Finos Piratini, which is
active in the automotive segment, is the only unit that has been investing
without interruption in technological upgrading and in research and development
(R&D). This unit maintains an R&D department responsible for new products and
the optimization of existing processes. These product development projects are
led by specialists who use tools such as `6 Sigma', a set of statistical
measurements that allow for an improved assessment of results, and `Quality
Function Deployment', a process in which the technicians identify the needs of
customers' processes. In the other plants, production and quality teams are
responsible for developing new products, to meet the needs of its customers and
the market.
37
As is usual for mini-mill steel makers, Gerdau usually acquires
technology in the market, since steel-making technology is readily available for
purchase.
Most sophisticated production equipment used by the Company is supplied
by international machinery builders and steel technology companies. Such
suppliers generally enter into technology transfer agreements with the purchaser
and provide extensive technical support and staff training in connection with
the installation and commissioning of the same equipment. Gerdau has entered
into technology transfer agreements with Nippon Steel, Sumitomo Steel, Thyssen,
Daido Steel and BSW.
D. TREND INFORMATION
Gerdau's business is focused on the production of long steel and the
distribution of steel products in general, with operations in North and South
America. One of the strategies adopted by the Company in the development of its
business is the regional concentration of its efforts with the aim of satisfying
its raw materials needs and selling its production to clients close to its
operating units. For this model, availability of the inputs used by the Company,
such as scrap and electric power, and local demand are very important factors in
the performance of the operating unit, although these do not necessarily
compromise consolidated performance. The steel business, especially the long
steel segment, regardless of the country in which a company operates, is
strongly influenced by global and regional macroeconomic issues, which Gerdau
analyzes in order to develop its own view of its likely performance in
forthcoming quarters.
In Brazil, where all Gerdau's steel operations are concentrated in
Gerdau Acominas, the Company believes that it can achieve growth in domestic
demand by the end of 2004, making three basic assumptions that were confirmed in
results for the first quarter of 2004: (i) IBS (Brazilian Steel Institute)
forecasts indicate that long steel domestic sales will increase by 10.2% in
2004, relative to 2003; (ii) domestic demand increased by some 7.7% in the first
quarter of 2004, with demand from manufacturing industry and for agricultural
products significant but not as strong as expected, and (iii) the partial
recovery in demand, which was slack in 2003, by some 13%.
Based on the expectation of domestic market growth over the next few
quarters, Gerdau, which gives priority to domestic sales, may witness a
reduction in its export volumes. In the first quarter of 2004, Brazilian exports
fell by 18%, although due to international prices, which are expected to remain
high, exports may remain an important part of the Company's revenues during the
next quarter and for the year as a whole.
The Company believes that the prices of inputs used in its production
process such as scrap, pig iron, coal and iron ore, are likely to decline from
current levels, based on the information that some of these inputs have been
negotiated in the international market at lower prices due to (i) a reduction in
purchases by China and (ii) a reduction of investments in that country, in
conjunction with current high levels of inventory. Despite the fact that it
purchases its main inputs in the domestic market, the Company believes that
prices in Brazil will follow this trend, albeit while admitting the possibility
of an increase in the price of inputs until the end of the year, in the event
that Chinese demand returns to the level of the first quarter.
At a macroeconomic level, Gerdau believes that movements in exchange
rates will offset inflation for the year and that conditions exist that favor
additional cuts in interest rates.
Its North American operations showed a strong improvement in first
quarter results due to the recovery of the American economy and, hence, to the
increase in sales volume for the period. Sales volumes for the first quarter of
2004 increased by 7.3% compared to the last quarter of 2003, with highly
favorable prices that generated good operating margins in that market. The steel
industry as a whole expects that these prices will be maintained for at least
another quarter due to the strong demand, which, together with reduced pressure
on input prices, point to a positive outlook for the rest of the year.
With higher demand, imports to the United States are also increasing,
albeit unlike in previous years, products are traded at market prices. The
Company believes this fact will not affect its businesses adversely, since if
demand returns to lower levels, these imports will be redirected to other
markets on account of a weakening of the U.S. dollar American currency, high
international prices and freight costs.
38
Due to the higher capacity utilization rates in the North American
mills (all working at over 95% of capacity) and the reduction of scrap prices in
that region, the Company estimates that its costs may also fall, on account of
factors such as lower yield loss costs.
The outlook for the Company's South American operations is also
positive. In Uruguay estimates for the economy are being revised with positive
GDP growth forecasts for 2004. In Chile, the most stable country in the region
where Gerdau operates, GDP is expected to grow, resulting in increasing demand
for steel products.
E. OFF-BALANCE SHEET ARRANGEMENTS
The Registrant does not have any off-balance sheet arrangements that
have or are reasonably likely to have a current or future effect on the
company's financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources other than the ones described below.
As detailed in Note 25 to the consolidated financial statements (Item
19), Gerdau has guaranteed 51.82% of the debt of Dona Francisca Energetica S.A.,
a non-public corporation which owns and operates a hydroelectric power plant,
known as Usina Hidroeletrica Dona Francisca, amounting to R$ 103.452 million
(equivalent to $ 35.806 million at the year-end exchange rate). The percentage
of this guarantee corresponds to Gerdau's 51.82% stake in Dona Francisca
Energetica, corresponding to the extent to which the Company has issued
guarantees to the creditors. There is no indication to date that this guarantee
will be executed by lenders, which would occur in the event of default by Dona
Francisca Energetica S.A. In addition, the Company has issued guarantees to
Banco Gerdau S.A. for $ 13.891 million relating to loans by Banco Gerdau S.A. to
the Company's customers which were used to purchase the Company's products.
F. DISCLOSURE OF CONTRACTUAL OBLIGATIONS
----------------------------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS PAYMENTS DUE BY PERIOD
------------------------------------------------ --------------------------------------------------------------------
TOTAL LESS THAN 1-3 YEARS 3-5 YEARS MORE THAN
1 YEAR 5 YEARS
------------------------------------------------ ------------ ------------ ------------ ------------ -----------
Long-Term Debt Obligations including Debentures 1,607,807 319,958 328,127 329,422 630,300
Operating Lease Obligations 66,449 9,248 13,914 9,764 33,523
------------ ------------ ------------ ------------ -----------
Total
1,674,256 329,206 342,041 339,186 663,823
============ ============ ============ ============ ===========
-------------------------------------------------------------------------------------------------------------------------
Purchase obligations correspond to payments that the Company has
undertaken to make as result of the following transactions: (a) its acquisition
of Margusa - Maranhao Gusa S.A., for which it undertook to pay a total
consideration of $ 18,000, that was subsequently reduced to $ 16,163, following
adjustments for due diligence, with $ 13,929 of this amount remaining unpaid as
of December 31, 2003, and (b) its acquisition of certain real estate and mining
rights located in Miguel Bournier, Varzea do Lopes and Gongo Soco in the state
of Minas Gerais, Brazil, for which it undertook to pay a total consideration of
$ 30,000, of which $ 22,500 remained unpaid as of December 31, 2003.
G. SAFE HARBOR
See "Cautionary Statement with Respect to Forward-Looking Statements".
39
H. CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those that are both (1) important to
the portrayal of the financial condition and results of the Company and (2)
require management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain. As the number of variables and assumptions affecting the
possible future resolution of the uncertainties increase, those judgments become
even more subjective and complex. In connection with the preparation of the
financial statements included in this annual report, the Company's management
has relied on variables and assumptions derived from historical experience and
various other factors that it deems reasonable and relevant. Although these
estimates and assumptions are reviewed by management in the ordinary course of
business, the portrayal of the financial condition and results of operation
often requires it to make judgments regarding the effects of inherently
uncertain matters on the carrying value of the Company's assets and liabilities.
Actual results may differ from those estimated using different variables,
assumptions or conditions. In order to provide an understanding of how
management forms its judgments about future events, including the variables and
assumptions underlying the estimates, comments have been included that relate to
each critical accounting policy, described as follows:
o revenue recognition and allowance for doubtful accounts;
o deferred income taxes;
o pension and post-retirement benefits;
o environmental liabilities; and
o derivative financial instruments
The consolidated financial statements presented in this annual report
were prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of the financial statements included
in this annual report necessarily involves certain assumptions derived from
historical experience and various other factors deemed reasonable and relevant.
Although management reviews these estimates and assumptions in the ordinary
course of business, the portrayal of the financial condition and results of
operation of the Company often requires it to make judgments regarding the
effects on the financial condition and results of operations of matters that are
inherently uncertain. Actual results may differ from those estimated under
different variables, assumptions or conditions.
REVENUE RECOGNITION AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company recognizes revenues from sales and the allowance for
estimated costs associated with returns from these sales when the product is
shipped and title transferred to the buyer. Provisions are made for estimated
product returns and customer claims based on estimates and actual historical
experience. If the historical data used in the estimates does not reflect future
returns and claim trends, additional provisions may be necessary. An allowance
for doubtful accounts is maintained for estimated losses resulting from the
inability of customers to make required payments. If the financial condition of
customers deteriorates, resulting in losses or the impairment of their ability
to make payments, additional allowances may be required.
DEFERRED INCOME TAXES
The liability method of accounting for income taxes is used for
deferred income taxes generated by temporary differences between the book value
of assets and liabilities and their respective tax values. Deferred income tax
assets and liabilities are measured using tax rates applicable to taxable income
in the years in which those temporary differences are expected to be realized. A
valuation allowance is recorded to the extent that the recoverability of the
future income tax assets is considered more likely than not. Future taxable
income may be higher or lower than estimates made when determining whether it is
necessary to make provisions for devaluation, as well as the amount of the same.
40
PENSION AND POST-RETIREMENT BENEFITS
The Company accrues its obligations relating to employee benefit plans
and their related costs, net of plan assets, adopting the following policies:
o The cost of pensions and other retirement benefits earned by
employees is actuarially determined using the projected benefit
method pro-rated for service and management's best estimate of
expected investment performance for funded plans, growth in
salaries, retirement ages of employees and expected health care
costs. The discount rate used for determining the liability for
future benefits is an estimate of the current interest rate at the
balance sheet date on high quality fixed income investments with
maturities that match the expected maturity of obligations
o Pension assets are valued at fair market value
o Past service costs from plan amendments are amortized on a
straight-line basis over the average remaining service period of
employees active at the date of amendment
o The net actuarial gain or loss that exceeds 10% of the greater of
the benefit obligation and the fair value of plan assets is
amortized over the average remaining service period of active
employees
o A plan curtailment will result if there has been a significant
reduction in the expected future service of present employees. A
net curtailment loss is recognized when the event is probable and
can be estimated, a net curtailment gain is deferred until
realized.
In accounting for pension and post-retirement benefits, several statistical and
other factors, which attempt to anticipate future events, are used in
calculating the expense and liability related to the plans. These factors
include assumptions about the discount rate, expected return on plan assets,
future increases in health-care costs and rate of future compensation increases.
In addition, actuarial consultants also use subjective factors such as
withdrawal, turnover and mortality rates to estimate these factors. The
actuarial assumptions used by the Company may differ materially from actual
results due to changing market and economic conditions, regulatory events,
judicial rulings, higher or lower withdrawal rates or longer or shorter life
spans of participants.
ENVIRONMENTAL LIABILITIES
The Company has made provisions for potential environmental liabilities
based on the best estimates of potential clean-up and compensation estimates for
known environmental sites. The Company employs a staff of environmental experts
to manage all phases of its environmental programs, and uses outside experts
where needed. These professionals develop estimates of potential liabilities at
these sites based on projected and known remediation costs. This analysis
requires the Company to make significant estimates, with changes in facts and
circumstances possibly resulting in material changes in environmental
provisions.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company applies SFAS No. 33, "Accounting for Derivative Instruments
and Hedging Activities" as amended and interpreted.
Derivative financial instruments include cross-currency interest rate swaps
entered into by the companies operating in Brazil mainly for swapping fixed-rate
debt denominated or indexed in U.S. dollars into variable rate debt in reais.
These swaps are recognized on the balance sheet at fair value and adjustments to
fair value are recorded through income. Such cross-currency interest rate swaps
are not traded derivatives and have been agreed with various financial
institutions in Brazil. The Company values such instruments considering
quotations obtained from market participants and following an internally
developed methodology that considers the forward rate of exchange of the real
against the U.S. dollar and interest rates in Brazilian reais prevailing on the
date of measurement. The Company understands that quotations obtained are
reasonable when compared with information on similar financial instruments
traded on the Sao Paulo Futures and Commodities Exchange (BM&F), that the
internally developed valuation methodology is consistent with methodologies used
by other participants in the swap market in Brazil and that its results
reasonably reflect the amount that would be paid or received to settle the swap
on the valuation date. Intense volatility in the
41
foreign exchange and interest rate markets in Brazil observed during 2003 has
nevertheless caused significant changes in forward rates and interest rates over
very short periods of time, generating significant changes in the fair value of
such cross-currency interest rate swaps over similarly short periods of time.
The fair value recognized in our financial statements may not, therefore,
necessarily represent the amount of cash that the Company would receive or pay,
as per the case, if it settled the transaction on December 31, 2003. As of
December 31, 2003 the unrealized gain on cross-currency interest rate swaps
amounted to $ 9.685 million and the unrealized loss to $ 40.938 million.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
The following is a brief biography of each of the Company Directors and
Executive Officers:
JORGE GERDAU JOHANNPETER (68) has been working for the Gerdau Group since 1954.
He and his brothers, Germano, Klaus and Frederico, started as apprentices. Jorge
Johannpeter became an Executive Officer in 1971 and a member of the Board of
Directors in 1973. In 1983 he became Chairman of the Board of Directors and
President of the Company. Since 2002, after the implementation of the new
Corporate Governance structure, he also became the President of the Gerdau
Executive Committee. He holds a degree in Law from the Federal University of Rio
Grande do Sul.
GERMANO HUGO GERDAU JOHANNPETER (72) has been working for the Gerdau Group since
1951. He became an Executive Officer in 1971 and has been a member of the Board
of Directors since 1973. In 2002, under the new Corporate Governance structure,
he became a Vice Chairman of the Board of Directors. He holds a degree in
Business Administration from the Getulio Vargas Foundation.
KLAUS GERDAU JOHANNPETER (69) has been working for the Gerdau Group since 1954.
He became an Executive Officer in 1971 and has been a member of the Board of
Directors since 1973. In 2002, under the new Corporate Governance structure, he
became a Vice Chairman of the Board of Directors. He holds a degree in Civil,
Electrical and Mechanical Engineering from the Federal University of Rio Grande
do Sul.
FREDERICO CARLOS GERDAU JOHANNPETER (62) has been working for the Gerdau Group
since 1961. He became an Executive Officer in 1971 and has been a member of the
Board of Directors since 1973. Under the new Corporate Governance structure he
also became Senior Vice President of the Gerdau Executive Committee. He holds a
degree in Business Administration from the Federal University of Rio Grande do
Sul and a Masters degree in Business, Finance, Costs and Investments from the
University of Cologne, Germany.
ANDRE PINHEIRO DE LARA RESENDE (53) was elected Independent Board Member in
2002. He graduated in Economics from the Pontifical Catholic University in Rio
de Janeiro (PUC), and holds a masters degree from the Postgraduate School of
Economics of the Getulio Vargas Foundation and a PhD from the Massachusetts
Institute of Technology in Cambridge, Massachusetts, USA. Andre Pinheiro de Lara
Resende is also a member of the Board of Alps Funds. He was formerly President
of the Brazilian Development Bank (BNDES), Special Advisor to the President of
Brazil, Managing Partner of Banco Matrix S.A., Brazil's Chief Foreign Debt
Negotiator, Executive President of Companhia Siderurgica Tubarao (CST),
Executive Vice President and member of the Board of Unibanco - Uniao de Bancos
Brasileiros S.A., Director of Brasil Warrant Administracao de Bens e Empresas
Ltda., a member of the Board of Directors of Cia. Ferro Brasileiro S.A., a
member of the Board of Directors of Lojas Americanas S.A., Managing Partner of
Banco de Investimento Garantia and Manager of Public Debt and Open Market of the
Brazilian Central Bank.
AFFONSO CELSO PASTORE (65) was elected Independent Board Member in 2002. He
holds a degree in Economics from the University of Sao Paulo and a PhD in
Economics from the same University. Affonso Celso Pastore is also Professor at
the Getulio Vargas Foundation in Rio de Janeiro and an independent economics
advisor. He was the Secretary of the Sao Paulo Treasury Department and President
of the Brazilian Central Bank.
42
OSCAR DE PAULA BERNARDES NETO (58) was elected Independent Board Member in 2002.
He holds a degree in Chemical Engineering from the Federal University of Rio de
Janeiro and a degree in Business Administration from the State University of Rio
de Janeiro. Oscar de Paula Bernardes Neto is the owner and director of LID -
Latin America Internet Development Group and a member of the consultive board of
Telesystem International Wireless (TIW) in Brazil. He is also member of the
boards of Bunge Alimentos, Seara and Serrana, all companies of the Bunge Group,
and board member of RBS (media network), CheckForte, Satipel and Alcoa in
Brasil, and Delphi Corp. in the United States.
CARLOS JOAO PETRY (63) has been working for the Gerdau Group since 1965. He
became an executive officer in 1974 and was appointed to the Board of Directors
in 1983. Under the new Corporate Governance structure he also became Senior Vice
President of the Gerdau Executive Committee. He holds a degree in Philosophy
from the Federal University of Rio Grande do Sul.
ANDRE BIER JOHANNPETER (41) has been working for the Gerdau Group since 1980. He
was recently given the position of Executive Vice President of the Gerdau
Executive Committee, and is responsible for its North American operations and
Information Technology processes. He holds a degree in Business Administration
from the Pontifical Catholic University of Rio Grande do Sul.
CLAUDIO JOHANNPETER (41) joined the Company in 1982. He became Executive Officer
in 1997, and is currently an Executive Vice President of the Gerdau Executive
Committee, responsible for the Ouro Branco mill and specialty steel, as well as
for industrial processes in Brazil and abroad. He was awarded a degree in
Metallurgical Engineering from the Federal University of Rio Grande do Sul in
1990.
OSVALDO BURGOS SCHIRMER (54) joined the Company in 1986 and was named Financial
Executive Officer in 1987. He has also been responsible for Gerdau Bank (Banco
Gerdau) since 1994 and was recently promoted to the position of Executive Vice
President of the Gerdau Executive Committee, while retaining the positions of
CFO and Investor Relations Director of Gerdau S.A. He is also responsible for
the South American operations of Gerdau S.A. Osvaldo Burgos Schirmer graduated
in Business Administration from the Federal University of Rio Grande do Sul in
1973, and holds an MBA from Illinois University. He has also held a position as
a director at the Iochpe-Maxion Group, a holding company for companies in the
auto parts and railroad equipment sectors.
DOMINGOS SOMMA (60) joined the Company in 1980 and became an Executive Officer
in 1988. He is currently the Executive Vice President of the Gerdau Executive
Committee, responsible for the Group's Brazilian Long Steel operations. He
graduated in Economics from Mackenzie University in 1968.
EXPEDITO LUZ (52) has been working for Gerdau since 1976 and, in 1989 became an
Executive Officer of the Legal Department. He was appointed to the Board of
Directors in 2001 and under the new Corporate Governance structure he is now
Secretary-General of the Board of Directors and the Gerdau Executive Committee.
Expedito Luz graduated in Law from the Federal University of Rio Grande do Sul
in 1975 and holds a Masters Degree in Law from the Columbia Law School in New
York, in 1980.
PAULO FERNANDO BINS DE VASCONCELLOS (59) joined the Company in 1972. In 2002 he
was appointed Executive Vice President of the Gerdau Executive Committee. In
2003 he was transferred to North America as Vice President of North Eastern
Steel Operations. He holds a degree in Metallurgical Engineering.
FRANCESCO SAVERIO MERLINI (62) joined the Company in 1977 and became an
Executive Officer in 1998. He graduated in Electromechanical Engineering from
the Cuyo National University of Argentina in 1970.
ELIAS PEDRO VIEIRA MANNA (49) joined the Company in 1988 and became an Executive
Officer in 2000. He graduated in Operational Mechanical Engineering, Mechanical
Engineering and Civil Engineering, from the Pontifical Catholic University of
Rio Grande do Sul in 1977, 1981 and 1982 respectively. He also received a
Masters degree in Materials Engineering from the Federal University of Santa
Catarina in 1982.
43
FAMILY RELATIONSHIP
Jorge Gerdau Johannpeter, Germano Hugo Gerdau Johannpeter, Klaus Gerdau
Johannpeter and Frederico Carlos Gerdau Johannpeter are brothers. Andre Bier
Johannpeter is Jorge Gerdau Johannpeter's son and Claudio Johannpeter is Klaus
Gerdau Johannpeter's son.
ARRANGEMENTS
Gerdau has no agreement of any kind with shareholders, clients,
suppliers or other parties regarding the election of its managers. There are no
pending legal proceedings to which any Board Member or Executive Officer of the
Company is a party against to the Company.
B. COMPENSATION
The employees' compensation system is based on two variables: a fixed
salary and a variable portion linked to specific targets.
The fixed portion of the compensation is constantly monitored and
compared to market benchmarks in order to maintain parity with the best market
practices as adopted by other companies. The variable portion of the
compensation package incorporates the accomplishment of short and long term
goals. These are measured against clearly specified standards that are intended
to motivate individuals and teams.
The Human Resources policy consists of the acknowledgement and the
recognition of co-workers as strategic for the business. An example of this
policy is the participative program which, during 2003, implemented 1,369
development projects, supported by 3,996 staff in 1,001 working groups. These
projects secured important savings for the Company which duly compensated its
workers.
In order to track the managerial skills of its executives, the Company
conducts evaluations based on several different methodologies, including the
`360 degree evaluation'. These evaluations aim to identify the degree of
alignment of executives with the Company's strategies and business management
and monitor individual development.
In 2003, Gerdau S.A. paid a total of $ 19.8 million to its executive
officers in salaries and variable remuneration. The variable remuneration for
executives is based on the overall performance of Gerdau S.A., on the basis of
realized EBTDA (as defined for purposes of computation of variable remuneration)
versus planned EBTDA (as defined for purposes of computation of variable
remuneration), on the performance of the unit to which the executive is related,
and on personal performance. Each of these factors corresponds to one third of
the variable remuneration.
The Company and other related companies in the Group co-sponsor pension
plans (the "Brazilian Plans") covering substantially all employees based in
Brazil, including Gerdau Acominas since its consolidation. The Brazilian Plans
consists of a plan for the employees of Gerdau and its subsidiaries ("Gerdau
Plan") and a plan for employees of the former Acominas and its subsidiaries
("Gerdau Acominas Plan"). The Brazilian Plans are mainly defined benefit plans
with certain limited defined contributions. Theal Company's Canadian and
American subsidiaries, including Gerdau Ameristeel, also sponsor defined benefit
plans (the "North American Plans") that cover the majority of their employees.
Contributions to the Brazilian Plans and the North American Plans are based on
actuarially determined amounts.
Gerdau's contributions to the Gerdau Plan during 2003 amounted to $
13.4 million (Basic income program) and an additional $ 38.1 million to the
supplementary fund. This sum refers only to that portion of contributions for
executives who do not currently receive retirement benefits form the Company.
These benefits are in no way different from those offered to the other employees
of the Company.
On April 30th, 2003, the Gerdau S.A. shareholders approved a new
compensation program for executives with strategic positions within the Company,
the Long term Incentive Program. This new compensation consists of call options
on the Company's preferred shares, granted on a yearly basis, representing 20%
of the annual base salary of each executive. This program aims to attract and
secure the long-term commitment of executives by allowing these to share in the
growth of the Company, thereby
44
enhancing the feeling of partnership in the business. (See Item 10.B -
"Memorandum and Articles of Association")
On the same date the shareholders' meeting authorized the granting by
the Management, as of January 1, 2003, of 683,936 options at an exercise price
of R$ 23.88 per share, of which 280,785 for the regular program with a five-year
(5) mandatory vesting period and, exceptionally in the first year, 403,151
additional options with a (3) three-year mandatory vesting period. As part of
this compensation program, on November 17, the Board of Directors authorized the
acquisition of Company shares to be held in treasury for future resale or
cancellation. 786,600 shares (345,000 through December 2003) were bought at an
average price of R$ 55.93 per share for eventual use in the Long Term
Compensation Program mentioned above. In February 2004, the Board authorized the
granting of 173,556 options at a price of R$ 61.00 as part of the regular
program, with a five-year (5) mandatory vesting period.
Considering the stock bonus of 1 share for each share held, which was
approved by the General Shareholders' meeting held on April 29, 2004, the number
of options granted was modified to (i) 1,367,872 options at an exercise price of
R$ 11.94, relating to the grant of 2003, and (ii) 347,112 options at an exercise
price of R$ 30.50, relating to the grant of 2004. The April 29 meeting also
changed the conditions of the "Long Term Incentive Plan", authorizing the
granting to directors or executive officers, when elected for the first time, of
a three-year (3) mandatory vesting period option in addition to the regular
program option. Additional information on the Long Term Incentive Program is
available in the Exhibits listed in the end of this Form.
C. BOARD PRACTICES
Gerdau announced its new corporate governance structure on July 8, 2002
aimed at broadening the Group's management skills, meeting the demands resulting
from growth and greater global competitiveness, guaranteeing the succession
process without losing accumulated experience, and increasing disclosure to
shareholders and capital markets. The General Shareholders' Meeting, held on
July 26, 2002, approved the changes in the Company's By-Laws to formalize its
new corporate governance structure.
With a view to building on its relationship with the market and keeping
up with the best practices in corporate governance, the Gerdau Executive
Committee is now responsible for coordinating the activities of the executive
officers and managing the Company's business. This major change in the Company's
management structure provides an administrative link between the Board of
Directors and the Company's business operations.
BOARD OF DIRECTORS: The Board of Directors is responsible for determining the
broad direction of the Group's business, and may have up to ten members. Three
independent members will participate in the Group's decision-making process.
CHAIRMAN
Jorge Gerdau Johannpeter
VICE CHAIRMEN
Germano Hugo Gerdau Johannpeter
Klaus Gerdau Johannpeter
Frederico Carlos Gerdau Johannpeter
INDEPENDENT MEMBERS
Andre Pinheiro de Lara Resende
Affonso Celso Pastore
Oscar de Paula Bernardes Neto
SECRETARY-GENERAL
Expedito Luz
45
COMPENSATION AND SUCCESSION COMMITTEE: With the new corporate governance
structure introduced in 2002, Gerdau has established a Compensation and
Succession Committee, which guides executive remuneration practices and consists
of:
MEMBERS
Frederico Carlos Gerdau Johannpeter
Carlos Joao Petry
Affonso Celso Pastore
Oscar de Paula Bernardes Neto
SECRETARY
Joao Aparecido de Lima
GERDAU EXECUTIVE COMMITTEE: This body represents the link between the Board of
Directors and the Group's operations. Its activities are divided into five
business operations (BOs), defined by product line and/or geographical location:
BO - Brazil Long Steel Products, BO - Specialty Steel Products, BO - Gerdau
Acominas (Ouro Branco mill), BO Gerdau Ameristeel and BO - South American
operations. The Gerdau Executive Committee is also responsible for the main
functional processes that operate vertically throughout the Group, such as
finance, accounting, human resources and planning. Committee members work
together to encourage a greater synergy among operations, and individually with
a focus on the management of each business and functional processes, in order to
maximize results.
PRESIDENT
Jorge Gerdau Johannpeter
VICE PRESIDENTS
Frederico Carlos Gerdau Johannpeter
Carlos Joao Petry
Andre Bier Johannpeter
Claudio Johannpeter
Osvaldo Burgos Schirmer
Domingos Somma
SECRETARY-GENERAL
Expedito Luz
STRATEGY AND EXCELLENCE COMMITTEES: The Strategy Committee has been installed to
provide strategic support to the Executive Committee, and consists of executives
who contribute to the achievement of growing levels of operating performance.
The committee analyzes the Group's current situation and growth opportunities,
and defines its long-term business focus. The Excellence Committees provide
support for functional processes, aiming at developing best management practices
and encouraging the exchange of know-how among the Group's units.
PROCESSES: The Processes consist of Operational Processes and Support Processes.
Operational Processes are those directly connected with the final results of the
business, such as Marketing and Sales, Industrial Processes, Purchasing,
Logistics and Transport and Scrap Purchasing. Support Processes are those which
provide backup for the range of processes involved in running the business as a
whole: Strategic Planning - Corporate and Operations, Corporate Communications
and Community Relations, Human Resources and Organizational Development, Legal,
Finance and Investor Relations, Holdings, Accounting and Auditing, Quality
Management Systems and Information Technology.
BUSINESS OPERATIONS: The Business Operations are managed by executive officers
under the coordination of the Gerdau Executive Committee and are structured as
follows: BO - Brazil Long Steel Products, BO - Specialty Steel Products, BO -
Gerdau Acominas (Ouro Branco mill), BO - Gerdau Ameristeel and BO South American
operations.
46
On November 28, 2003, the shareholders of Gerdau S.A. and Aco Minas
Gerais S.A. - Acominas approved the integration of the operating assets of both
companies into a single company. This transaction consisted of the transfer of
all steel operations and complementary assets of Gerdau S.A. in Brazil to
Acominas and the change in name of the latter to Gerdau Acominas S.A. This new
structure led to the transfer of most executive officers of Gerdau S.A. to
Gerdau Acominas S.A., which since then has been the Gerdau Group's sole steel
manufacturing company in Brazil.
BOARD OF AUDITORS
Gerdau S.A. does not have an audit committee, but has elected a board
of auditors (conselho fiscal) with the aims of improving its relationship with
the capital markets and shareholders and complying with the Brazilian Corporate
Law No. 6,404/76. This board exists to monitor and verify the actions of
directors and their legal duties, to provide opinions and official statements on
management's annual report, to provide opinions concerning the proposals of
board members, to denounce errors or fraud, to call meetings whenever necessary
and to analyze financial statements. The Gerdau S.A. board of auditors has three
members, one of whom is elected by minority holders of the Company's common
shares.
The Board of Auditors elected at the Shareholder's Meeting of 2003 had
the following members:
EFFECTIVE
Jose Antonio Cruz de Modena
Peter Wilm Rosenfeld
Jose Bernardo de Medeiros Neto
(elected by minority shareholders)
SUBSTITUTES
Rudolfo Teodoro Tanscheit
Tranquilo Paravizi
Alfredo Tostes Bello da Silva
(elected by minority shareholders)
Members of the Board of Auditors are elected at the ordinary
shareholders' meeting for one-year terms, and may be re-elected. In accordance
with the Brazilian Corporate Law, the board of auditors may, at the request of
any of its members, ask independent auditors to provide explanations or
information and investigate specific facts.
All members of the Board of Directors and the Gerdau Executive
Committee, as well as the executive officers, are elected for one-year terms,
with re-election or re-appointment permitted. Members of the Board of Directors
are appointed at the General Meeting of Shareholders while members of the Gerdau
Executive Committee and executive officers are elected at meetings of the Board
of Directors.
D. EMPLOYEES
The following table presents information on the geographical
distribution of Gerdau's employees:
-------------------------------------------------------------------
DIRECT BRAZIL ABROAD TOTAL
-------------------------------------------------------------------
1998 8,639 1,172 9,811
1999 8,495 3,361 11,856
2000 8,436 3,654 12,090
2001 8,631 3,565 12,196
2002 12,978 5,048 18,026
2003 14,263 5,334 19,597
-------------------------------------------------------------------
47
-------------------------------------------------------------------
OUTSOURCED* BRAZIL ABROAD TOTAL
-------------------------------------------------------------------
2003 8,609 243 8,852
-------------------------------------------------------------------
* `Outsourced employees' refers to individuals hired by other companies
to develop or exercise activities that are not the core business of the Company.
As of December 31, 2003, the Company had 19,597 employees in its
industrial units excluding the two joint ventures, Sipar and Gallatin Steel. Of
this total, 73% are based in Brazil and the remainder in units in South and
North America, which have 472 and 4,862 employees, respectively. The number of
employees in Brazil grew considerably in 2002 due to the full consolidation of
the Acominas plant. In North America, the number of employees increased in 2002
as a result of the incorporation of employees of the former Co-Steel into Gerdau
Ameristeel Corp.
As unions in Brazil are organized on a regional rather than a national
basis, the Company has no nationally applicable agreements with its workers.
Gerdau believes that its employee pay and benefit structure is comparable to
general market rates. Gerdau also provides its employees with fringe benefits
such as health and child care.
Gerdau Acominas seeks to maintain good working conditions at its plants
and as a consequence has what it believes to be a comparatively low employee
turnover rate. Due to a strong emphasis on employee training, the Company
attempts to manage any necessary production curtailments through the timing of
vacations, rather than workforce reductions.
Gerdau Ameristeel Corp. has been and continues to be proactive in
establishing and maintaining a climate of good employee relations. Ongoing
initiatives include organizational development skills training, team-building
programs, opportunities for participation in employee involvement teams, and an
`open book' system of management. Gerdau Ameristeel Corp. believes that a high
level of employee involvement is a key factor in the success of its operations.
Compensation programs are designed to bring the financial interests of employees
into line with those of Gerdau Ameristeel's shareholders.
Gerdau Ameristeel currently has 4,862 employees. Of this total,
approximately 1,000 are represented by unions in a number of collective
bargaining agreements. Agreements with the mill employees expire on various
dates, beginning in February 2004. The first negotiation of contracts was
successfully completed at the Whitby, Ontario facility in Canada, and should
form the basis for subsequent negotiations with the remaining mills (two in
Canada and two in the United States).
E. SHARE OWNERSHIP
The following chart indicates the individual holdings of Preferred and
Common shares of Gerdau S.A. by each director and executive officer, as of
December 31, 2003. None of the directors or executive officers indicated below
own more than 1% or more of the company's capital for each class of share.
------------------------------------------------------------------------------------------------------
SHAREHOLDER COMMON SHARES % PREFERRED SHARES %
------------------------------------------------------------------------------------------------------
Jorge G. Johannpeter * 57 0.00% 2,295 0.00%
Frederico C. G. Johannpeter * 58 0.00% 7,073 0.01%
Germano G. Johannpeter * 95 0.00% 44,737 0.05%
Klaus G. Johannpeter * 111 0.00% 369 0.00%
Affonso Celso Pastore - 0.00% 1 0.00%
Oscar de Paula Bernardes Neto - 0.00% 1,810 0.00%
48
Andre Lara Resende - 0.00% 1 0.00%
Carlos Joao Petry 409 0.00% - 0.00%
Paulo F. B. Vasconcellos 4 0.00% 355 0.00%
Domingos Somma 31 0.00% 2,431 0.00%
Osvaldo B. Schirmer - 0.00% 8,008 0.01%
Expedito Luz - 0.00% 78 0.00%
Elias Pedro V. Manna - 0.00% 78 0.00%
Claudio Johannpeter 3,510 0.01% 31,894 0.03%
Andre Bier Johannpeter 3,622 0.01% 13,697 0.01%
Francesco Saverio Merlini - 0.00% 78 0.00%
------------------------------------------------------------------------------------------------------
TOTAL 7,897 0.02% 112,905 0.11%
------------------------------------------------------------------------------------------------------
* The Gerdau family controls Metalurgica Gerdau S.A. through the holding
companies, Indac - Industria, Administracao e Comercio S.A., Grupo Gerdau
Empreendimentos Ltda. and Gersul Empreendimentos Imobiliarios Ltda., holding,
collectively, 68.83% of the voting capital and 22.95% of the total capital of
Metalurgica Gerdau S.A.. Individually, Indac - Industria, Administracao e
Comercio S.A. holds 29.33% of the voting capital and 9.78% of the total capital
of Metalurgica Gerdau S.A., Grupo Gerdau Empreendimentos Ltda. holds 25.57% of
the voting capital and 8.53% of the total capital of Metalurgica Gerdau S.A.,
and Gersul Empreendimentos Imobiliarios Ltda. holds 13.93% of the voting capital
and 4.64% of the total capital of Metalurgica Gerdau S.A..
ITEM 7. MAJOR SHAREHOLDERS AND RELATED-PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
As of December 31, 2003, the Company had 51,468,224 Common Shares and 96,885,787
Preferred Shares outstanding. Of the two kinds of share traded in the market,
only the Common Shares carry voting rights. Under the terms of the Company's
By-Laws, however, specific rights are assured to the non-voting Preferred
Shares. See the By-Laws of Gerdau S.A. in the exhibits in the end of this form.
The table below presents certain information as of December 31, 2003,
regarding (i) any person known to the Company as the owner of more than 5% of
the company's outstanding Common Shares, (ii) any person known to the Company as
the owner of more than 5% of the company's outstanding Preferred Shares and
(iii) the total amount of the Company's Common Shares and Preferred Shares owned
by the Board of Directors and executive officers of the Company as a group.
-----------------------------------------------------------------------------------------------------------
SHAREHOLDER COMMON SHARES % PREFERRED SHARES %
-----------------------------------------------------------------------------------------------------------
Metalurgica Gerdau S.A. 42,897,208 83.35 22,509,988 23.23
BNDES Participacoes S.A. - BNDESPAR 3,801,058 7.39 1,971,391 2.03
Santa Felicidade Com. Imp. Exp. Prod. Sid. Ltda. * 1,218,034 2.37 4,913,618 5.07
Gersul Empreendimentos Imobiliarios S.A. * 971,379 1.89 - -
Grupo Gerdau Empreendimentos Ltda. * 712,148 1.38 12,261 0.01
Members of the Board of Directors and Executive
Officers as a group (16 members) 7,897 0.02 112,905 0.12
* Controlled by or affiliated with Metalurgica Gerdau S.A.
Metalurgica Gerdau S.A. and its subsidiaries hold 90.78% of the voting
capital of Gerdau S.A. and thus have the ability to control the Company's Board
of Directors as well as its management and operations.
49
B. RELATED-PARTY TRANSACTIONS
Transactions of the Company with related parties consist of (i) loans
and (ii) commercial operations with subsidiaries and related parties.
(i) Gerdau S.A. maintains loans with some of its subsidiaries and
other affiliates by means of loan contracts, which are repaid
under conditions similar to those prevailing in the open market.
Contracts between related parties and subsidiaries in Brazil incur
interest at the average market rate Contracts with the Group's
foreign companies incur interest at LIBOR + 3%/year and are
subject to indexation based on variations in the exchange rate.
(ii) Commercial operations between Gerdau S.A. and its subsidiaries or
related parties basically consist of transactions involving the
purchase and sale of inputs and products. These transactions are
carried out under the same conditions and terms as those of
transactions with non-related third parties. The commercial
operations also include payments for the use of the Gerdau brand
and payments relating to loan guarantees.
On April 16th, 2004, Gerdau Ameristeel sold 26,800,000 common shares to its
majority shareholder, Gerdau S.A. at a price of Cdn$ 4.90 per share, the closing
price of the Company's common shares on the Toronto Stock Exchange on March 31,
2004. As a result of the transaction, Gerdau increased its stake in Gerdau
Ameristeel from 68.6% to 72.3%.
Gerdau Ameristeel intends to use the total net proceeds of
approximately US$100 million for general corporate purposes, which may include
funding capital equipment or working capital and repayment of debt.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
50
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
The Company's financial statements are included in Item 18.
LEGAL PROCEEDINGS
Like other Brazilian company's, Gerdau S.A. is a party to claims with
respect to tax, labor and civil law, most of them arising in the regular course
of business. Management believes, based in part on advice from legal counsel,
that the reserve for contingencies is sufficient to meet probable and reasonably
estimable losses in the event of unfavorable rulings, and that the ultimate
resolution will not have a significant effect on its consolidated financial
position as of December 31, 2003. The most significant legal and administrative
disputes (involving amounts exceeding $ 5 million) are detailed below. For
further information on the reserve for contingencies, see the notes to the
financial statements.
All figures presented in this analysis are stated in thousands of U.S. dollars.
I) TAX CONTINGENCIES
Part of the total balance of the contingency reserve refers to tax claims. The
most significant contingent liabilities accounted for are as follows:
o The Company recognized in its contingency reserve, as of December
31, 2003, a provision of $ 17,464 relating to `compulsory loans'
that all consumers are obliged to make to Eletrobras ("Emprestimo
Compulsorio Eletrobras sobre Energia Eletrica"), the
government-owned energy company. The Company has, along with other
electricity consumers, challenged the constitutionality of these
loans.
In March 1995, the Supreme Court ruled against the interests of
the consumers. Some of the Company's cases are still awaiting a
ruling in the Higher Courts, but the outcome can be predicted in
the light of previous decisions. The Company has established a
provision relating to these `compulsory loans', since: (i) even
though the payment to Eletrobras was in the form of a loan, the
Company will be repaid in Eletrobras shares, and (ii) the
conversion to Eletrobras shares will be based on their book value.
(iii) based on currently available information, the market value
of Eletrobras shares is well below their book value.
o The Company has made a contingent provision relating to the Social
Contribution on Income (Contribuicao Social Sobre o Lucro). The
balance of the provision, which amounts to $ 14,106, refers to (i)
a claim for $ 10,958 relating to social contribution compensated
in excess of the 30% limit on the reduction of net earnings by the
subsidiary Gerdau Acominas S.A, a matter that is currently in
progress with the Regional Federal Court for the 1st Region, for
which the Company has made judicial deposits for the total amount
of the claim, and (ii) law suits challenging the constitutionality
of the contributions collected in 1989, 1990 and 1992. Some of
these claims are still awaiting judgment, with the majority in
Higher Courts.
o Of the total balance of the contingency reserve, $35,004 relates
to corporate income tax (Imposto de Renda de Pessoa Juridica)
("IRPJ").With regard to this issue, the Company has made a
judicial deposit of $27,996, corresponding to the portion that
subsidiary Gerdau Acominas will be required to pay in IRPJ after
compensating tax losses, without observing the limit for using tax
losses of 30% of net income.
51
o The Company has made a contingent provision for social security
contributions (INSS), amounting to $6,013. These claims refer
mainly to the abrogation of liabilities, and are under review in
the First Federal Court of Rio de Janeiro. Its subsidiary, Gerdau
Acominas, has also filed other suits that challenge the INSS'
decision to charge social security contributions on profit sharing
payments, as well as services provided by work cooperatives. The
Company has nevertheless made judicial deposits that substantially
cover the whole of the contingent liability.
o The Company has challenged the constitutionality of charging a
total of $ 5,511, relating to the Emergency Capacity Charge
(Encargo de Capacidade Emergencial - ECE) and the Extraordinary
Tariff Readjustment (Recomposicao Tarifaria Extraordinaria - RTE),
which represent tariffs charged for supplying energy to the
Company's industrial units. Management believes that these tariffs
represent taxes and are thus incompatible with the National Tax
System, as described in the Federal Constitution. The claims are
currently under review in the Lower Federal Courts of the states
of Pernambuco, Ceara, Minas Gerais, Rio de Janeiro, Sao Paulo,
Parana, Rio Grande do Sul, as well as in the Regional Federal
Courts of the 1st and 2nd Regions. The Company has made escrow
deposits equivalent to the total amount of these claims.
o Judicial deposits, which represent restricted assets of the
Company, refer to amounts held in judicial escrow accounts until
the final decision of the corresponding legal issues. As of
December 31, 2003, the balance of such deposits stood at $ 62,140.
Other contingent liabilities with only a small possibility of loss, involve
great uncertainty regarding their applicability, and are thus not recognized
among contingent provisions. These include:
o Law suits filed by the State Government of Minas Gerais to collect
presumed value added tax (ICMS) credits, based mainly on sales by
exporting companies, with claims amounting to $ 10,788. Management
understands that this tax is not applicable, since sales of
products for export purposes are exempt from value added tax. The
Company thus has not recognized any provision related to these
issues.
o The Company and its subsidiary, Gerdau Acominas S.A. are
defendants in tax claims filed by the State Government of Minas
Gerais for value added (ICMS) tax credits on exports of
industrialized semi-finished products. The total amount of this
contingency is $ 59,139. The Company has not made a provision for
such claims, as its management believes that this tax is not
applicable, since its products do not fit the definition of
industrialized semi-finished products, as established in federal
law, so that these are not subject to value added tax.
o The Federal Revenue Service has submitted claims for $ 18,954,
relating to operations of the Company's subsidiary, Gerdau
Acominas S.A. under the drawback concession act issued by DECEX,
the Department of Foreign Trade. The Federal Revenue Service
understands that this concession is not in accordance with the
law. Gerdau Acominas is awaiting judgment of its previous
administrative defense, which claims that the operation is legal.
Since the tax credit has not yet been definitely constituted, and
considering that the operation that generated the demand fits the
requirements of concession and also, that the concession was
sustained after analysis by the competent administrative
authority, the Company believes that it faces only a remote chance
of losing this case and has not, therefore, provisioned for this
contingent liability.
Management believes that it may be able to realize certain contingent assets.
Contingent but unprovisioned tax assets include:
o $ 9,200 relating to an ordinary action against the State
Government of Rio de Janeiro, for breaching the "Mutual Contract
of Periodic Execution in Cash", a tax incentive program signed as
part of the Special Industrial Development Program - PRODI, which
established payments to be made by the State Government of Rio de
Janeiro to the Company. Due to the insolvency of the State
Government of Rio de Janeiro, as well as the lack of
implementation by it of Constitutional
52
Amendment 30/00, which granted the state government a 10 year
moratorium for payment of non-food judicial debts (precatorios
nao-alimentares), there is no expectation that this credit will be
realized in 2004.
o The Company and its subsidiaries are plaintiffs in many ordinary
actions challenging changes in the basis for calculating PIS
defined by Complementary Law No. 7/70, and based on the
unconstitutionality rulings on Decrees Nos. 2,445/88 and 2,449/88,
expect to recover tax credits relating to the payment of the
difference. Management believes the total amount of tax credits
claimed to be $ 37,718.
o Based on previous court decisions on preliminary judgments, the
Company and its subsidiary Gerdau Acominas S.A. expect to recover
IPI tax credits. Gerdau S.A. has filed administrative requests for
reimbursement, and is awaiting judgment of these requests. In the
case of subsidiary, Gerdau Acominas S.A., the claim has been filed
in court, where an unfavorable ruling was given, with the company
currently awaiting an appeal, estimating that the amount
reimbursable is $ 136,371.
II) LABOR CONTINGENCIES
The Company is also a party to a number of lawsuits by ex-employees. As
of December 31, 2003, the Company had made provisions of $10,248 relating to
such lawsuits. None of these individual actions entail significant amounts, and
disputes mainly involve claims of overtime, health and danger bonuses. As of
December 31, 2003, balances of escrow deposits relating to labor contingencies,
amounted to $3,546.
III) CIVIL CONTINGENCIES
The Company is involved in a number of lawsuits with only a remote likelihood of
loss, and great uncertainty with regard to their applicability, for which it has
not, therefore, made contingency provisions. These include:
o Antitrust proceedings pending against Gerdau S.A, relating to a
complaint brought by two construction unions in Sao Paulo which
alleging that Gerdau S.A. and other Brazilian long steel producers
in Brazil were dividing clients among themselves and thus
violating antitrust laws. Following investigations conducted by
the Department of Economic Rights (Secretaria de Direito
Economico) "(SDE)" and based on a number of public hearings, the
Department decided that a cartel existed. This conclusion was also
supported by a previous ruling by the Department of Economic
Monitoring (Secretaria de Acompanhamento Economico) "(SEAE)". The
case will now proceed to its final stage at the Administrative
Council for Economic Defence (Conselho Administrativo de Defesa
Economica) "(CADE)", the Treasury Department agency responsible
for ruling on competition issues, which will decide the case.
The Company denies any anticompetitive conduct and its directors
believe, on the basis of available information, including the
opinion of its legal counsel, that the administrative case has so
far displayed many irregularities, some of which are inadmissible.
For example, the SDE investigations did not follow the due process
of law with representatives of the Department advising some
witnesses in the case. The SDE also issued its ruling before
Gerdau S.A. was able to respond to final allegations, indicating
partiality on the SDE's part. The same considerations apply to the
ruling by the SEAE, which does not consider the economic aspects
of the case and is based solely on statements by witnesses.
These irregularities, which do not respect the relevant terms of
the constitution, will undoubtedly affect an administrative
decision based on the conclusions presented so far by antitrust
authorities. Gerdau S.A. has identified and opposed all of these
irregularities and will continue to reject the allegations against
itself, as well as the irregular procedures of the administrative
process,
53
believing that it will ultimately be successful, if not in the
administrative case, then possibly in a court of law.
The Company has thus made no provisions in this case. According to
applicable Brazilian law, the Company may be fined up to 30% of
gross sales revenue of previous fiscal years and, if the personal
responsibility of an executive can be proven, such an individual
could be fined between 10-50% of the fine applied to the Company.
There is no precedent within Brazil for fines of more than 4% of
gross sales revenues. In a similar case involving plain steel
companies, the fines were approximately equal to 1% of gross sales
revenues.
o A claim against Gerdau Acominas S.A., relating to the rescinding
of a contract for the supply of slag and indemnification for
losses. As of December 31, 2003, this claim amounted to
approximately $12,460.
Gerdau Acominas S.A. has contested all claims and filed a
counterclaim requesting that the plaintiff rescinds the contract
and indemnifies it for breach of the same contract.
The court ruled that the contract be rescinded, since the request
was common to both parties, while denying the request for
indemnification on grounds of reciprocal guilt.
This ruling was sustained by the Jurisdictional Court of Minas
Gerais, and is based on expert opinion and interpretation of the
contract. The process is currently under appeal in the Superior
Court of Justice.
Gerdau Acominas S.A. expects that there is only a remote
possibility of loss, since it is unlikely that the previous ruling
will be changed.
o A civil action filed by the insurer, Sul America Cia Nacional de
Seguros against Gerdau Acominas S.A. and the New York branch of
Westdeutsche Landesbank Girozentrale (WestLB), regarding the
payment into escrow of $ 11,900, to settle the indemnity owed by
the insurance company for an insurable event. Sul America alleges
that it has no certainty as to whom it should pay. The Bank has
challenged this allegation, claiming that it has no rights to the
amount deposited, as well as by the Company, which alleges that
the amount owed by Sul America is higher than the amount
deposited. The case is currently in its initial phase. The
Company's expectation, based on the opinion of its legal counsel,
is that it stands only a remote chance of losing the case and that
the court will rule that the amount of the indemnity claimed by
the Insurance Company is not the correct one.
This law suit relates to the accident of March 23, 2002, in the
regenerators of the blast furnace plant of Presidente Arthur
Bernardes mill, which caused the shutdown of various activities,
material damages to the mill's equipment and financial losses. The
equipment, as well as the consequent losses, were covered by
insurance policy. A report on the event, as well as a loss claim
was filed with IRB - Brasil Resseguros S.A., and the Company
received an advance payment of $ 21,460, in 2002.
NO MATERIAL EFFECT
Management believes that the probability of losses as a consequence of
other contingencies is remote, and that were these to arise, they would not have
a materially adverse effect on the consolidated financial position of the
Company.
DIVIDEND DISTRIBUTION POLICY
Brazilian Corporate Law generally requires the By-Laws of each
Brazilian corporation to specify a minimum percentage of the profits for each
fiscal year that must be distributed to shareholders as dividends.
54
The law requires a minimum payout of 25% of adjusted net income. Under the
Company's By-Laws, this percentage has been fixed at no less than 30% of the
adjusted net income for distribution for each fiscal year (See Item 10.A -
"Dividend Policy").
Dividends for a given fiscal year are payable from (i) retained
earnings from prior periods and (ii) after tax income for the same period, after
the allocation of income to the legal reserve and to other reserves ("Adjusted
Net Income"). In order to convert the dividends paid by the Company from reais
into dollars, the Custodian will use the relevant commercial market exchange
rate on the date that these dividends are made available to shareholders in
Brazil. Under Brazilian Corporate Law, a Brazilian company is required to
maintain a legal reserve, to which it must allocate 5% of net income determined
in accordance with Brazilian Corporate Law for each fiscal year until such
reserve reaches an amount equal to 20% of the company's paid-in capital. On
December 31, 2003, in accordance with Brazilian GAAP, Gerdau S.A.'s legal
reserve amounted to R$ 184.4 million ($ 63.8 million, using the year-end
exchange rate) or 10.6% of total paid-in capital of R$ 1,735.7 million ($ 600.7
million, using the year-end exchange rate).
According to Law No. 9,457, holders of preferred shares in a Brazilian
corporation are entitled to dividends at least 10% greater than the dividends
paid on common shares, unless one of three exceptions described in the Law
holds. Gerdau S.A.'s executive directors presented a proposal at the 2002
shareholders' meeting, to grant both Common Shares and Preferred Shares 100%
tag-along rights. Shareholders approved this measure and the right was extended
to all shareholders, even though the new Brazilian Corporate Law only required
that such rights be granted to the minority holders of Common Shares (and only
for 80% of the consideration paid to the controlling shareholders).
Under the recent amendments to the Brazilian Corporate Law, by
extending the tag along right to minority shareholders the Company no longer
needs to comply with the requirement to pay an additional 10% premium on
dividends paid to preferred shareholders. Following the approval and
implementation of the amendments to the Company's By-Laws to provide for the
tag-along as described above, the Company pays the stated minimum dividend of
30% of Adjusted Net Profit to all shareholders, and no premium to preferred
shareholders. As a result, dividends on net income paid from January 1, 2002
onwards were not subject to the requirement to pay holders of Preferred Shares
least 10% more than holders of Common Shares.
As a general requirement, shareholders who are non-resident in Brazil
must have their Brazilian company investment registered with the Central Bank in
order to be eligible for conversion into foreign currency of dividends, sales
proceeds or other amounts related to their shares for remittance outside Brazil.
Preferred Shares underlying the ADRs will be held in Brazil by the Custodian as
agent for the Depositary. The holder of Preferred Shares will be the registered
holder recorded in the Register of Preferred Shares.
Payments of cash dividends and distributions, if any, will be made in
Brazilian currency to the Custodian, on behalf of the Depositary, which will
then convert such proceeds into U.S. dollars and deliver the same U.S. dollars
to the Depositary for distribution to holders of ADRs. If the Custodian is
unable to convert the Brazilian currency received as dividends into U.S. dollars
immediately, the amount of U.S. dollars payable to holders of ADRs may be
adversely affected by any devaluation or depreciation of the Brazilian currency
relative to the U.S. dollar that may occur before such dividends are converted
and remitted. Dividends in lieu of the Preferred Shares paid to holders who are
not resident in Brazil, including holders of ADRs, are not subject to Brazilian
withholding tax.
INTEREST ON STOCKHOLDERS' EQUITY
Law No. 9,249, of December 1995, provides that a company may, at its
sole discretion, pay interest on stockholders' equity in addition to or instead
of dividends. A Brazilian corporation is entitled to pay its shareholders
interest on stockholders' equity up to the limit of an amount computed as the
TJLP (Long-Term Interest Rate) rate of return on its stockholders' equity or 50%
of the net income for the fiscal year, whichever is the larger. The payment of
interest as described here is subject to a 15% withholding income tax. See "Item
10 - Taxation"
55
DIVIDEND POLICY
The Company currently intends to pay dividends on its outstanding
Preferred Shares at its mandatory distribution rates for any particular fiscal
year, subject to any determination by the Board of Directors that such
distributions would be inadvisable in view of the Company's financial condition.
Although not required to do so by its By-Laws, the Company has paid dividends
twice a year in the form of interest on stockholders' equity. As of March 31,
2003, the Board of Directors approved a new policy for paying dividends and
interest on stockholders' equity on a quarterly basis.
Since 1999, dividends have been paid to holders of the Company's Common
Shares and Preferred Shares in reais and in U.S. dollars translated from reais
at the commercial exchange rate on the date of payment. Relevant amounts are
described in Item 3 - "Selected Financial Data".
B. SIGNIFICANT CHANGES
GERDAU ANNOUNCED THE SECOND TRANCHE OF ITS SECURED EXPORT NOTES PROGRAM
On June 3, 2004, Gerdau Acominas S.A. placed the second U.S.$ 128
million tranche of its Export Receivables Notes program, with a final maturity
of 8 years (April 2012) and a coupon of 7.321% per year. The notes have a
quarterly amortization schedule starting in July 2006. The operation was
concluded in parallel with a U.S. Treasury Lock derivative, yielding Gerdau an
effective final cost of 6.798% per year. At the time of pricing (May 24, 2004),
this represented a coupon 488 basis points below that of the Brazilian Sovereign
bond of equivalent average maturity, and 292 basis points above the yield on the
five-year U.S. Treasury bond, corresponding to the average duration of this
tranche. The operation was granted a "BBB-" rating by Fitch, on the basis of
receivables to be generated by sales of steel products of Gerdau Acominas.
DIRECTORS
At the Board of Directors meeting on April 29, 2004, Dirceu Tarcisio
Togni was elected executive officer of Gerdau S.A. He joined the Company in
1974 and became executive officer in 2002. Mr. Togni holds a degree in
Mechanical Engineering.
STOCK BONUS
In accordance with the proposal presented by the Board of Directors, a
capital stock increase was approved on April 29, 2004 by the General, Ordinary
and Extraordinary Meetings of Gerdau S.A. and will result in the issuance of new
shares through the capitalization of reserves. Gerdau S.A.'s paid-in capital was
increased from R$ 1,735,656,174.86 to R$ 3,471,312,349.01 through the
incorporation of reserves and the issue of 1 (one) bonus share for each share
existing on the date of the Shareholders' Meeting.
ACQUISITION OF POTTER FORM & TIE CO.
On February 16, 2004, Gerdau S.A. announced that its North American
subsidiary, Gerdau Ameristeel Corporation, had signed an agreement to acquire
the assets of Potter Form & Tie Co., of Belvidere, Illinois. Potter has units in
Belvidere, Urbana and Decatur (Illinois), Madison and Appleton (Wisconsin) and
Eldridge (Iowa).
Approved by the regulatory authorities, the operation was finalized by
the end of March, 2004. Together with Gerdau Ameristeel's 16 rebar fabricating
facilities, the purchase of Potter Form & Tie will provide experience in
engineering, operations and sales processes, as well as geographical expansion
into the heavily populated Midwest corridor.
56
GERDAU ACOMINAS' NEW WIRE ROD ROLLING MILL BEGAN OPERATIONS
The new Gerdau Acominas rolling mill produced its first coils of wire
rod. Located in Ouro Branco, in the state of Minas Gerais, the US$ 66 million
rolling mill is the most modern wire rod production facility in the Americas,
with annual production capacity of 550,000 metric tons. Wire rod is a raw
material for the production of wire for civil construction, agriculture and
general industry.
The rolling mill uses modern technology to produce special quality wire
rod, which has been produced since the first quarter of 2004 to meet the strong
export demand.
ITEM 9. THE OFFER AND LISTING
A. OFFER AND LISTING DETAILS
PRICE INFORMATION
The following table presents high and low market prices in Brazilian
reais for Gerdau S.A. Preferred Shares (GGBR4) on the Sao Paulo Stock Exchange
(BOVESPA) for the indicated periods, as well as the high and low market prices
in U.S. dollars (converted at the PTAX exchange rate) for the same period.
CLOSING PRICES GGBR4 - ANNUAL BASIS
Adjusted for dividends
-------------------------------------------------------------------------------------------------------------------------
YEAR BRAZILIAN REAIS PER SHARE US DOLLARS PER SHARE
-------------------------------------------------------------------------------------------------------------------------
HIGH (R$) LOW (R$) HIGH (US$) LOW (US$)
1999 7.15 1.06 3.91 0.76
2000 8.46 4.17 4.72 2.11
2001 7.57 4.03 3.67 1.44
2002 12.49 7.15 4.73 2.25
2003 30.17 10.49 10.44 2.88
-------------------------------------------------------------------------------------------------------------------------
Source: Economatica
CLOSING PRICES GGBR4 - QUARTERLY BASIS
Adjusted for dividends
-------------------------------------------------------------------------------------------------------------------------
YEAR BRAZILIAN REAIS PER SHARE US DOLLARS PER SHARE
-------------------------------------------------------------------------------------------------------------------------
HIGH (R$) LOW (R$) HIGH (US$) LOW (US$)
2002
1st Quarter 9.85 7.15 4.20 3.10
2nd Quarter 11.32 8.92 4.73 3.19
3rd Quarter 11.57 8.76 3.83 2.25
4th Quarter 12.49 8.76 3.53 2.34
2003
1st Quarter 12.10 10.49 3.57 2.88
2nd Quarter 16.36 10.68 5.72 3.26
3rd Quarter 22.63 15.11 7.81 5.12
4th Quarter 30.17 20.03 10.44 6.86
2004
1st Quarter 34.17 26.25 12.00 8.90
-------------------------------------------------------------------------------------------------------------------------
Source: Economatica
57
CLOSING PRICES GGBR4 - MONTHLY BASIS
Adjusted for dividends
-------------------------------------------------------------------------------------------------------------------------
YEAR BRAZILIAN REAIS PER SHARE US DOLLARS PER SHARE
-------------------------------------------------------------------------------------------------------------------------
HIGH (R$) LOW (R$) HIGH (US$) LOW (US$)
2003
January 12.10 10.49 3.57 2.88
February 12.07 10.70 3.37 2.95
March 12.10 10.68 3.44 3.10
April 13.31 10.68 4.61 3.26
May 15.23 12.87 5.32 4.41
June 16.36 13.83 5.72 4.67
July 17.02 15.12 5.89 5.34
August 22.15 15.76 7.45 5.13
September 22.63 18.73 7.81 6.38
October 22.62 20.08 7.90 6.92
November 23.86 20.03 8.09 6.86
December 30.17 23.64 10.44 8.03
2004
-------------------------------------------------------------------------------------------------------------------------
January 34.17 28.73 11.99 9.77
February 30.96 26.25 10.66 8.90
March 33.73 29.23 11.71 10.03
April 35.28 29.77 12.21 10.01
May 34.00 25.25 11.08 8.08
-------------------------------------------------------------------------------------------------------------------------
Source: Economatica
In the above tables, share prices have been retroactively adjusted for
all periods to reflect: (a) a share split approved in 2000 of 2 shares for each
share held, (b) a share bonus approved in April 2003 of 3 shares for each share
held and (c) a reverse stock split approved in April 2004 of 1 share for 1,000
shares held.
The following table presents high and low market prices for Gerdau S.A.
ADRs as negotiated on the New York Stock Exchange (NYSE) since March 10, 1999,
when the company upgraded its ADRs to level II.
CLOSING PRICES GGB - ANNUAL BASIS
Adjusted for dividends
------------------------------------------------------------------------------
YEAR US Dollars per Share
------------------------------------------------------------------------------
HIGH (US$) LOW (US$)
1999 (from March 10, 1999) 5.19 1.62
2000 5.77 3.03
2001 3.77 1.80
2002 5.38 2.65
2003 9.76 3.39
------------------------------------------------------------------------------
Source: Bloomberg
58
CLOSING PRICES GGB - QUARTERLY BASIS
Adjusted for dividends
---------------------------------------------------------------------------
YEAR US Dollars per Share
---------------------------------------------------------------------------
HIGH (US$) LOW (US$)
2002
1st Quarter 4.78 3.67
2nd Quarter 5.38 3.56
3rd Quarter 4.20 2.65
4th Quarter 3.83 2.67
2003
1st Quarter 3.80 3.11
2nd Quarter 5.90 3.42
3rd Quarter 8.03 5.46
4th Quarter 10.23 7.14
2004
1st Quarter 11.83 9.45
---------------------------------------------------------------------------
Source: Bloomberg
CLOSING PRICES GGB - MONTHLY BASIS
Adjusted for dividends
---------------------------------------------------------------------------
YEAR US Dollars per Share
---------------------------------------------------------------------------
HIGH (US$) LOW (US$)
2003
January 3.80 3.11
February 3.58 3.21
March 3.71 3.39
April 4.68 3.42
May 5.48 4.71
June 5.90 4.92
July 6.02 5.70
August 7.50 5.45
September 8.03 6.87
October 8.00 7.28
November 8.24 7.14
December 10.23 8.46
2004
January 11.83 10.46
February 10.80 9.45
March 11.67 10.17
April 12.25 10.33
May 10.80 7.96
--------------------------------------------------------------------------
Source: Bloomberg
The above tables show the lowest and highest market prices of Gerdau's
shares since 1999. Share prices have been retroactively adjusted for all periods
to reflect: (a) a share split approved in 2000 of 2 shares for each share held,
(b) a share bonus approved in April 2003 of 3 shares for each share held and (c)
a reverse stock split approved in April 2004 of 1 share for 1,000 shares held.
59
B. DISTRIBUTION PLAN
Not required.
C. MARKETS
SAO PAULO STOCK EXCHANGE - BRASIL
The Sao Paulo Stock Exchange - BOVESPA is a non-profit association
owned by its member brokerage firms. Trading on the BOVESPA is limited to member
brokerage firms and a limited number of authorized non-members. The BOVESPA
currently has two open outcry trading sessions each business day, from 10:00
a.m. to 5:00 p.m. Trading is also conducted between 10:00 a.m. and 5:00 p.m. on
the BOVESPA automated system. There is also trading on the so-called
After-Market, a system that allows for evening trading through an electronic
trading system. Trades are made by entering orders in the Mega Bolsa electronic
trading system, created and operated by BOVESPA. The system limits individual
orders to R$ 100,000 and price variations are limited to 2% (above or below) the
closing quote of the day.
Since March 17, 2003 market maker activities have been allowed on the
BOVESPA, although there are no specialists or market makers for the Company's
shares on this exchange. The Brazilian Securities Commission (Comissao de
Valores Mobilarios) (CVM) and the BOVESPA have discretionary authority to
suspend trading in shares of a particular issuer under certain circumstances.
Trading in securities listed on the BOVESPA may be effected off the exchange
under certain circumstances, although such trading is very limited.
Although any of the outstanding shares of a listed company may trade on
the BOVESPA, in most cases less than half of the listed shares are actually
available for trading by the public, the remainder being held by small groups of
controlling shareholders that rarely trade their shares. For this reason, data
showing the total market capitalization of the BOVESPA tend to overstate the
liquidity of the Brazilian equity securities market, which is relatively small
and illiquid compared to major world markets.
Settlement of transactions is effected three business days after the
trade date without adjustment of the purchase price for inflation. Payment for
shares is made through the facilities of a separate clearing house, the
Brazilian Clearing and Depository Corporation (Companhia Brasileira de
Liquidacao e Custodia) (CBLC), which maintains accounts for member brokerage
firms. The seller is ordinarily required to deliver the shares to the exchange
on the second business day following the trade date. The CBLC is controlled by
clearing agents such as member brokerage firms and banks, and the BOVESPA.
Trading on the BOVESPA by non-residents of Brazil is subject to certain
limitations under Brazilian foreign investment legislation.
REGULATION OF BRAZILIAN SECURITIES MARKETS
The Brazilian securities markets are regulated by the Brazilian
Securities Commission (CVM), which has authority over stock exchanges and the
securities markets generally, and by the Brazilian Central Bank (BACEN), which
has, among other powers, licensing authority over brokerage firms and regulates
foreign investment and foreign exchange transactions. The Brazilian securities
market is governed by the Brazilian Securities Law (Law No. 6,385, dated
December 7, 1976, as amended) and the Brazilian Corporate Law (Law No. 6,404,
dated December 15, 1976, as amended).
Law No. 10,303 of October 31, 2001, amended Law No. 6,385/76 and Law
No. 6,404/76. The most important changes were (i) the conversion of the CVM into
an autonomous governmental agency linked to the Ministry of Finance, with legal
independence and a separate budget, assets and liabilities; (ii) the requirement
of greater disclosure by listed companies; (iii) the tag-along right for
minority common shareholders in the event of transfer of control of a listed
company; (iv) the right of preferred shareholders with non-voting rights or
restricted voting rights representing at least 10% of the total stock of a
listed company to elect one board
60
member and substitute (considering that until April 2005, the representative of
such shareholders shall be chosen from a three-name list prepared by controlling
shareholders); (v) the right of the minority common shareholders to elect one
board member; and (vi) the condition that preferred shares shall only be traded
on the stock market if they have at least one of the rights mentioned below: (a)
priority over dividends corresponding to at least 3% of the shares' net worth
based on the company's last approved balance sheet; (b) the right to receive
dividends at least 10% higher than the dividend assigned to each common share;
or (c) the tag-along right in the event of transfer of control of the company.
Under the Brazilian Corporate Law, a company is either listed, such as
Gerdau S.A., or not listed. All listed companies must apply for registration
with the CVM and one of the Brazilian Stock Exchanges and are subject to ongoing
reporting requirements. A listed company may have its securities traded either
on the BOVESPA or on the Brazilian over-the-counter markets (Brazilian OTC). The
shares of a listed company, including Gerdau S.A., may also be traded privately
subject to certain limitations established in CVM regulations.
There are certain cases requiring disclosure of information to the
CVM, the BOVESPA, or even the public. These include (i) the direct or indirect
acquisition by an investor of at least 5% (five percent) of any class or type of
shares representing the share capital of a listed company, (ii) the sale of
shares representing the transfer of control of a listed company and (iii) the
occurrence of a material event for the corporation.
On March 5, 2002, the CVM issued Regulation No. 361, which regulates
tender offers if one of the following events occurs: (i) delisting of companies;
(ii) an increase in the equity interest of the controlling shareholder; or (iii)
the transfer of control of a listed company.
The Brazilian OTC market consists of direct trades between individuals
in which a financial institution registered with the CVM serves as intermediary.
No special application, other than registration with the CVM, is necessary for
securities of a listed company to be traded on the Brazilian OTC. The CVM must
be notified of all trades carried out on the Brazilian OTC by the company's
respective intermediaries.
The trading of a company's securities on the BOVESPA may be suspended
in anticipation of a material announcement. Trading may also be suspended at the
initiative of the BOVESPA or the CVM on the basis of a belief that a company has
provided inadequate information regarding a material event, has not provided an
adequate response to the inquiries by the CVM or the exchange, or for other
reasons.
The laws and regulations regarding the Brazilian Securities Market
provide for disclosure requirements, restrictions on insider trading and price
manipulation, and protection of minority shareholders. Although many changes and
improvements have been introduced, the Brazilian securities markets are not as
highly regulated and supervised as the U.S. securities markets or those in
certain other jurisdictions.
TRADING ON EXCHANGES OUTSIDE BRAZIL
In addition to the BOVESPA, Gerdau shares are traded on two other
exchanges:
NEW YORK STOCK EXCHANGE
On March 10, 1999, Gerdau S.A. obtained registration for the issuance
of Level II ADRs, which began trading on the New York Stock Exchange the same
day. Under the GGB symbol, these Level II ADRs have been traded in virtually
every session since the first day. In 2003, 23.5 million ADRs were traded, a
figure 67.4% higher than in 2002, representing trading volume of U.S.$ 315.3
million, equivalent to a daily average of US$ 1.2 million.
LATIBEX - MADRID STOCK EXCHANGE
Since December 2, 2002, Gerdau S.A. preferred shares have been traded
on the Latibex, the segment of the Madrid Stock Exchange devoted to Latin
American companies traded in Euros. Following approval by the CVM and the
Brazilian Central Bank, this date marked the beginning of the Depositary
Receipts (DR)
61
Program for preferred shares issued by the company in Spain. The shares are
traded in Spain under the symbol XGGB in the form of DRs, each corresponding to
one preferred share. This participation in the Latibex boosted the Company's
visibility in the European market and brought increased liquidity to its shares
on the BOVESPA, as each unit traded in Madrid generates a corresponding
operation on the BOVESPA. In 2003, a total of 297,700 Gerdau preferred shares
were traded on the Madrid Stock Exchange (Latibex), representing trading volume
of 3.1 million euros.
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not applicable.
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
The information required for this item was included in the Registration
Statement in Form 20-F dated February 3, 1999 (Commission file number 0-29956)
and in the subsequent annual reports in Form 20-F. The items listed below refer
to significant changes to the By-Laws. The full document, with the following
changes can be found as an exhibit to this annual report.
STOCK OPTION PLAN
The General Shareholders' meeting held on April 30, 2003, approved the
change in Article 4 of the Company's By-Laws and included a new 2nd paragraph
with the following text and consequent renumbering of the ensuing paragraphs:
Art. 4(0), ss. 2(0) - Within the limits of the authorized capital
stock, the Board may, based on a program approved by the Shareholders' meeting,
grant stock options to the directors, officers, employees or individuals that
provide services to the Company or to companies under its control.
The shareholders' meeting also approved a stock option plan that
constitutes a new form of compensation of strategic executives termed the "Long
Term Incentive Program", with the document containing the policies of the
program filed as an exhibit with this annual report. The meeting authorized the
granting by the Management, effective as of January 1, 2003, of 683,936 options
at an exercise price of R$ 23.88 (twenty-three reais and eighty-eight cents) per
share (ex-stock dividend and ex-reverse split as described in Resolution Nos.
145 and 146/2003-AGE), of which 280,785 in the regular program with a five-year
(5) mandatory vesting period and, exceptionally in the first year, 403,151
additional options with a (3) three-year mandatory vesting period. In February
2004, the Board authorized the granting of 173,556 options at an exercise price
of R$ 61.00 (sixty-one reais) as part of the regular program, with a five-year
(5) mandatory vesting period.
On account of the stock bonus of 1 share for each share held that was
approved by the General Shareholders' meeting held on April 29, 2004, the terms
of the options granted was modified to (i) 1,367,872 options at an exercise
price of R$ 11.94 (eleven reais and ninety-four cents), relating to the grant of
2003, and (ii) 347,112 options at an exercise price of R$ 30.50 (thirty reais
and fifty cents), relating to the grant of 2004. The April 29 meeting also
changed the conditions of the "Long Term Incentive Plan" authorizing the
granting to an individual elected as director or executive officer for the first
time of a three-year (3) mandatory vesting period option in addition to a
three-year (3) mandatory vesting period option.
TAG-ALONG RIGHT
The new Brazilian Corporate Law (Law No. 10,302, issued on October 31,
2001) introduced changes concerning the rights of minority shareholders. One of
these changes is the obligation, in case of transfer of control, of the new
controlling entity to make a public offer for the acquisition of remaining
voting shares for an amount equivalent to at least 80% of the price paid for
each voting share in the controlling block.
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On April 30, 2002, the Company's Shareholders' Meeting approved a
change to the Company's By-Laws (Art. 4, ss.5) regarding the rights of Preferred
Shares. As part of this alteration, a 100% tag-along right for all shareholders
was approved, whereby all non-controlling common and preferred shares now have
the right to be included in a potential public offer for the transfer of
control. In addition, the change guarantees that the amount to be paid to the
non-controlling shares is the same as that paid for the common shares in the
controlling block.
CORPORATE GOVERNANCE STRUCTURE
Gerdau announced its new corporate governance structure on July 8,
2002. The General Shareholders' Meeting, held on July 26, 2002, approved the
changes to the Company's By-Laws that formalize the new structure (See By-Laws
of Gerdau S.A. as an exhibit to this annual report). The major change in the
Company's management structure was the creation of the Gerdau Executive
Committee, which provides an administrative link between the Board of Directors
and the Business' operations. The members of the Board of Directors, Gerdau
Executive Committee and executive officers are presented in Item 6.A -
Directors, Senior Management and Employees.
SUMMARY OF SPECIAL CONDITIONS RELATING TO DIRECTORS AND OFFICERS
Although the By-Laws do not specifically address this matter, the
Company and its directors and officers are obliged to follow the provisions of
Law No. 6.404/76, which regulates corporations in Brazil.
In general terms, Article 153 of the Corporate Law establishes that in
exercising his duties, a company director or officer shall employ the care and
diligence which an active and honest man normally employs in the administration
of his own affairs.
The same Article 154, 2nd paragraph of the Corporate Law, states that
directors and officers shall not: a) perform a act of liberality at the expense
of the company; b) borrow money or property from the company or use company
property, services or credits for his or her own advantage or for the advantage
of any entity in which he, she or any third party has an interest without the
prior approval of a General Shareholders' Meeting or the Board of Directors; c)
by virtue of his/her position, receive any type of direct or indirect personal
benefit without the authorization of the Company's By-Laws or a General
Shareholders' Meeting.
In more specific terms, as outlined in the 1st paragraph of Article 156
of the same law, a director or an officer may only carry out transactions with
the company under reasonable and fair conditions, identical to the conditions
prevailing in the market, or in situations in which the company would contract
with third parties, including occasional loan agreements between the company and
its director or officers.
With regard to the financial compensation of directors and officers, as
well as any benefits and representation allowances, Article 152 of the Brazilian
Corporate Law states that such amounts will be established by the General
Shareholders' Meeting.
Article 146 of Law No. 6,404/76 establishes that the members of the
Company's board of directors must be shareholders, and that they must own at
least one share in the Company.
There is no By-Law or legal rule concerning any mandatory employment
limit date or retirement age for directors and officers.
In addition to enforcing the pertinent legal provisions, the Company
also observes the rules and corporate governance recommendations of the Sao
Paulo Stock Exchange (see the BOVESPA's rules of corporate governance as an
exhibit to this annual report.).
Adherence to these rules is consolidated in a contract in which the
company and its directors and officers agree to enforce the relevant
regulations, which establish that the company shall submit to the Sao Paulo
Stock Exchange and disclose information on any contract established between the
company and its controlled and associated companies, senior managers and the
controlling shareholder; between the company
63
and the subsidiary or associated companies of its senior managers and the
controlling shareholder; and between the company and any other companies that
form a de facto or de jure group with the entities mentioned above, whenever one
single contract, or a series of related contracts, with or without the same
purpose, equals or exceeds two hundred thousand reais (R$ 200,000.00) within any
one-year period, or equals or exceeds an amount equal to one percent (1%) of the
company's net equity, whichever is higher. When submission or disclosure of
information is required, the information must detail the scope of the contract,
its term of effectiveness and value, the conditions for termination and early
expiration and any influence that such contract may have on the company's
management and business.
This issue is also covered in the Gerdau Ethical Guidelines, which
outline and consolidate the rules guiding the behavior of Gerdau Group and its
employees, as described in item 16B of this document, which is attached to this
Form 20-F as an exhibit and is also available at www.gerdau.com.br
Gerdau officers must abide by the Gerdau Ethical Guidelines, both
internally and when representing the Company. They must act in accordance with
standards that reflect their personal and professional integrity and that are
compatible with the bond they have established with the Company and society at
large, they must carefully evaluate situations involving conflicts between
personal interests and those of the Company, and carry out in the Company's best
interest all activities involving Company resources, property, services or
credits, reporting any private activities that may interfere or conflict with
the Company's interests, disclosing the extent and nature of such activities,
maintaining their loyalty to the Company, and refraining from using privileged
information concerning business opportunities to their own benefit or to the
benefit of others, regardless of whether these are to the advantage or the
disadvantage of the Company
C. MATERIAL CONTRACTS
Gerdau S.A. has entered into financial agreements in order to fund and
improve its debt profile. Although some of these contracts entail significant
amounts, none exceeds 10% of the Company's consolidated total assets. The most
significant financial agreements are described below, with the Company
undertaking to provide a copy of the debt instruments described herein to the
Securities and Exchange Commission upon request.
EURO COMMERCIAL PAPER
A Euro Commercial Paper program for a total amount of $ 300 million was
announced by Gerdau S.A., with the first tranche of $ 100 million issued in the
first half of October 2003. The program matures on October 15th, 2004 with the
paper bearing a coupon of 4.0% per year.
EXPORT RECEIVABLES NOTES
On September 4, 2003, Gerdau Acominas S.A. concluded the placement of
the first $ 105 million tranche of an Export Receivable Notes program. This
program, which will total $ 400 million, represents an important tool for
improving the Company's debt profile. This initial tranche was placed with a
coupon of 7.37% per year, and final maturity in July 2010. The operation has a 2
year grace period and amortization will be carried out quarterly beginning in
October 2005. The operation was awarded a "BBB-" rating by Fitch Ratings. The
certificates are backed by receivables generated by future sales of steel
products by Gerdau Acominas S.A.
On June 3, 2004, Gerdau Acominas S.A. placed the second $ 128 million
tranche of its Export Receivables Notes program. This second tranche was placed
with a final maturity of 8 years (April 2012) and a coupon of 7.321% per year.
The notes have a quarterly amortization schedule starting in July 2006. The
operation was concluded in parallel with a U.S. Treasury Lock derivative,
yielding an effective final cost to Gerdau of 6.798% per year. At the time of
pricing (May 24, 2004), this represented a yield 488 basis points below the
Brazilian Sovereign Bond of an equivalent average maturity, and 292 basis points
above that of the five-year U.S. Treasury Bond, which corresponds to the average
duration of this tranche. The operation was granted a "BBB-" rating by Fitch,
based on receivables to be generated by sales of steel products by Gerdau
Acominas.
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SENIOR NOTES AND SENIOR SECURED CREDIT FACILITY
On June 27, 2003, Gerdau Ameristeel refinanced most of its outstanding
debt by issuing $ 405.0 million of 10 3/8% Senior Notes and entering into a $
350.0 million Senior Secured Credit Facility with a syndicate of lenders.
The proceeds were used to repay existing debt under several lending
arrangements and to pay costs associated with the refinancing.
Following the refinancing, the principal sources of liquidity are cash
flow generated from operations and borrowings under the new Senior Secured
Credit Facility.
Gerdau Ameristeel believes these sources will be sufficient to meet its
cash flow requirements. The principal liquidity requirements are working
capital, capital expenditures and debt service. Gerdau Ameristeel does not have
any off-balance sheet financing arrangements or relationships with
unconsolidated special purpose entities.
The following is a summary of existing credit facilities:
SENIOR SECURED CREDIT FACILITY: provides funding of up to $ 350.0
million. Gerdau Ameristeel will be able to borrow under the Senior
Secured Credit Facility the lesser of (i) the committed amount, and
(ii) the borrowing base (which is based upon a portion of inventory and
accounts receivable held by most of the Company's operating units less
certain reserves), minus outstanding loans, letter of credit
obligations and other obligations owed under the Senior Secured Credit
Facility. Since the borrowing base under the Senior Secured Credit
Facility will be based on actual levels of inventory and accounts
receivable, available borrowings under the facility will fluctuate. The
borrowings under the Senior Secured Credit Facility are secured by the
Company's inventory and accounts receivable. On December 31, 2003, the
Company had approximately $ 135.0 million of outstanding borrowings and
approximately $ 130.3 million available under the Senior Secured Credit
Facility.
Loans under the Senior Secured Credit Facility bear interest at an
annual rate equal to one of several options (LIBOR, federal funds rate,
bankers' acceptance or prime rate) based on the facility chosen at the
time of borrowing plus an applicable margin determined from time to
time by excess availability.
Borrowings under the Senior Secured Credit Facility may be made in U.S.
dollars or Canadian dollars, at the option of the Company.
SENIOR NOTES: On June 27, 2003, Gerdau Ameristeel issued $ 405.0
million in 10 3/8% Senior Notes, of which $ 35.0 million were sold to
an indirect wholly owned subsidiary of Gerdau S.A. The notes mature on
July 15, 2011 and were issued at 98% of face value. The notes are
unsecured, are effectively junior to secured debt to the extent of the
value of the assets securing such debt, rank equally with all existing
and future unsecured unsubordinated debt, and are senior to any future
senior subordinated or subordinated debt.
The notes carry a 10 3/8% annual coupon (10.75% effective rate) which
is payable semi-annually on July 15 and January 15. At any time prior
to July 15, 2006, Gerdau Ameristeel may redeem up to 35% of the
original principal amount of the notes with the proceeds of one or more
equity offerings of common shares at a redemption price of 110.75% of
the principal amount of the notes, plus accrued and unpaid interest, if
any, until the date of redemption.
The indenture governing the notes permits Gerdau Ameristeel and its
restricted subsidiaries to incur additional indebtedness, including
secured indebtedness, subject to certain limitations. On January 23,
2004, Gerdau Ameristeel completed the exchange of the Senior Notes. The
exchanged notes have
65
substantially the same form and terms as the original notes issued on
June 27, 2003. The exchanged notes were issued under a prospectus in
Ontario, Canada, and the exchanged notes and subsidiary guarantees have
been registered under the U.S. Securities Act of 1933, as amended, and
are not subject to restrictions on transfer.
D. EXCHANGE CONTROLS
There are no restrictions on ownership or voting of the Company's paid-in
capital by individuals or legal entities domiciled outside Brazil. The right to
convert dividend payments and proceeds from the sale of the Company's paid-in
capital into foreign currency and to remit such amounts outside Brazil is
subject to restrictions under foreign investment legislation which generally
require, among other things, the prior registration of the relevant investment
with the Central Bank.
In Brazil, a mechanism is available to foreign investors interested in
trading directly on the Sao Paulo Stock Exchange. Until March 2000, this
mechanism was known as Annex IV Regulations, in reference to the Annex IV of
Resolution No. 1,289 of the National Monetary Council ("Annex IV Regulations").
Currently, this mechanism is regulated by Resolution No. 2,689, of January 26,
2000, of the National Monetary Council and by CVM Instruction No. 325, of
January 27, 2000, as amended ("Regulation 2,689").
Regulation 2,689, which took effect on March 31, 2000, establishes new
rules for foreign investments in Brazilian equities. Such rules allow foreign
investors to invest in almost all types of financial asset and to engage in
almost all transactions available in the Brazilian financial and capital
markets, provided that some requirements are fulfilled. In accordance with
Regulation 2,689, foreign investors are defined as individuals, legal entities,
mutual funds and other collective investments resident, domiciled or
headquartered abroad. Regulation 2,689 prohibits the offshore transfer or
assignment of the title of the securities, except in the cases of (i) corporate
reorganization effected abroad by a foreign investor or (ii) inheritance.
Pursuant to Regulation 2,689, foreign investors must: (i) appoint at least
one representative in Brazil with powers to perform actions relating to the
foreign investment; (ii) fill in the appropriate foreign investor registration
form; (iii) obtain registration as a foreign investor with the CVM; and (iv)
register the foreign investment with the Central Bank.
The securities and other financial assets held by the foreign investor
pursuant to Regulation 2,689 must be registered or maintained in deposit
accounts or under the custody of an entity duly licensed by the Central Bank or
by the CVM or be registered in registration, clearing and custody systems
authorized by the Central Bank or by the CVM. In addition, securities trading is
restricted to transactions carried out on exchanges or organized
over-the-counter markets licensed by the CVM.
All investments made by a foreign investor under Regulation 2,689 will be
subject to electronic registration with the Central Bank.
Resolution No. 1,927 of the National Monetary Council, which is the
Amended and Restated Annex V to Resolution No. 1,289 ("Annex V Regulations"),
provides for the issuance of depositary receipts in foreign markets in respect
of shares of Brazilian issuers. Since ADRs have been approved under the Annex V
Regulations by the Central Bank and the CVM, the proceeds from the sale of the
ADRs by ADR holders outside Brazil are free of Brazilian foreign investment
controls and holders of the ADRs will be entitled to favorable tax treatment.
According to the 2,689 Regulation, foreign investments registered under Annex V
Regulations may be transferred to the new investment system created by
Regulation 2,689 and vice-versa, with due regard to the conditions set forth by
the Central Bank and by the CVM.
A foreign investment registration has been made in the name of The Bank of
New York, as Depositary for the Preferred ADRs ("Depositary"), and is maintained
by Banco Itau S.A. ("Custodian") on behalf of the Depositary. Pursuant to the
registration, the Custodian and the Depositary are able to convert dividends and
other distributions with respect to the Preferred Shares represented by
Preferred ADRs into foreign currency and remit the proceeds abroad. In the event
that a holder of Preferred ADRs exchanges Preferred ADRs for Preferred Shares,
such a holder will be entitled to continue to rely on the Depositary's
registration of foreign
66
investment for only five business days after such exchange, after which time,
the same holder must seek its own registration with the Central Bank.
Thereafter, unless the Preferred Shares are held pursuant to the 2,689
Regulation by a foreign investor, the same holder may not be able to convert
into foreign currency and remit outside Brazil the proceeds from the disposal
of, or distributions with respect to, such Preferred Shares, and will generally
be subject to less favorable Brazilian tax treatment than a holder of Preferred
ADRs.
Restrictions on the remittance of foreign capital abroad could hinder or
prevent the Custodian, as custodian for the Preferred Shares represented by
Preferred ADRs or holders who have exchanged Preferred ADRs for Preferred Shares
from converting dividends, distributions or the proceeds from any sale of
Preferred Shares into U.S. dollars and remitting such U.S. dollars abroad.
Holders of Preferred ADRs could be adversely affected by delays in, or refusal
to grant any required government approval for conversions of Brazilian currency
payments and remittances abroad of the Preferred Shares underlying the Preferred
ADRs.
EXCHANGE RATES
There are two legal foreign exchange markets in Brazil, the Commercial
Market and the Floating Market. The Commercial Market is reserved primarily for
foreign trade transactions and transactions that generally require previous
approval from Brazilian monetary authorities, such as the purchase and sale of
registered investments by foreign individuals and related remittances of funds
abroad. Purchases of foreign exchange in the Commercial Market may only be
carried out through a financial institution in Brazil authorized to buy and sell
currency in that market. The Commercial Rate is the commercial exchange rate for
Brazilian currency into U.S. dollars, as reported by the Central Bank. The
Floating Rate is the prevailing exchange rate for Brazilian currency into U.S.
dollars which is applicable to transactions to which the Commercial Rate does
not apply. Prior to the implementation of the "Real Plan", the Commercial Rate
and the Floating Rate have at times diverged considerably. Since the
introduction of the real, the two rates have not differed significantly,
although there can be no assurance that there will not be significant
differences between the two rates in the future.
The Company will make all cash distributions related to the Preferred
Shares in Brazilian currency. Accordingly, exchange rate fluctuations may affect
the U.S. dollar amounts received by the holders of Preferred ADRs on conversion
by the Depositary of such distributions. Fluctuations in the exchange rate
between the real and the U.S. dollar may also affect the U.S. dollar equivalent
of the price in reais of the Preferred Shares on the Brazilian stock exchanges.
E. TAXATION
The following summary contains a description of the principal Brazilian
and U.S. federal income tax consequences of the ownership and disposal of a
Preferred Share and Preferred ADR. It does not purport to be a comprehensive
description of all the tax considerations that may be relevant to a decision to
purchase those securities. In particular, this summary deals only with holders
that will hold Preferred Shares or Preferred ADRs as capital assets and does not
address the tax treatment of a holder that may be subject to special tax rules,
like a bank, an insurance company, a dealer in securities, a person that holds
Preferred Shares or Preferred ADRs in a hedging transaction or as a position in
a "straddle" or "conversion transaction" for tax purposes, a person that has a
"functional currency" other than the U.S. dollar, a person liable for
alternative minimum tax, a partnership (or other entity treated as a partnership
for U.S. federal income tax purposes) or a person that owns or is treated as
owning 10% or more of the voting shares of the company. Each prospective
purchaser of a Preferred Share or Preferred ADR should consult his own tax
advisers as to the personal tax consequences of his investment, which may vary
for investors in different tax situations.
The summary is based upon tax laws of Brazil and the United States and
applicable regulations, judicial decisions and administrative pronouncements in
effect on the date hereof. The same authorities may be subject to change or new
interpretations, possibly with retroactive effect. Although there is no income
tax treaty between Brazil and the United States at this time, the tax
authorities of the two countries have held discussions that may culminate in a
treaty. No assurance can be given, however, as to whether or when a treaty will
enter into force or how it will affect the U.S. holders of Preferred Shares or
Preferred ADRs. This summary is also based upon the representations of the
Depositary and on the assumption that each obligation
67
in the Deposit Agreement relating to the Preferred ADRs and any related
documents will be performed in accordance with its terms.
BRAZILIAN TAX CONSIDERATIONS
The following discussion summarizes the material Brazilian tax
consequences of the ownership and disposal of Preferred Shares or Preferred ADRs
by a holder that is not domiciled in Brazil for purposes of Brazilian taxation
and, in the case of a holder of Preferred Shares that has registered its
investment in such securities with the Central Bank as a U.S. dollar investment
(in each case, a "non-Brazilian holder"). The following discussion does not
specifically address every Brazilian tax consideration applicable to any
particular non-Brazilian holder, and each non-Brazilian holder should consult
his or her own tax advisor concerning the Brazilian tax consequences of an
investment in this kind of security.
TAXATION OF DIVIDENDS
Dividends paid with respect to income earned since January 1, 1996,
including dividends paid in kind (i) to the Depositary in respect of the
Preferred Shares underlying the Preferred ADRs or (ii) to a non-Brazilian holder
in respect of Preferred Shares, are not subject to any withholding tax in
Brazil. The current tax legislation eliminated the then existing 15% withholding
tax on dividends paid to companies, resident individuals or non-residents in
Brazil. Accordingly, dividends with respect to profits generated on or after
January 1, 1996 are not subject to withholding tax in Brazil. Dividends related
to profits generated prior to December 31, 1993 will be subject to Brazilian
withholding tax of 25%. Dividends related to profits generated between January
1, 1994 and December 31, 1995 will be subject to Brazilian withholding tax of
15%.
TAXATION OF GAINS
Gains realized outside Brazil by a non-Brazilian holder on the disposal
of Preferred ADRs to another non-Brazilian holder are not subject to Brazilian
tax, subject to the uncertainties to which the third paragraph below refers. The
withdrawal of Preferred Shares in exchange for Preferred ADRs is not subject to
Brazilian tax. On receipt of the underlying Preferred Shares, a non-Brazilian
holder who qualifies under Regulation 2,689 will be entitled to register the
U.S. dollar value of such shares with the Central Bank as described below. The
deposit of Preferred Shares in exchange for Preferred ADRs is not subject to
Brazilian tax provided that the Preferred Shares are registered by the investor
or its agent under Regulation 2,689. In the event of the Preferred Shares not
being so registered, the deposit of Preferred Shares in exchange for Preferred
ADRs may be subject to Brazilian tax at the rate of 15%.
When Preferred Shares are registered under Regulation 2,689, a
non-Brazilian holder cannot transfer or assign them abroad. As a general rule,
non-Brazilian holders are subject to a withholding tax imposed at a rate of 15%
on gains realized on sales or exchanges of Preferred Shares that occur off the
Sao Paulo Stock Exchange. In the case of non-Brazilian holders that are
residents of a tax haven - i.e., a country that does not impose income tax or
imposes income tax at a rate lower than 20% -, the gains are taxed at a rate of
25%. Non-Brazilian holders are subject to withholding tax at the rate of 20% on
gains realized on sales in Brazil of Preferred Shares that occur on the Sao
Paulo Stock Exchange unless such a sale is made under Regulation 2,689. Gains
realized arising from transactions on the Sao Paulo Stock Exchange by an
investor under the Regulation 2,689 are not subject to tax - except if the
investor is resident in a tax haven, in which case, gains realized are taxed at
a rate of 20%. There can be no assurance that the current tax treatment under
Regulation 2,689 for holders of Preferred ADRs and non-Brazilian holders of
Preferred Shares that are not residents of a tax haven will be maintained in the
future. The `gain realized' as a result of a transaction on the Sao Paulo Stock
Exchange is the difference between the amount in Brazilian currency realized on
the sale or exchange and the acquisition cost measured in Brazilian currency,
without any correction for inflation, of the shares sold. The `gain realized' as
a result of a transaction that occurs off the Sao Paulo Stock Exchange is the
positive difference between the amount realized on the sale or exchange and the
acquisition cost of the Preferred Shares, with both values to be accounted for
in reais. There are grounds, however, for maintaining that the `gain realized'
should be calculated on the basis of the foreign currency amount registered with
the Central Bank.
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Pursuant to Provisional Measure No. 135, of October 30, 2003, converted
into Law No. 10,833, of December 29, 2003, gains realized on the disposal of any
assets in Brazil, by residents or non-residents of Brazil, inside or outside
Brazil, are subject to Brazilian income tax, which is to be paid by the relevant
purchaser or, in case of a non-Brazilian purchaser, by its legal representative
in Brazil. The new provision seems to simply transfer the obligation for payment
of the tax from the seller to the purchaser (or its legal representative).
However, in practice, before the enactment of Provisional Measure No. 135/2003,
gains realized on sales of Brazilian assets that occurred abroad between two
non-Brazilian residents were not subject to tax by the Brazilian tax
authorities. Although there are grounds for challenging this new rule with
regard to gains realized by non-Brazilian residents outside Brazil, Brazilian
tax authorities may, as of February 2004, claim that even transactions between
non-residents involving sales of Preferred Shares and, less probably, Preferred
ADRs, are taxable.
Any exercise of preemptive rights relating to Preferred Shares will not
be subject to Brazilian taxation. Any gain on the sale or assignment of
preemptive rights relating to Preferred Shares by the Depositary on behalf of
holders of Preferred ADRs will be subject to Brazilian income taxation at the
rate of 15%, unless such sale or assignment is carried out on the Sao Paulo
Stock Exchange, in which case the gains are exempt from Brazilian income tax.
Any gain on the sale or assignment of preemptive rights relating to
Preferred Shares, will be subject to Brazilian income tax at the same rate
applicable to the sale or disposal of Preferred Shares. The maximum rate of such
tax is currently 15%.
INTEREST ON STOCKHOLDERS' EQUITY
Distributions of interest on stockholders' equity with regard to the
Preferred Shares as an alternative form of payment to shareholders who are
either Brazilian residents or non-Brazilian residents, including holders of
ADRs, are subject to Brazilian withholding tax at the rate of 15%. In the case
of non-Brazilian residents that are residents of a tax haven, the income tax
rate is 25%. Currently, such payments are tax deductible by the company in
determining social welfare contributions and income tax. (See item 8.A. -
Interest on Stockholders' Equity).
OTHER BRAZILIAN TAXES
There are no Brazilian inheritance, gift or succession taxes applicable
to the ownership, transfer or disposal of Preferred Shares or Preferred ADRs by
a non-Brazilian holder except for gift and inheritance taxes which are levied by
some states of Brazil on gifts made or inheritances bestowed by individuals or
entities not resident or domiciled in Brazil or domiciled within the state to
individuals or entities resident or domiciled within such state in Brazil. There
are no Brazilian stamp, issue, registration or similar taxes or duties payable
by holders of Preferred Shares or Preferred ADRs. A financial transaction tax
("IOF tax") may be imposed on a variety of transactions, including the
conversion of Brazilian currency into foreign currency (e.g. for purposes of
paying dividends and interest). The IOF tax rate on such conversions is
currently 0%, but the Minister of Finance has the legal power to increase the
rate to a maximum of 25%. Any such increase will be applicable only on a
prospective basis. IOF may also be levied on transactions involving bonds or
securities ("IOF/Titulos") even if the transactions are effected on Brazilian
stock, futures or commodities exchanges. The rate of the IOF/Titulos with
respect to Preferred Shares and ADRs is currently 0%. The Minister of Finance
nevertheless has the legal power to increase the rate to a maximum of 1.5% of
the amount of the taxed transaction per day of the investor's holding period,
but only to the extent of the gain realized on the transaction and only on a
prospective basis. In addition to the IOF tax, a temporary tax applies to all
fund transfers in connection with financial transactions in Brazil ("CPMF tax").
Pursuant to Law 9,311, of October 24, 1996, and Constitutional Amendment 42, of
December 19, 2003, the CPMF tax will be levied at a rate of 0.38% until December
31, 2007. The CPMF tax was initially set to expire on February 1998. Its
collection has nevertheless been extended for additional periods throughout the
past years. Accordingly, the Brazilian Congress is discussing the possibility of
converting this tax into a permanent tax. The responsibility for the collection
of the CPMF tax is borne by the financial institution that carries out the
relevant financial transaction. Under Constitutional Amendment 37 of June 12,
2002, when the non-Brazilian holder remits
69
funds exclusively in connection with the purchase, sale or assignment of
Preferred Shares, the CPMF tax will not be levied.
REGISTERED CAPITAL
The amount of an investment in Preferred Shares held by a non-Brazilian
holder registered with the CVM under Regulation 2,689, or in ADRs held by the
Depositary representing such holder, as the case may be, is eligible for
registration with the Central Bank. Such registration (the amount so registered
is referred to as "Registered Capital") allows the remittance abroad of foreign
currency, converted at the Commercial Market rate, acquired with the proceeds of
distributions on, and amounts realized with respect to the disposal of the same
Preferred Shares. The Registered Capital for Preferred Shares purchased in the
form of a Preferred ADR, or purchased in Brazil and deposited with the
Depositary in exchange for a Preferred ADR, will be equal to the price (in U.S.
dollars) paid by the purchaser. The Registered Capital for Preferred Shares that
are withdrawn upon surrender of Preferred ADRs, will be the U.S. dollar
equivalent of (i) the average price of the Preferred Shares on the Sao Paulo
Stock Exchange on the day of withdrawal, or (ii) if no Preferred Shares were
sold on such day, the average price of Preferred Shares that were sold in the
fifteen trading sessions immediately preceding the same withdrawal. The U.S.
dollar value of the Preferred Shares is determined on the basis of the average
Commercial Market rates quoted by the Central Bank on the same date (or, if the
average price of Preferred Shares is determined under clause (ii) of the
preceding sentence, the average of such average quoted rates on the same fifteen
dates used to determine the average price of the Preferred Shares). A
non-Brazilian holder of Preferred Shares may experience delays in effecting the
registration of Registered Capital, which may delay remittances abroad. Such a
delay may adversely affect the amount, in U.S. dollars, received by the
non-Brazilian holder.
US FEDERAL INCOME TAX CONSIDERATIONS
As used below, a "U.S. holder" is a beneficial owner of a Preferred
Share or Preferred ADR that is, for U.S. federal income tax purposes, (i) a
citizen or resident alien individual of the United States, (ii) a corporation
(or an entity treated as a corporation) organized under the laws of the United
States, any State thereof or the District of Columbia, (iii) an estate, the
income of which is subject to U.S. federal income tax without regard to its
source or (iv) a trust if (1) a court within the United States is able to
exercise primary supervision over the administration of the trust, and one or
more United States persons have the authority to control all substantial
decisions of the trust, or (2) the trust was in existence on August 20, 1996 and
properly elected to continue to be treated as a United States person. For
purposes of this discussion, a "non-US holder" is the beneficial owner of a
Preferred Share or Preferred ADR that is (i) a nonresident alien individual,
(ii) a corporation (or an entity treated as a corporation) created or organized
in or under the law of a country other than the United States or a political
subdivision thereof or (c) an estate or trust that is not a U.S. Holder.
In general, for U.S. federal income tax purposes, the owner of a Preferred ADR
will be treated as the owner of the Preferred Share represented by the Preferred
ADR, and a deposit or withdrawal of a Preferred Share in exchange for a
Preferred ADR will not be a taxable transaction for U.S. federal income tax
purposes.
TAXATION OF DIVIDENDS
U.S. holders: In general, subject to the passive foreign investment
company rules discussed below, a distribution relating to a Preferred Share or
Preferred ADR (including for this purpose a distribution of interest on
shareholders' equity) will constitute a dividend for U.S. federal income tax
purposes to the extent that it is made from the company's current or accumulated
earnings and profits as determined under U.S. federal income tax principles. If
a distribution exceeds the company's current and accumulated earnings and
profits, it will be treated as a non-taxable reduction of basis to the extent of
the U.S. holder's tax basis in the Preferred Share or Preferred ADR on which it
is paid, and to the extent it exceeds that basis it will be treated as a capital
gain. For purposes of this discussion, the term "dividend" means a distribution
that constitutes a dividend for U.S. federal income tax purposes.
The gross amount of any dividend on a Preferred Share or Preferred ADR
(which will include the amount of any Brazilian taxes withheld) will be subject
to U.S. federal income tax as foreign source dividend
70
income. The amount of a dividend paid in Brazilian currency will be its value in
U.S. dollars based on the prevailing spot market exchange rate in effect on the
day that the U.S. holder receives the dividend or, in the case of a dividend
received in respect of a Preferred ADR, on the date the Depositary receives it,
whether or not the dividend is converted into U.S. dollars. Any gain or loss
realized on a conversion or other disposal of the Brazilian currency will
generally be treated as U.S. source ordinary income or loss. Any Brazilian
withholding tax will be treated as a foreign income tax eligible for credit
against a U.S. holder's U.S. federal income tax liability, subject to generally
applicable limitations under U.S. federal income tax law. For purposes of
computing those limitations separately for specific categories of income, a
dividend will generally constitute foreign source "passive income" or, in the
case of certain holders, "financial services income". A foreign tax credit may
not be allowed for withholding tax imposed in respect of certain short-term or
hedged positions in a Preferred Share or Preferred ADR. Alternatively, any
Brazilian withholding tax may be taken as a deduction against taxable income. A
dividend will not be eligible for deduction of corporate dividends received.
Subject to certain exceptions for short-term and hedged positions, any
dividend that an individual receives on a Preferred ADR before January 1, 2009
will be subject to a maximum tax rate of 15% if the dividend is a "qualified
dividend." A dividend on a Preferred ADR will be a qualified dividend if (i) the
Preferred ADRs are readily tradable on an established securities market in the
United States, and (ii) the company was not, in the year prior to the year the
dividend was paid, and is not, in the year the dividend is paid, a passive
foreign investment company ("PFIC"), a foreign personal holding company ("FPHC")
or a foreign investment company ("FIC"). The Preferred ADRs are listed on the
New York Stock Exchange and will qualify as readily tradable on an established
securities market in the United States so long as they are so listed. Based on
existing guidance, it is not entirely clear whether a dividend on a Preferred
Share will be treated as a qualified dividend, because the Preferred Shares
themselves are not listed on a U.S. exchange. Based on the company's audited
financial statements and relevant market and shareholder data, the Company does
not believe that it was a PFIC, FPHC or FIC for U.S. federal income tax purposes
for its 2003 taxable year. In addition, based on the Company's audited financial
statements and its current expectations regarding the value and nature of its
assets, the sources and nature of its income, and relevant market and
shareholder data, the Company does not anticipate becoming a PFIC, FPHC or FIC
for its 2004 taxable year. The U.S. Treasury has announced its intention to
promulgate rules pursuant to which holders of stock of non-US corporations, and
intermediaries though whom such stock is held, will be permitted to rely on
certifications from issuers to establish that dividends are treated as qualified
dividends. Because those procedures have not yet been issued, it is not clear
whether the Company will be able to comply with them. Special limitations on
foreign tax credits apply to dividends subject to the reduced rate of tax.
Holders of Preferred ADRs and Preferred Shares should consult their own tax
advisers regarding the availability of the reduced dividend tax rate in the
light of their own particular circumstances.
Non-U.S. holders: A dividend paid to a non-U.S. holder on a Preferred
Share or Preferred ADR will not be subject to U.S. federal income tax unless the
dividend is effectively connected with the conduct of trade or business by the
non-U.S. holder within the United States (and is attributable to a permanent
establishment or fixed base the non-U.S. holder maintains in the United States
if an applicable income tax treaty so requires as a condition for the non-U.S.
holder to be subject to U.S. taxation on a net income basis on income from the
Preferred Share or Preferred ADR). A non-U.S. holder generally will be subject
to tax on an effectively connected dividend in the same manner as a U.S. Holder.
A corporate non-U.S. holder may also be subject under certain circumstances to
an additional "branch profits tax," the rate of which may be reduced pursuant to
an applicable income tax treaty.
TAXATION OF CAPITAL GAINS
U.S. holders. Subject to the passive foreign investment company rules
discussed below, on a sale or other taxable disposal of a Preferred Share or
Preferred ADR, a U.S. holder will recognize a capital gain or loss for an amount
equal to the difference between the U.S. holder's adjusted basis in the
Preferred Share or Preferred ADR and the amount realized on the sale or other
disposal, each determined in U.S. dollars. Any gain a U.S. holder recognizes
will generally be U.S. source income for U.S. foreign tax credit purposes, and,
subject to certain exceptions, any loss will generally be a U.S. source loss. If
a Brazilian tax is withheld on a sale or other disposal of a Preferred Share,
the amount realized will include the gross amount of the proceeds
71
of that sale or disposal before deduction of the Brazilian tax. The generally
applicable limitations under U.S. federal income tax law on crediting foreign
income taxes may preclude a U.S. holder from obtaining a foreign tax credit for
any Brazilian tax withheld on a sale of a Preferred Share.
In general, any adjusted net capital gain of an individual in a taxable
year ending before January 1, 2009 is subject to a maximum tax rate of 15%. In
subsequent years, the maximum tax rate on the net capital gain of an individual
will be 20%. The deductibility of capital losses is subject to limitations.
Non-U.S. holders. A non-U.S. holder will not be subject to U.S. federal
income tax on a gain recognized on a sale or other disposal of a Preferred Share
or Preferred ADR unless (i) the gain is effectively connected with the conduct
of trade or business by the non-U.S. holder within the United States (and is
attributable to a permanent establishment or fixed base that the non-U.S. holder
maintains in the United States if an applicable income tax treaty so requires as
a condition for the non-U.S. holder to be subject to U.S. taxation on a net
income basis on income from the Preferred Share or Preferred ADR), or (ii) in
the case of a non-U.S. holder who is an individual, the holder is present in the
United States for 183 or more days in the taxable year of the sale or other
disposal and certain other conditions apply. Any effectively connected gain of a
corporate non-U.S. holder may also be subject under certain circumstances to an
additional "branch profits tax", the rate of which may be reduced pursuant to an
applicable income tax treaty.
PASSIVE FOREIGN INVESTMENT COMPANY RULES
A special set of U.S. federal income tax rules applies to a foreign
corporation that is a PFIC for U.S. federal income tax purposes. As noted above,
based on the company's audited financial statements and relevant market and
shareholder data, the Company believes it was not a PFIC for U.S. federal income
tax purposes for its 2003 taxable year. In addition, based on the Company's
audited financial statements and its current expectations regarding the value
and nature of its assets, the sources and nature of its income, and relevant
market and shareholder data, the Company does not anticipate becoming a PFIC for
its 2004 taxable year.
In general, a foreign corporation is a PFIC if at least 75% of its
gross income for the taxable year is passive income or if at least 50% of its
assets for the taxable year produce passive income or are held for the
production of passive income. In general, passive income for this purpose means,
with certain designated exceptions, dividends, interest, rents, royalties (other
than certain rents and royalties derived in the active conduct of trade or
business), annuities, net gains from disposals of certain assets, net foreign
currency gains, income equivalent to interest, income from notional principal
contracts and payments in lieu of dividends. The determination of whether a
foreign corporation is a PFIC is a factual determination made annually and is
therefore subject to change. Subject to certain exceptions, once stock in a
foreign corporation is stock in a PFIC in the hands of a particular shareholder
that is a United States person, it remains stock in a PFIC in the hands of that
shareholder.
If the company is treated as a PFIC, contrary to the tax consequences
described in "U.S. Federal Income Tax Considerations - Taxation of Dividends"
and "U.S. Federal Income Tax Considerations - Taxation of Capital Gains" above,
a U.S. holder that does not make a choice described in the next two paragraphs
would be subject to special rules with respect to (i) any gain realized on a
sale or other disposal of a Preferred Share or Preferred ADR and (ii) any
"excess distribution" by the company to the U.S. holder (generally, any
distribution during a taxable year in which distributions to the U.S. holder on
the Preferred Share or Preferred ADR exceed 125% of the average annual taxable
distributions that the U.S. holder received on the Preferred Share or Preferred
ADR during the preceding three taxable years or, if the relevant holding period
of the U.S. holder is shorter, the same holding period for the Preferred Share
or Preferred ADR). Under those rules, (i) the gain or excess distribution would
be allocated pro-rata over the U.S. holder's holding period for the Preferred
Share or Preferred ADR, (ii) the amount allocated to the taxable year in which
the gain or excess distribution is realized would be taxable as ordinary income
and (iii) the amount allocated to each prior year, with certain exceptions,
would be subject to tax at the highest tax rate in effect for that year, and the
interest charge generally applicable to underpayments of tax would be imposed in
respect of the tax attributable to each such year. A U.S. holder who owns a
Preferred Share or Preferred ADR during any year that the company is a PFIC must
file Internal Revenue Service Form 8621.
72
The special PFIC rules described above will not apply to a U.S. holder
if the U.S. holder makes a timely decision to treat the company as a "qualified
electing fund" ("QEF") in the first taxable year in which the U.S. holder owns a
Preferred Share or Preferred ADR and if the company complies with certain
reporting requirements. Instead and in general, a shareholder of a QEF is
currently taxed on a pro-rata share of the company's ordinary earnings and net
capital gain treated as ordinary income and long-term capital gain,
respectively. Neither this ordinary income nor any actual dividend from the
company would qualify for the 15% maximum tax rate on dividends described above
if the company is a PFIC in the taxable year that the ordinary income is
realized or the dividend is paid or in the preceding taxable year. The Company
has not yet determined whether, if it were a PFIC, it would make the
computations necessary to supply U.S. holders with the information needed to
report income and gain pursuant to a QEF election. It is, therefore, possible
that U.S. holders would not be able to make or retain that election in any year
that the company is a PFIC. Although a QEF election generally cannot be revoked,
if a U.S. holder makes a timely QEF election for the first taxable year that it
owns a Preferred Share or Preferred ADR and the company is a PFIC (or is treated
as having done so pursuant to any of certain elections), the QEF election will
not apply during any later taxable year in which the company fails to satisfy
the qualifying criteria for a PFIC. If a QEF election is not made in that first
taxable year, an election in a later year will generally require the payment of
tax and interest, and in certain circumstances the election may cease to be
available at a later date.
Instead of a QEF election, a U.S. holder of stock in a PFIC that is
considered marketable stock could elect to mark the stock to market annually,
recognizing as ordinary income or loss each year an amount equal to the
difference as of the close of the taxable year between the fair market value of
the stock and the U.S. holder's adjusted basis in the stock. Losses would be
allowed only to the extent of the net mark-to-market gain previously included in
income by the U.S. holder under the election for prior taxable years. A U.S.
holder's adjusted basis in the ordinary Shares of ADRs will be adjusted to
reflect the amounts included or deducted with respect to the mark-to-market
election. If the mark-to-market election were made, the rules stated in the last
paragraph but one would not apply for periods covered by the election. A
mark-to-market election will not apply during any later taxable year in which
the company does not satisfy the tests to be a PFIC. In general, the ADRs will
be considered to be marketable stock if the ADRs trade, other than in de minimis
quantities, on at least 15 days during each calendar quarter. There is no
guarantee, however, that the Common Shares will be considered to be "marketable
stock" for these purposes unless and until the Internal Revenue Service
designates the Bovespa as qualified to implement the PFIC rules. There can be no
assurance that the Internal Revenue Service will designate it as such.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Dividends paid on, and proceeds from the sale or other disposal of a
Preferred Share or Preferred ADR to a U.S. holder may generally be subject to
information reporting requirements and may be subject to backup withholding at
the rate of 28% unless the U.S. holder provides an accurate taxpayer
identification number or otherwise demonstrates that they are exempt. The amount
of any backup withholding collected from a payment to a U.S. holder will be
allowed as a credit against the U.S. holder's U.S. federal income tax liability
and may entitle the U.S. holder to a refund, provided that certain required
information is submitted to the Internal Revenue Service.
A non-U.S. holder will generally be exempt from these information
reporting requirements and backup withholding tax but may be required to comply
with certain certification and identification procedures in order to establish
its eligibility for exemption.
F. DIVIDENDS AND PAYING AGENTS Not applicable.
G. STATEMENT BY EXPERTS Not applicable.
H. DOCUMENTS ON DISPLAY
73
The Company makes its filings in electronic form under the EDGAR filing
system of the U.S. Securities and Exchange Commission. Its filings are available
through the EDGAR system at www.sec.gov. In addition, the Company's filings are
available to the public over the internet at Gerdau's website at
www.gerdau.com.br. Such filings and other information on its website are not
incorporated by reference in this Annual Report. Interested parties may request
a copy of this filing, and any other report, at no cost, by writing to the
Company at the following address: Av. Farrapos, 1811 - Porto Alegre-RS -
90.220-005 - BRASIL or contacting it by telephone on 00-55-51-33232703 or by
E-mail at inform@gerdau.com.br. The Company has, in compliance with New York
Stock Exchange Corporate Governance Rule 303A.11, provided on its website a
summary of how its corporate governance practices differ from those followed by
U.S. domestic companies under the New York Stock Exchange listing standards.
I. SUBSIDIARY INFORMATION
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISKS
Gerdau is exposed to various market risks, mainly variations in
exchange rates and interest rate volatility. Market risk is the potential loss
arising from adverse changes in market rate and prices. Gerdau enters into
derivatives and other financial instruments to manage and reduce the impact of
fluctuations of exchange rates and interest rates. Gerdau has established
policies and procedures for risk assessment and the approval, reporting and
monitoring of its derivative financial activities.
Gerdau's short-term investments, which consist mainly of fixed-term
private obligations and government securities, are not subject to equity risk.
FOREIGN EXCHANGE RISK
Gerdau is exposed to fluctuations in exchange rate movements since
substantially all of its revenues generated outside its North American
subsidiaries are in reais, while a significant portion of its debt is
denominated in or indexed to U.S. dollars. Gerdau enters into derivative
financial instruments to manage and reduce the impact of changes in exchange
rates relating to its dollar-denominated or indexed debt. As of December 31,
2003, its derivative portfolio consisted essentially of foreign currency swaps.
The table below provides information about Gerdau's significant exchange rate
risk sensitive instruments as of December 31, 2003 as well as the related
financial instruments acquired to mitigate such potential risk.
74
The Company's estimate of the fair value of its financial instruments,
including long-term debt, approximates to their recognized book value.
--------------------------------------------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS INDEXED TO THE U.S. DOLLAR EXCLUDING NORTH AMERICA SUBSIDIARIES
--------------------------------------------------------------------------------------------------------------------
MATURITY
-------------------------------------------------------------------------
2004 2005 2006 2007 2008 AFTER 2008 TOTAL
--------------------------------------------------------------------------------------------------------------------
BRAZILIAN SUBSIDIARIES
DEBT ASSOCIATED WITH CURRENCY OPERATIONS IN BRAZILIAN REAIS
Eurobonds
Outstanding amount 32,074 - - - - - 32,074
Average interest rate FX+11.1%
--------------------------------------------------------------------------------------------------------------------
Import financing
Outstanding amount 140,594 20,261 11,531 9,531 6,089 5,515 193,521
Average interest rate FX+5.6% FX+8.1% FX+10.5% FX+10.5% FX+10.5% FX+10.5%
Export financing
Outstanding amount 207,340 44,389 74,602 19,770 21,268 41,168 408,537
Average interest rate FX+8.6% FX+10.2% FX+7.4% FX+7.4% FX+7.4% FX+7.4%
Working capital and other
financing
Outstanding amount 56,310 64,997 3,300 - - - 124,607
Average interest rate FX+9.7% FX+9.7% FX+9.5%
--------------------------------------------------------------------------------------------------------------------
Acquisition of interest in
Margusa
Outstanding amount 15,800 - - - - - 15,800
Average interest rate FX+8.0%
--------------------------------------------------------------------------------------------------------------------
CROSS-CURRENCY INTEREST RATE SWAP CONTRACTS
--------------------------------------------------------------------------------------------------------------------
Notional amount 211,146 158,718 89,820 - - - 459,684
Average interest received in US$ FX+4.8% FX+7.3% FX+8.9%
Average interest paid in R$ (%
of CDI) 87.6% 100.0% 102.9%
--------------------------------------------------------------------------------------------------------------------
TOTAL BRAZILIAN DEBT INDEXED TO
U.S. DOLLARS AND NET OF
CROSS-CURRENCY SWAPS 240,972 (29,071) (387) 29,301 27,357 46,683 314,855
--------------------------------------------------------------------------------------------------------------------
As of December 31, 2003, of U.S. dollar-denominated debt associated with
Brazilian operations that totaled $ 774.5 million, approximately $ 459.7
million were swapped into securities denominated in reais as if these loans
had originally been denominated in reais with coupons linked to the
interbank interest rate (CDI).
INTEREST RATE RISK
Part of Gerdau Ameristeel's borrowings, primarily those associated with
its Senior Secured Credit Facility, were negotiated at variable interest rates
and expose the Company to interest rate risk. If interest rates increase, debt
service obligations on its floating rate debt would increase, leading to a
decrease in net income.
From time to time, the Company has entered into interest rate swaps in order to
reduce interest rate risk and interest expense. The Company makes only limited
use of derivative instruments for non-speculative purposes, in order to manage
well-defined interest rate risks arising during the normal course of its
business.
75
In order to reduce its exposure to changes in the fair value of its
Senior Notes (See Item 10C - Material Contracts), Gerdau Ameristeel entered into
interest rate swaps subsequent to the June 2003 refinancing program (See Item 5B
- Liquidity and Capital Resources). These agreements have a notional value of $
200 million, expiring on July 15, 2011. The Company receives a fixed interest
rate and pays a variable interest rate based on LIBOR. The aggregate
mark-to-market (fair value) of the interest rate agreements, which represents
the amount that would have been received if the agreements were terminated at
December 31, 2003, was approximately $ 89 million.
For information regarding the refinancing process of Gerdau Ameristeel, see Item
10.C - Material Contracts.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELIQUENCIES
Not applicable.
76
PART II
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
The Company has carried out an evaluation under the supervision of its
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of its disclosure controls and
procedures. There are inherent limitations to the effectiveness of any system of
disclosure controls and procedures, including the possibility of human error and
the circumvention or overriding of the controls and procedures. Accordingly,
even effective disclosure controls and procedures can only provide reasonable
assurance that they will achieve their control objectives. Based on and as of
the date of the Company's evaluation, its Chief Executive Officer and Chief
Financial Officer concluded that the disclosure controls and procedures were
effective in providing reasonable assurance that the information which the
Company was obliged to disclose in the reports that it filed and submitted under
the terms of the Exchange Act would be recorded, processed, summarized and
reported as and when required.
Gerdau S.A. has created a Disclosure Committee composed of the Investor
Relations Director, Osvaldo Schirmer, the Accounting Director, Geraldo
Toffanello and the Legal Director of the Company, Expedito Luz. This Committee
oversees and reviews all materials for which there is a legal disclosure
requirement, together with all data required to support the documents mentioned
above. This committee meets at regular intervals in order to review all data.
In addition, there have been no significant changes in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Please see Exhibit 12.01 and 12.02 for the certifications required by this Item.
ITEM 16.
A. AUDIT COMMITTEE FINANCIAL EXPERT
The Company has not yet decided whether it will install an Audit
Committee or maintain in use its current Board of Auditors (Conselho Fiscal).
Under the rules of the SEC, foreign private issuers must comply with the audit
committee requirements by July 2005.
B. CODE OF ETHICS
Gerdau S.A. has adopted a Code of Ethics, termed "Gerdau Ethical
Guidelines", which consolidates the ethical principles and values underlying the
Company's activities.
"Gerdau Ethical Guidelines" is a document applicable to all Group
employees in South America, independent of their position (excepting employees
of Gerdau Acominas' Ouro Branco mill and its administrative office, in Belo
Horizonte, as described below). Gerdau's principal executive officer, principal
financial officer, principal accounting officer and other persons performing
similar functions are thus bound by the provisions of the document.
The Gerdau Ethical Guidelines document may be accessed through its
internet website (www.gerdau.com.br), and is attached to this form as an
exhibit.
77
"Gerdau Ethical Guidelines" has not yet been introduced to employees of
Gerdau Acominas' Ouro Branco mill and its administrative office, in Belo
Horizonte, or to employees of Gerdau Ameristeel. The Company does not,
therefore, considerer these employees to be bound by the document.
Its subsidiary, Gerdau Ameristeel, has its own Code of Ethics that is
perfectly compatible with Gerdau's guidelines, with the former document provided
upon request by e-mail to its address: inform@gerdau.com.br. Both documents meet
the definition of code of ethics, preventing wrongdoing related to business
conduct, conflicts of interest, disclosure in reports and other documents, as
well as compliance with legislation.
The Company is in the process of reviewing its Ethical Guidelines, and
will evaluate the extension of the document to employees not currently covered,
as well as its consolidation with Gerdau Ameristeel's Code.
The Company has also adhered to the BOVESPA Level 1 Corporate
Governance Guidelines and has agreed to comply with all corresponding practices.
These include improving quarterly disclosures, promoting compliance with
disclosure rules, disclosing the existence and contents of shareholders'
agreements and stock options plans as well as an annual agenda for corporate
events.
C. PRINCIPAL AUDITING FEES AND SERVICES
The following table provides information on fees billed to Gerdau for
professional services rendered by the independent registered public accounting
firm responsible for auditing the financial statements included in this Annual
Report (in U.S. dollars):
2003 2002
------------------------ ----------------------
Auditing fees 1,471,197 987,264
Audit-related fees 100,000 118,374
Tax fees 277,000 150,000
All other fees - -
------------------------ ----------------------
Total 1,849,197 1,255,637
======================== ======================
Auditing fees for 2002 and 2003 related to professional services
rendered in the auditing of Gerdau's consolidated financial statements,
quarterly reviews of Gerdau's consolidated financial statements, statutory
audits and interim reviews of certain of the Company's subsidiaries as required
by the appropriate legislation, as well as of comfort letters for the issuance
of securities, including private offerings.
Audit-related fees for 2002 and 2003 related to audits of employee
benefit plans of several of the Company's subsidiaries, as well as consulting on
accounting standards and transactions.
Tax fees for 2002 and 2003 related to services provided to
subsidiaries in North America relating to tax compliance, assistance with tax
audits and inquiries, and tax planning services.
D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Gerdau S.A. does not have an Audit Committee. It has, however, elected
a Board of Auditors (Conselho Fiscal) in accordance with Brazilian Corporate Law
No. 6,404/76, since April 2000. The role of this board is to monitor and verify
the actions of directors and their legal duties, providing opinions and official
statements on the annual management report and the proposals of members of the
Board of Directors, denouncing errors or fraud, calling meetings whenever
necessary and analyzing financial statements.
The Board of Auditors has three members who are elected at the Ordinary
Shareholders' Meeting for one-year terms and who may be reelected. One of the
current members was elected by minority preferred shareholders. As required by
Brazilian law, members of the Board of Auditors must have held office for at
least 3 years as business administrators or as members of boards of auditors.
The Board of Auditors, at the request of
78
any of its members, may ask independent auditors to provide explanations or
information and to investigate specific facts.
On April 10, 2003, the SEC published its final resolution on how
foreign companies with securities listed on U.S. stock exchanges should comply
with the provisions of the Sarbanes-Oxley Act, in so far as it relates to audit
committees. According to this Law, all companies must comply with a series of
more stringent requirements.
The Company is currently evaluating the changes necessary for its
current Board of Auditors to comply with the more stringent requirements of the
Act. Under the rules of the SEC, foreign private issuers must comply with the
audit committee requirements by July 2005.
E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
On November 17, 2003, the Board of Directors of Gerdau S.A. met in
accordance with statutory requirements and the terms of Instruction No. 10/80 of
the Brazilian Securities Commission (CVM), deciding to authorize the acquisition
of shares issued by Gerdau S.A. and to maintain the same as treasury stock for
later disposal or cancellation.
These shares were acquired using cash funds backed by existing profit
reserves up to the limit of 1,380,000 preferred shares, representing 2% of
outstanding stock, which amounted to 69,311,014 shares on October 31, 2003.
This authorization remained in force for 90 days from that date. The
operation was carried out on stock exchanges, at market prices, with the
intermediation of the following brokers:
Bradesco S.A. Corretora de Titulos e Valores Mobiliarios
Itau Corretora de Valores S.A.
Merrill Lynch S.A. Corretora de Titulos Valores Mobiliarios
Unibanco Corretora de Valores Mobiliarios S.A.
PURCHASES BY THE ISSUER OF EQUITY SECURITIES
-----------------------------------------------------------------------------------------------------------------
TOTAL NUMBER OF AVERAGE PRICE PAID TOTAL NUMBER OF MAXIMUM NUMBER OF
SHARES PURCHASED PER SHARE (1) OF SHARES SHARES THAT MAY
(IN r$) PURCHASED STILL BE
AS PART OF PURCHASED UNDER
PUBLICLY ANNOUNCED THE PLANS OR
PROGRAMS
--------------------------------------------------------------------------------------------------------------------
NOVEMBER 56,700 44.82 4.1% 1,323,300
(11/17/2003 - 11/30/2004)
-----------------------------------------------------------------------------------------------------------------
DECEMBER 288,300 50.31 25.0% 1,035,000
(12/01/2003 - 12/31/2003)
-----------------------------------------------------------------------------------------------------------------
JANUARY 270,300 62.56 44.6% 764,700
(01/01/2003 - 01/31/2003)
-----------------------------------------------------------------------------------------------------------------
FEBRUARY 171,300 58.62 57.0% 593,400
(02/01/2003 - 02/14/2003)
-----------------------------------------------------------------------------------------------------------------
TOTAL 786,600 55.93 57.0% 593,400
-----------------------------------------------------------------------------------------------------------------
(1) Price paid divided by number of shares. Does not include broker fees.
PART III
ITEM 17. FINANCIAL STATEMENTS
The Company has responded to Item 18 in lieu of responding to this
item.
ITEM 18. FINANCIAL STATEMENTS
Reference is made to Item 19 for a list of all financial statements
filed as part of this Annual Report.
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS
(A) FINANCIAL STATEMENTS
PAGE
Report of independent registered public accounting firm F-1
Report of independent public accountants F-2
Consolidated balance sheets as of December 31, 2003 and 2002 F-3
Consolidated statements of income for the years ended December 31, 2003, 2002 and 2001 F-5
Consolidated statements of comprehensive income for the years ended December 31, 2003, 2002 and 2001 F-6
Consolidated statement of changes in shareholders' equity for the years ended December 31, 2003, 2002 and 2001 F-7
Consolidated statement of cash flows for the years ended December 31, 2003, 2002 and 2001 F-8
Notes to consolidated financial statements F-10
(B) LIST OF EXHIBITS
1.01 By-Laws of Gerdau S.A.
1.02 Corporate Governance Level 1 - Bovespa
4.01 The total amount of long-term debt of the Company authorized under any
instrument must not exceed 10% of the total assets of the Company and
its subsidiaries, on a consolidated basis. The Company undertakes to
furnish to the SEC all other instruments relating to its own long-term
debt and that of its subsidiaries, whenever requested to do so by the
SEC.
4.02 Policies of the Stock Option Plan
11.01 Code of Ethics - Gerdau Ethical Guidelines
12.01 Certification of the Chief Executive Officer under Item 15.
12.02 Certification of the Chief Financial Officer under Item 15.
13.01 Certification pursuant to 18 U.S.C. Section 1350.
13.02 Certification pursuant to 18 U.S.C. Section 1350
80
SIGNATURES
The registrant hereby certifies that it meets all of the requirements
for filing Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf.
GERDAU S.A.
By: /s/ Jorge Gerdau Johannpeter
---------------------------------------------
Name: Jorge Gerdau Johannpeter
Title: Chief Executive Officer
By: /s/ Osvaldo Burgos Schirmer
---------------------------------------------
Name: Osvaldo Burgos Schirmer
Dated: June 30, 2004 Title: Chief Financial Officer
81
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Gerdau S.A.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of comprehensive income (loss), of cash flows
and of changes in shareholders' equity present fairly, in all material respects,
the financial position of Gerdau S.A. and its subsidiaries at December 31, 2003
and 2002, and the results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States of America. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provide a reasonable basis for our opinion. The
financial statements of the Company for the year ended December 31, 2001, prior
to the revisions described in Note 11 "Goodwill" and in Note 22 "Segment
information" and the retroactive restatement of the information on earnings per
share described in Note 18 "Earnings per Share", were audited by other
accountants who have ceased operations. Those accountants expressed an
unqualified opinion on those financial statements in their report dated January
28, 2002.
As disclosed in Note 11 "Goodwill", the Company changed the manner in which it
accounts for goodwill and other intangible assets upon adoption on January 1,
2002 of the accounting guidance of Statement of Financial Accounting Standards
No. 142 ("SFAS No. 142") "Goodwill and Intangible Assets". As discussed above,
the financial statements of the Company for the year ended December 31, 2001
were audited by other accountants who have ceased operations. As described in
the "Earnings Per Share" note and in the "Segment Information" note, these
financial statements have been revised to retroactively reflect the effect in
earnings per share of two stock bonuses and a reverse stock split and the change
in the composition of the Company's reportable segments, respectively. As
described in the "Goodwill" note, these financial statements have also been
revised to include the transitional disclosures required by SFAS No. 142. We
audited the adjustments described in the "Earnings Per Share" and the "Segment
Information" notes that were applied to restate the 2001 financial statements.
We also audited the adjustments in the transitional disclosures in the
"Goodwill" note. In our opinion, all such adjustments are appropriate and have
been properly applied. However, we were not engaged to audit, review, or apply
any procedures to the 2001 financial statements of the Company other than with
respect to such adjustments and, accordingly, we do not express an opinion or
any other form of assurance on the 2001 financial statements taken as a whole.
PricewaterhouseCoopers Auditores Independentes
Porto Alegre, Brazil
February 20, 2004, except for Note 18 and Note 26 which are dated as of April
29, 2004
F-1
--------------------------------------------------------------------------------
The following report is a copy of a report previously issued by Arthur Andersen
S/C, Porto Alegre, Brazil and has not been reissued by Arthur Andersen S/C. As
discussed in the Segment Information note, subsequent to 2001 changes were
introduced to the Company's operational structure which modified its reportable
segments under Statement of Financial Standards ("SFAS") No. 131 "Disclosures
About Segments of an Enterprise and Related Information" and the Company
restated comparative information for the year ended December 31, 2001. As
discussed in the Earnings Per Share Note in April 2004 the Company approved a
stock bonus and in April 2003 the Company approved both a stock bonus and a
reverse split and, as a result, the Company has adjusted retroactively earnings
per share for the year ended December 31, 2001. Additionally, in 2002, as
discussed in the Goodwill note, the Company has presented the transitional
disclosures for 2001 required by SFAS No. 142. The Arthur Andersen S/C report
does not extend to these adjustments to the 2001 consolidated financial
statements. The adjustments to the 2001 consolidated financial statements were
reported on by PricewaterhouseCoopers Auditores Independentes, Porto Alegre,
Brazil as stated in their report appearing herein.
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Gerdau S.A.:
We have audited the accompanying consolidated balance sheets of Gerdau S.A. and
its subsidiaries, translated into U.S. dollars, as of December 31, 2001 and
2000, and the related translated consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statements presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the translated financial statements referred to above present
fairly, in all material respects, the financial position of Gerdau S.A. and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America.
Arthur Andersen S/C
Porto Alegre, Brazil
January 28, 2002 except with respect to the matters discussed in Note 24, as to
which the date is March 28, 2002
F-2
GERDAU S.A.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 and 2002
(in thousands of U.S. Dollars, except number of shares)
--------------------------------------------------------------------------------
ASSETS
NOTE 2003 2002
-------- --------------- ---------------
Current assets
Cash and cash equivalents 92,504 40,457
Restricted cash 1,935 15,001
Short-term investments 5 236,137 367,748
Trade accounts receivable, net 6 465,857 361,801
Inventories 7 797,961 632,806
Unrealized gains on derivatives 20 9,599 8,712
Deferred income taxes, net 17 49,451 34,585
Tax credits 8 37,953 14,954
Prepaid expenses 21,859 12,468
Other 46,576 35,686
--------------- ---------------
Total current assets 1,759,832 1,524,218
Non-current assets
Property, plant and equipment, net 10 2,304,158 2,084,895
Deferred income taxes 17 231,306 12,055
Judicial deposits 15.1 66,121 13,391
Unrealized gains on derivatives 20 86 43,146
Equity investments 153,555 112,016
Investments at cost 23,854 7,220
Goodwill, net 11 119,531 116,826
Prepaid pension cost 12 35,253 25,050
Other 77,138 61,484
--------------- ---------------
Total assets 4,770,834 4,000,301
=============== ===============
F-3
LIABILITIES
NOTE 2003 2002
-------- --------------- ---------------
Current liabilities
Short-term debt 13 479,586 707,378
Current portion of long-term debt 14 318,910 397,415
Trade accounts payable 372,518 281,855
Income taxes payable 27,790 23,978
Unrealized losses on derivatives 20 29,582 2,003
Deferred income taxes 17 7,286 7,628
Payroll and related liabilities 54,478 53,682
Dividends (interest on equity) payable 53,202 42,288
Taxes payable, other than income taxes 26,482 21,255
Other 89,328 50,315
--------------- ---------------
Total current liabilities 1,459,162 1,587,797
Non-current liabilities
Long-term debt, less current portion 14 1,132,429 794,571
Debentures 14 155,420 200,766
Deferred income taxes 17 72,125 42,368
Accrued pension and other post-retirement benefits obligation 12 108,679 109,870
Provision for contingencies 15 102,060 45,304
Unrealized losses on derivatives 20 11,356 -
Other 61,543 45,860
--------------- ---------------
Total non-current liabilities 1,643,612 1,238,739
--------------- ---------------
Total liabilities 3,102,774 2,826,536
COMMITMENTS AND CONTINGENCIES 15
Minority interest 264,997 308,755
SHAREHOLDERS' EQUITY 16
Preferred shares - no par value
193,771,574 shares issued at December 31, 2003 and 2002, after giving
retroactive effect to the stock bonus and stock split approved on April 30,
2003 and the stock bonus approved on April 29, 2004 (Note 16.1 and
Note 26(b)) 653,344 562,801
Common shares - no par value
102,936,448 shares issued at December 31,2003 and 2002, after giving
retroactive effect to the stock bonus and stock split approved on April 30,
2003 and the stock bonus approved on April 29, 2004 (Note 16.1 and
Note 26(b)) 329,257 281,158
Additional paid-in capital 3,271 2,086
Treasury stock - 690,000 preferred shares at December 31, 2003 after giving
retroactive effect to the stock bonus approved on April 29, 2004 (Note
26(b)) (5,920) -
Legal reserve 63,834 36,105
Retained earnings 1,161,527 936,612
Cumulative other comprehensive loss
- Foreign currency translation adjustment (790,731) (935,133)
- Additional minimum pension liability (11,519) (16,309)
- Unrealized loss on cash flow hedge - (2,310)
--------------- ---------------
Total shareholders' equity 1,403,063 865,010
--------------- ---------------
Total liabilities and shareholders' equity 4,770,834 4,000,301
=============== ===============
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
GERDAU S.A.
CONSOLIDATED STATEMENTS OF INCOME
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, except number of shares and per share amounts)
--------------------------------------------------------------------------------
NOTE 2003 2002 2001
-------- ----------------- ------------------ -----------------
Sales 5,033,472 3,664,920 2,751,872
Less: Federal and state excise taxes (414,198) (344,654) (311,223)
Less: Discounts (88,305) (55,340) (39,511)
----------------- ------------------ -----------------
Net sales 4,530,969 3,264,926 2,401,138
Cost of sales (3,445,564) (2,349,636) (1,722,228)
----------------- ------------------ -----------------
Gross profit 1,085,405 915,290 678,910
Sales and marketing expenses (146,388) (112,645) (105,801)
General and administrative expenses (241,854) (221,895) (181,108)
----------------- ------------------ -----------------
Operating income 697,163 580,750 392,001
Financial expenses (416,953) (292,463) (166,496)
Foreign exchange gains (losses), net 162,190 (131,684) (71,773)
Financial income 62,036 100,350 55,002
Equity in earnings (losses) of unconsolidated 22,062 (10,057) 18,324
companies, net
Other non-operating expense, net (824) (18,178) (7,853)
----------------- ------------------ -----------------
Income before income taxes and minority interest 525,674 228,718 219,205
Provision for income taxes 17
Current (87,812) (27,065) (40,981)
Deferred 121,925 20,507 (13,666)
----------------- ------------------ -----------------
34,113 (6,558) (54,647)
----------------- ------------------ -----------------
Income before minority interest 559,787 222,160 164,558
Minority interest (49,623) 9,667 2,795
----------------- ------------------ -----------------
Net income 510,164 231,827 167,353
================= ================== =================
PER SHARE DATA (IN US$) 18
Basic earnings per share
Preferred 1.72 0.78 0.59
Common 1.72 0.78 0.53
Diluted earnings per share
Preferred 1.72 0.78 0.59
Common 1.72 0.78 0.53
Number of weighted-average common shares outstanding
after giving retroactive effect to stock bonus and
reverse stock split (Note 16.1 and Note 26 (b)) - Basic 102,936,448 102,686,166 102,393,254
================= ================== =================
Number of weighted-average common shares outstanding
after giving retroactive effect to stock bonus and
reverse stock split (Note 16.1 and Note 26 (b)) - Diluted 102,936,448 102,686,166 102,921,254
================= ================== =================
Number of weighted-average preferred shares outstanding
after giving retroactive effect to stock bonus and
reverse stock split (Note 16.1 and Note 26 (b)) - Basic 193,742,824 193,307,254 192,685,184
================= ================== =================
Number of weighted-average preferred shares outstanding
after giving retroactive effect to stock bonus and
reverse stock split (Note 16.1 and Note 26 (b)) - Diluted 194,047,622 193,307,254 193,741,184
================= ================== =================
F-5
The accompanying notes are an integral part of these consolidated
financial statements.
GERDAU S.A.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(LOSS) for the years ended December 31,
2003, 2002 and 2001
(in thousands of U.S. Dollars)
--------------------------------------------------------------------------------
2003 2002 2001
---------------- ----------------- -----------------
NET INCOME AS REPORTED IN THE CONSOLIDATED STATEMENT OF INCOME 510,164 231,827 167,353
Foreign currency translation adjustments 144,402 (311,071) (129,395)
Pension fund additional minimum liability 4,790 (16,309) -
Cash flow hedge 2,310 (2,310) -
---------------- ----------------- -----------------
COMPREHENSIVE INCOME (LOSS) FOR THE YEAR 661,666 ( 97,863) 37,958
================ ================= =================
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
GERDAU S.A.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S
EQUITY for the years ended December 31,
2003, 2002 and 2001
(in thousands of U.S. Dollars, except share data)
--------------------------------------------------
ADDITIONAL
PREFERRED COMMON PAID-IN TREASURY LEGAL
NOTE SHARES SHARES CAPITAL STOCK RESERVE
------- ------------ ----------- ------------- ----------- ------------
BALANCES AS OF JANUARY 1(0), 2001 558,971 279,243 - - 46,07
Net income - - - - -
Foreign currency translation adjustment - - - - -
Dividends (interest on equity) - $0.23 per Common share
and $0.25 per Preferred share (*) 16.4. - - - - -
Transfer to legal reserve - - - - 9,999
------------ ----------- ------------- ----------- ------------
BALANCES AS OF DECEMBER 31, 2001 558,971 279,243 - - 56,074
Capital increase by conversion of debentures 3,830 1,915 - - -
Net income - - - - -
Foreign currency translation adjustment - - - - -
Pension fund additional minimum liability - - - - -
Unrealized loss on cash flow hedge, net of tax - - - - -
Excess of sale price over cost on treasury stock - - 2,086 - -
Dividends (interest on equity) - $0.26 per Common share
and $0.26 per Preferred share (*) 16.4 - - - - -
Transfer from legal reserve - - - - (19,969)
------------ ----------- ------------- ----------- ------------
BALANCES AS OF DECEMBER 31, 2002 562,801 281,158 2,086 - 36,105
Capitalization of reserves 16.4 90,543 48,099 - - -
Net income - - - - -
Appropriation of reserves 16.2 - - 1,061 - 27,729
Purchase of treasury preferred shares 16.1 (5,920)
Foreign currency translation adjustment - - - - -
Reduction of pension fund additional minimum liability - - - - -
Reversal of unrealized loss on cash flow hedge, net of - - - - -
tax
Dividends (interest on equity) - $0.40 per Common share - - - - -
and 16.4
$0.40 per Preferred share (*)
Stock option plan expense recognized during the period 3.13 - - 124 - -
------------ ----------- ------------- ----------- ------------
BALANCES AS OF DECEMBER 31, 2003 653,344 329,257 3,271 (5,920) 63,834
============ =========== ============= =========== ============
Table Continued
OTHER
RETAINED COMPREHENSIVE
EARNINGS LOSS TOTAL
----------- ------------------ --------------
BALANCES AS OF JANUARY 1(0), 2001 676,037 (494,667) 1,065,659
Net income 167,353 - 167,353
Foreign currency translation adjustment - (129,395) (129,395)
Dividends (interest on equity) - $0.23 per Common share
and $0.25 per Preferred share (*) (70,897) - (70,897)
Transfer to legal reserve (9,999) - -
----------- ------------------ --------------
BALANCES AS OF DECEMBER 31, 2001 762,494 (624,062) 1,032,720
Capital increase by conversion of debentures - - 5,745
Net income 231,827 - 231,827
Foreign currency translation adjustment - (311,071) (311,071)
Pension fund additional minimum liability - (16,309) (16,309)
Unrealized loss on cash flow hedge, net of tax - (2,310) (2,310)
Excess of sale price over cost on treasury stock - 2,086
Dividends (interest on equity) - $0.26 per Common share
and $0.26 per Preferred share (*) (77,678) - (77,678)
Transfer from legal reserve 19,969 - -
----------- ------------------ --------------
BALANCES AS OF DECEMBER 31, 2002 936,612 (953,752) 865,010
Capitalization of reserves (138,642) - -
Net income 510,164 - 510,164
Appropriation of reserves (28,790) - -
Purchase of treasury preferred shares - (5,920)
Foreign currency translation adjustment - 144,402 144,402
Reduction of pension fund additional minimum liability - 4,790 4,790
Reversal of unrealized loss on cash flow hedge, net of - 2,310 2,310
tax
Dividends (interest on equity) - $0.40 per Common share -
and (117,817) (117,817)
$0.40 per Preferred share (*)
Stock option plan expense recognized during the period - - 124
------------ ------------------ --------------
BALANCES AS OF DECEMBER 31, 2003 1,161,527 (802,250) 1,403,063
============ ================== ==============
(*) After giving retroactive effect to the stock bonus and reverse stock split
described in Note 16.1 and Note 26(b). Preferred treasury stock shares for the
year ended December 31, 2003 are not considered to be outstanding.
The accompanying notes are an integral part of these consolidated
financial statements.
F-7
GERDAU S.A.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars)
--------------------------------------------------------------------------------
2003 2002 2001
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income 510,164 231,827 167,353
Adjustments to reconcile net income to cash flows
from operating activities:
Depreciation and amortization 182,403 178,805 135,878
Equity in earnings (losses) on non-consolidated companies, net (22,062) 10,057 (18,324)
Foreign exchange (gains) losses, net (162,190) 266,594 71,773
Unrealized losses (gains) on derivative instruments 78,257 (58,772) -
Minority interest 49,623 (9,667) (2,795)
Deferred income taxes (121,925) (20,507) 13,666
(Gain) loss on dispositions of property, plant and equipment (1,913) 997 10,395
Provision for doubtful accounts 6,714 1,310 6,743
Provision for contingencies 43,106 20,773 (4,099)
CHANGES IN ASSETS AND LIABILITIES:
Increase in accounts receivable (80,017) (28,657) (16,948)
Increase in inventories (74,248) (94,477) (57,563)
Increase (decrease) in accounts payable and accrued liabilities 100,298 (9,632) 66,496
Decrease (increase) in other assets and liabilities, net (39,733) (138,196) 22,867
------------- ------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 468,477 350,455 395,442
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant and equipment (297,755) (185,892) (244,021)
Proceeds from dispositions of property, plant and equipment 2,284 6,029 11,482
Acquisitions of equity and cost investments (7,680) - -
Acquisition of additional interest in Gerdau Ameristeel (7,050) - -
Dispositions of investments - - 29,850
Cash paid for acquisitions in 2002, mainly Acominas - (412,150) -
Cash acquired in acquisitions in 2002 - 19,954 -
Purchases of short-term investments (959,522) (847,806) (282,967)
Proceeds from maturities and sales of short-term investments 1,102,314 847,108 223,874
Cash received from joint ventures 1,692 - -
------------- ------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (165,717) (572,757) (261,782)
------------- ------------- -------------
The accompanying notes are an integral part of these consolidated
financial statements.
F-8
GERDAU S.A.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars)
--------------------------------------------------------------------------------
2003 2002 2001
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends (interest on equity) paid (122,262) (74,265) (64,399)
(Purchase) sale of treasury shares (5,920) 2,318 -
Decrease (increase) of restricted cash 13,593 (6,091) -
Debt issuance 1,997,978 1,186,109 377,633
Repayment of debt (2,126,520) (824,880) (436,622)
Net related party debt repayments (5,956) - -
------------- ------------- -------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (249,087) 283,191 (123,388)
------------- ------------- -------------
Effect of exchange rate changes on cash (1,626) (48,264) 5,127
Increase in cash 52,047 12,625 15,399
Cash at beginning of year 40,457 27,832 12,433
------------- ------------- -------------
CASH AT END OF YEAR 92,504 40,457 27,832
============= ============= =============
SUPPLEMENTAL CASH FLOW DATA Cash paid during the year for:
Interest (net of amounts capitalized) 127,413 123,680 83,258
Income taxes 100,305 28,003 11,890
SUPPLEMENTAL DISCLOSURE OF NON CASH INVESTING AND FINANCIAL ACTIVITIES:
Purchase consideration, representing 51,503,960 Co-Steel shares at $2.51
per share 129,275
Debentures converted into common and preferred shares 5,745
The accompanying notes are an integral part of these consolidated
financial statements.
F-9
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
1 OPERATIONS
Gerdau S.A. is a sociedade anonima incorporated as a limited liability
company under the laws of the Federative Republic of Brazil. The
principal business of Gerdau S.A. ("Gerdau") in Brazil and of its
subsidiaries in Argentina, Canada, Chile, the United States and Uruguay
(collectively the "Company") comprise the production of crude steel and
related long rolled products, drawn products and long specialty products.
The Company produces steel based on the mini-mill concept, whereby steel
is produced in electric arc furnaces from scrap and pig iron acquired
mainly in the region where each mill operates. The Company also operates
plants which produce steel from iron ore in blast furnaces and through
the direct reduction process.
The Company manufactures steel products for use in civil constructions,
manufacturing and agribusiness, as well as specialty steel products. The
markets where the Company operates are located in Brazil, the United
States, Canada and Chile and, to a lesser extent, Argentina and Uruguay.
2 BASIS OF PRESENTATION
2.1 STATUTORY RECORDS
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United
States ("U.S. GAAP"), which differ in certain aspects from the accounting
practices adopted in Brazil ("Brazilian GAAP") applied by the Company in
the preparation of its statutory financial statements and for other legal
and regulatory purposes. The consolidated financial statements for
statutory purposes are prepared in Brazilian reais.
2.2 CURRENCY REMEASUREMENT
The Company has selected the United States dollar as its reporting
currency. The U.S. dollar amounts have been translated or remeasured, as
appropriate, following the criteria established in Statement of Financial
Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation" from
the financial statements expressed in the local currency of the countries
where Gerdau and each subsidiary operates.
The Company's main operations are located in Brazil, the United States,
Canada and Chile. The local currency is the functional currency for those
operations. These financial statements, except for those of the
subsidiaries located in the United States which already prepare their
financial statements in United Stated dollars, are translated from the
functional currency into the United States dollar. Assets and liabilities
are translated at the exchange rate in effect at the end of each year.
Average exchange rates are used for the translation of revenues,
expenses, gains and losses in the statement of income. Capital
contributions, treasury stock transactions and dividends are translated
using the exchange rate as of the date of the transaction. Translation
gains and losses resulting from the translation methodology described
above are recorded directly in "Cumulative other comprehensive loss"
within shareholders' equity. Gains and losses on foreign currency
denominated transactions are included in the consolidated statement of
income.
2.3 CONTROLLING SHAREHOLDER
As of December 31, 2003, the Company's parent, Metalurgica Gerdau S.A.
("MG", collectively with its subsidiaries and affiliates, the
"Conglomerate") owned 48.22% (2002 - 48.31%) of the total capital of the
Company. MG's share ownership consisted of 85.71% (2002 - 85.71%) of the
Company's voting common shares and 28.31% (2002 - 28.44%) of its
non-voting preferred shares.
F-10
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
3 SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting policies adopted
in the preparation of the consolidated financial statements.
3.1 CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company and its majority-owned operational subsidiaries, as
follows:
PERCENTAGE OF INTEREST (%)
------------------------------
2003 2002
------------- --------------
Aceros Cox S.A. (Chile) 100 100
Armafer Servicos de Construcao Ltda. (Brazil) 100 100
Gerdau AmeriSteel Corporation (Canada) and its subsidiaries: 69 74
AmeriSteel Bright Bar Inc. (USA) 69 74
Gerdau Ameristeel MRM Special Sections Inc. (Canada) 69 74
Gerdau Ameristeel Cambridge Inc. (Canada) (a) - 74
Gerdau Ameristeel Perth Amboy Inc. (USA) 69 74
Gerdau Ameristeel Sayreville Inc. (USA) 69 74
Gerdau Ameristeel US Inc. (USA) (b) 69 74
Gerdau Acominas S.A. (c) 92 79
Gerdau Aza S.A. (Chile) 100 100
Gerdau Internacional Emprendimentos Ltda. (Brazil) and its wholly owned
subsidiary Gerdau GTL Spain S. L. (Spain) and subsidiaries 100 100
Gerdau Laisa S.A. (Uruguay) 99 99
Seiva S.A. - Florestas e Industrias (Brazil) and subsidiaries 97 97
(a)During 2003, Gerdau Ameristeel Cambridge Inc. amalgamated with Gerdau
AmeriSteel Corporation
(b)Formerly known as Ameristeel Corp.
(c)As described in Note 4.1, Gerdau Acominas was formerly known as Aco
Minas Gerais S.A. ("Acominas")
The consolidated financial statements include all the companies in which
the Company has a controlling financial interest through direct or
indirect ownership of a majority voting interest. The consolidated
financial statements include, in addition to the operational companies
presented in the table above, all the other companies which meet the
criteria for consolidation under US GAAP which consist of holding
companies for its investments in the operating companies and for
financing transactions.
The consolidated financial statements include the results of operations
of Gerdau AmeriSteel Corporation (formerly known as Co-Steel Inc.) and
its subsidiaries (Note 4.4) for the period from October 23, 2002 (the
date of acquisition). The results of Acominas for the year ended December
31, 2002 have been accounted for following the equity method up to
February 13, 2002, (the date of acquisition of a controlling interest)
and have been consolidated as from such date.
All significant intercompany balances and transactions have been
eliminated on consolidation.
F-11
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
3.2 USE OF ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosures of contingent assets and liabilities as of the dates of
the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Significant estimates include,
but are not limited to, the allowance for doubtful accounts,
depreciation and amortization, impairment of long-lived assets, useful
lives of assets, valuation allowances for income taxes, actuarial
assumptions, utilized in the calculation of employee benefit
obligations, contingencies and environmental liabilities. Actual results
could differ from those estimates.
3.3 CASH AND CASH EQUIVALENTS
Cash and cash equivalents are carried at cost plus accrued interest.
Cash equivalents are considered to be all highly liquid temporary cash
investments, mainly deposits, with original maturity dates of three
months or less.
3.4 SHORT-TERM INVESTMENTS
Short-term investments consist of bank certificates of deposit and
trading securities including investments held in a fund administered by a
related party for the exclusive use of the Company (Note 9). The
certificates of deposit and trading securities have maturities ranging
from four months to one year at the time of purchase. Certificates of
deposit are stated at cost plus accrued interest. Trading securities are
recorded at fair value with changes in fair value recognized in the
consolidated statement of income.
3.5 TRADE ACCOUNTS RECEIVABLE
Accounts receivable are stated at estimated realizable values. Allowances
are provided, when necessary, in an amount considered by management to be
sufficient to meet probable future losses related to uncollectible
accounts.
3.6 INVENTORIES
Inventories are valued at the lower of cost or replacement or realizable
value. Cost is determined using the average cost method.
3.7 PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost, including capitalized
interest incurred during the construction phase of major new facilities.
Interest capitalized on loans denominated in reais includes the effect of
indexation of principal required by certain loan agreements. Interest
capitalized on foreign currency borrowings excludes the effects of
foreign exchange gains and losses.
Depreciation is computed under the straight-line method at rates which
take into consideration the useful lives of the related assets: 10 to 30
years for buildings and improvements, 4 to 15 years for machinery and
equipment, 10 years for furniture and fixtures, and 5 years for vehicles
and computer equipment. Assets under construction are not depreciated
until they are in condition to be placed into service. Major renewals
and improvements are capitalized. Expenditures for maintenance and
repairs are charged to expense as incurred. Any gain or loss on the
disposal of property plant and equipment is recognized on disposal.
During the year ended December 31, 2002 certain subsidiaries changed the
depreciable lives of certain buildings and equipment to reflect updated
estimates of their economic lives. The effect of this change in an
accounting estimate reduced depreciation expense in 2002 by $ 3.2
million.
The Company periodically evaluates the carrying value of its long-lived
assets for impairment. The carrying value of a long-lived asset or group
of such assets is considered impaired by the Company when the anticipated
undiscounted
F-12
cash flow from such asset(s) is separately identifiable and less than the
carrying value. In that event, a loss would be recognized based on the
amount by which the carrying value exceeds the fair market value of the
long-lived asset. Fair market value is determined primarily using
discounted anticipated cash flows. No impairment losses have been
recorded for any of the periods presented.
3.8 EQUITY INVESTMENTS
Investments in entities where the Company owns 20% to 50% of the voting
interest or where the Company has the ability to exercise significant
influence are accounted for under the equity method. As of December 31,
2003, the Company's equity investments are comprised of: (a) a 38.18%
(2002 - 38.18%) interest in the capital of Sipar Aceros S.A. - Sipar, (b)
a 50.00% (2002 - 50.00%) interest in Gallatin Steel Company, Bradley
Steel Processors and MRM Guide Rail, (c) a 50.00% (2002 - 50.00%)
interest in Armacero Industrial y Comercial Limitada and (d) a 51.82%
(2002 - 21.82%) interest in Dona Francisca Energetica S.A. (See Note
4.2).
3.9 INVESTMENTS AT COST
Investments at cost consists of investments in entities where the
Company owns less than 20% of the voting interest including tax
incentives to be utilized in government approved projects, stated at
cost and reduced by valuation allowances based on management estimates
of realizable values.
3.10 GOODWILL
Goodwill represents the cost of investments in excess of the fair value
of net identifiable assets acquired and liabilities assumed.
Effective January 1, 2002, the Company adopted SFAS No. 142 ("SFAS 142"),
"Goodwill and Other Intangible Assets". Under this standard, goodwill,
including goodwill recognized for business combinations consummated
before initial application of the standard, is no longer amortized but is
tested for impairment at least annually, using a two-step approach that
involves the identification of "reporting units" and the estimation of
fair value. During the year ended December 31, 2001 goodwill resulting
from acquisitions was amortized over 20 to 25 years, the estimated lives
of the related benefits.
During the years ended December 31, 2003 and 2002 goodwill was tested for
impairment and no impairment charges were recorded.
Had goodwill not been amortized in the year ended December 31, 2001, net
income would have been $171,355, Earnings per share had goodwill not been
amortized for the year ended December 31, 2001 are presented in Note 11.
3.11 PENSION AND OTHER POST-RETIREMENT BENEFITS
The Company accrues its obligations under pension and other
post-retirement benefits in accordance with SFAS No. 87, "Employers'
Accounting for Pensions" and SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions", respectively (Note 12).
The cost of pensions and other post-retirement benefits is actuarially
determined using the projected unit credit method based on management's
best estimates of expected investment performance for funded plans,
salary increases, retirement ages of employees and expected health care
costs. Assets of funded pension plans are valued at fair value. The
excess of the net actuarial gains or losses over 10% of the greater of
the benefit obligation and the fair value of the assets is amortized over
the average remaining service period of the active employees (corridor
approach).
An additional minimum liability is recognized in "Cumulative other
comprehensive loss" in shareholders' equity if the
F-13
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
unfunded accumulated benefit obligation ("ABO") exceeds the fair value of
plan assets and this amount is not covered by the pension liability
recognized in the balance sheet. An additional minimum liability has been
recognized as of December 31, 2003 and 2002 in relation to pension plans
offered to employees in North America.
3.12 COMPENSATED ABSENCES
Compensated absences are accrued over the vesting period.
3.13 STOCK BASED COMPENSATION PLANS
Gerdau Ameristeel Corp and subsidiaries and Gerdau (as from April 30,
2003) maintain stock based compensation plans (Note 24). The Company
accounts for the stock-based compensation plans under Accounting
Principles Board Opinion ("APB") No. 25 "Accounting for Stock Issued to
Employees" and related interpretations. SFAS No. 123 "Accounting for
Stock-Based Compensation" as amended by SFAS No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure" allows companies to
continue following the accounting guidance of APB 25 but requires pro
forma disclosures of net income and earnings per share for the effects on
compensation had the accounting criteria of SFAS No. 123 been adopted.
The following table illustrates the effects on net income and on earnings
per share if the fair value method had been applied.
2003 2002 2001
---------- ------------- ------------
Net income as reported 510,164 231,827 167,353
Reversal of stock-based compensation cost included in the determination of
net income as reported 124 102 (487)
Stock-based compensation cost following the fair value method (556) (247) 354
---------- ------------- ------------
Pro-forma net income 509,732 231,682 167,220
========== ============= ============
Earnings per share - basic
Common - As reported and pro-forma 1.72 0.78 0.53
Preferred- As reported and pro-forma 1.72 0.78 0.59
Earnings per share - diluted
Common
As reported 1.72 0.78 0.53
Pro-forma 1.71 0.78 0.53
Preferred
As reported 1.72 0.78 0.59
Pro-forma 1.71 0.78 0.59
3.14 REVENUE RECOGNITION
Revenues from sales of products are recognized when title is transferred
and the client has assumed the risk and rewards of ownership in
accordance with the contractual terms.
F-14
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
3.15 INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes", which requires the application of the
liability method of accounting for income taxes. Under this method, a
company is required to recognize a deferred tax asset or liability for
all temporary differences. Deferred tax assets and liabilities are
measured using enacted tax rates in effect for the year in which those
temporary differences are expected to be recovered or settled. Under
SFAS No. 109, the effect on deferred tax assets and liabilities of
changes in tax rates is recognized in income for the period that
includes the enactment date.
Deferred tax assets are reduced through the establishment of a valuation
allowance, as appropriate, if, based on the weight of available
evidence, it is more likely than not that the deferred tax asset will
not be realized.
3.16 EARNINGS PER SHARE
The Company calculates earnings per share in accordance with SFAS No.
128, "Earnings Per Share".
Each share of common and preferred stock entitles the shareholder to
participate in earnings. Through December 31, 2001, in accordance with
Brazilian law and the by-laws of the Company, preferred shareholders were
entitled to receive per-share dividends at least 10% greater than the
per-share dividends paid to common shareholders. As the result of changes
in the Gerdau's by-laws approved in the Shareholders Meeting held on
April 30, 2002, effective January 1, 2002, the preferred shareholders are
no longer entitled to the 10% differential dividend and dividends to both
common and preferred shareholders are paid on the same per-share amounts.
In calculating earnings per share ("EPS") through December 31, 2001,
preferred stock has been treated as a participating security and the
Company has adopted the two-class method. This method is an earnings
allocation formula that determines earnings per share for each class of
common stock and participating security according to the dividends
declared and the participation rights to undistributed earnings. Under
this method, net income is first reduced by the amount of dividends
declared in the current period for each class of stock; the remaining
earnings are then allocated to common stock and participating securities
to the extent that each security may share in earnings. The total
earnings allocated to each security (i.e. actual dividends declared and
the amount allocated for the participation feature) is then divided by
the weighted average number of shares outstanding during the period.
Basic EPS excludes dilution, while diluted EPS for the year ended
December 31, 2001 reflects the potential dilution that could occur if the
convertible debentures were converted into shares. In calculating diluted
EPS, interest expense net of tax on the convertible securities is added
back to "Allocated net income available to Common and Preferred
shareholders", with the resulting amount divided by the number of
dilutive shares outstanding. Convertible debentures are considered in the
number of dilutive Common and Preferred shares outstanding. See Note 18.
During the year ended December 31, 2002 all outstanding convertible
debentures issued by Gerdau were converted into shares. No other
instruments that could have a dilutive effect are outstanding as of
December 31, 2002.
During the year ended December 31, 2003 diluted EPS reflects the
potential dilution resulting from options granted during that year to
acquire shares of Gerdau S.A. The Company uses the "treasury Stock"
method to compute the dilutive effect of such stock options.
All EPS data is calculated giving retroactive consideration to the stock
bonus and the reverse stock split approved on April 30, 2003 as well as
to the stock bonus approved on April 29, 2004 (See Note 26(b)). EPS is
presented on a per share basis (Note 18).
F-15
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
3.17 DIVIDENDS AND INTEREST ON EQUITY
The Company's By-Laws of Gerdau require it to pay to its Common and
Preferred shareholders annual dividends of at least of 30% of net income
calculated in accordance with the provisions of the Brazilian Corporate
Law. Approval of the payment of such dividends is granted at the Annual
General Meeting, which must be held on or before April 30 of each year.
Dividends are payable in Brazilian reais and reflected in these
financial statements once declared by the Annual General Meeting.
Brazilian corporations are permitted to distribute interest on equity,
similar to a dividend distribution, which is deductible for income tax
purposes. The amount payable may not exceed 50% of the greater of net
income for the year or retained earnings, as measured under Brazilian
Corporate Law. It also may not exceed the product of the Taxa de Juros
Longo Prazo ("TJLP") (long-term interest rate) and the balance of
shareholders' equity, as measured under Brazilian Corporate Law.
Payment of interest on equity is beneficial to the Company when compared
to making a dividend payment, since it recognizes a tax deductible
expense on its income tax return for such amount. The related tax
benefit is recorded in the consolidated statement of income. Income tax
is withheld from the stockholders relative to interest on equity at the
rate of 15%, except for interest on equity due to the Brazilian
government, which is exempt from tax withholdings.
3.18 ENVIRONMENTAL AND REMEDIATION COSTS
Expenditures relating to ongoing compliance with environmental
regulations, designed to minimize the environmental impact of the
Company's operations, are capitalized or charged against earnings, as
appropriate. The Company provides for potential environmental
liabilities based on the best estimate of potential clean-up and
remediation estimates for known environmental sites. Management believes
that, at present, each of its facilities is in substantial compliance
with the applicable environmental regulations.
3.19 ADVERTISING COSTS
Advertising costs included in selling and marketing expenses were
$12,884, $9,386 and $9,144 for the years ended December 31, 2003, 2002,
and 2001 respectively. No advertising costs have been deferred at the
balance sheet dates.
3.20 TREASURY STOCK
Common and preferred shares reacquired are recorded under "Treasury
stock" within shareholders' equity at cost. Sales of treasury stock are
recorded at the average cost of the shares in treasury held at such date.
The difference between the sale price and the average cost is recorded as
a reduction or increase in additional paid-in capital.
3.21 DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments that do not qualify for hedge accounting
are recognized on the balance sheet at fair value with unrealized gains
and losses recognized in the statement of income.
To qualify as a hedge, the derivative must be (i) designated as a hedge
of a specific financial asset or liability at the inception of the
contract, (ii) effective at reducing the risk associated with the
exposure to be hedged, and (iii) highly correlated with respect to
changes either in its fair value in relation to the fair value of the
item being hedged or with respect to changes in the cash flows, both at
inception and over the life of the contract.
The Company held derivatives (swaps) which qualified as cash flows hedges
only in the subsidiaries in North America. Swaps are recognized on the
balance sheet at fair value with unrealized gains and losses on the
mark-to
F-16
market valuation of the swaps qualifying for cash flow hedge recorded in
other comprehensive income (loss) except for any ineffective portion
which is recorded against income.
3.22 RECLASSIFICATIONS
Certain reclassifications have been made to the financial statements for
year ended December 31, 2002 to conform to the presentation in the
current year. Such reclassifications had no effect on amounts previously
reported for net income or shareholder's equity.
3.23 RECENT ACCOUNTING STANDARDS NOT YET ADOPTED
In December 2003, the FASB issued FIN 46R - "Consolidation of Variable
Interest Entities, (revised December 2003)". The primary objectives of
FIN 46R are to provide guidance on the identification of entities for
which control is achieved through means other than through voting rights
(variable interest entities or VIEs) and how to determine when and which
entity should consolidate the VIE (the primary beneficiary). This new
model for consolidation applies to an entity in which either (1) the
equity investors (if any) do not have a controlling financial interest or
(2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial
support from other parties. In addition, FIN 46R requires that both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures regarding the nature,
purpose, size and activities of the VIE and the enterprise's maximum
exposure to loss as a result of its involvement with the VIE.
The implementation date of FIN 46R is the first period ending after
December 15, 2003 for Special Purpose Entities (SPEs) and as from January
1, 2004 for previously existing variable interest entities which are not
SPEs. FIN 46R may be applied prospectively with a cumulative adjustment
as of the date on which it is first applied or by restating previously
issued financing statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year
restated.
In March 2004 the American Institute of Certified Public Accountants
issued a letter to the Securities & Exchange Commission ("SEC") regarding
application of FIN 46 to foreign private issues and the SEC issued a
letter indicating that it would not object the conclusions as to the
effective date of FIN 46 for private issuers, like the Company. Under the
letter as the company presents through December 31, 2003 only financial
information under US GAAP on an annual basis the provisions of FIN 46
apply to SPEs for periods beginning after January 1, 2004 and to non-SPEs
for periods ending December 31, 2004. If the Company begins to disclose
as from the first quarter of 2004 financial information under US GAAP on
a quarterly basis FIN 46 would become effective both for SPEs and
non-SPES for the period ended March 31, 2004.
The Company is evaluating the effect of implementing FIN 46R (for periods
commencing after January 1, 2004) with respect to consolidating variable
interest entities which are not SPEs, in particular with respect to its
investment in Dona Francisca Energetica S.A. and to its equity
investments in North America on which it owns 50% (Gallatin Steel
Company, Bradley Steel Processors and MRM Guide Rail)
In May 2003 FASB issued SFAS No. 150 - "Accounting For Certain Financial
Instruments with Characteristics of Both Liabilities and Equity", which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that
is within its scope as a liability (or an asset in some circumstances).
The FASB decided to make this statement effective shortly after issuance
for contracts created or modified after it is issued and for existing
contracts at the beginning of the first interim period beginning after
June 15, 2003. The Company does not expect SFAS 150 to have a material
impact on the financial statements.
F-17
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
4 ACQUISITIONS
4.1 ACOMINAS
COMMON CONTROL TRANSACTION DURING THE YEAR ENDED DECEMBER 31, 2003
On November 28, 2003 Gerdau transferred all the assets and liabilities of
its steel operations in Brazil to its subsidiary Acominas as a capital
contribution. The other shareholders made no contributions and as a
result Gerdau increased its ownership in voting and total shares of
Acominas from 78.9% to 92.15%. The company was renamed Gerdau Acominas
S.A. ("Gerdau Acominas").
In accordance with SFAS 141, this transaction is defined as a common
control transaction (because the transaction did not involve the
acquisition of shares held by minority shareholders, but rather the
issuance of new shares to the Company by Acominas) and is accounted for
using the carrying value of assets and liabilities being transferred. The
decrease in the minority interest in Acominas as the result of the
increase in participation from 78.9% to 92.15% exceeds the increase in
minority interest resulting from transferring net assets previously
wholly owned to Acominas on which the Company has, as the result of the
transaction, a 92.15% participation. The resulting net credit amounted to
$130,034 and was allocated, considering deferred income tax effects, to
reduce the carrying value of property, plan and equipment of Gerdau
Acominas.
BUSINESS COMBINATION DURING THE YEAR ENDED DECEMBER 31, 2002
On February 13, 2002 and October 18, 2002 Gerdau acquired an additional
16.12% and 24.79%, respectively, of voting and total shares of Acominas.
The acquisition in February 2002 increased the interest of Gerdau in the
voting stock to 54.0% and, since this acquisition date, the financial
position, results of operations and cash flows have been consolidated in
the results of Gerdau.
The total purchase price, which was paid in cash, was $ 179,042 for the
shares acquired in February 2002 and $ 226,730 for the shares acquired in
October 2002. No goodwill resulted from the acquisitions. The excess of
fair value of assets acquired and liabilities assumed in relation to the
purchase price was allocated to reduce the value of long-lived assets
acquired.
The following table summarizes the estimated fair value of assets
acquired and liabilities assumed at February and October 2002:
FEBRUARY 2002 OCTOBER 2002
----------------------- ----------------------
Current assets 313,023 246,176
Property, plant and equipment 1,280,382 1,167,590
Other assets 79,962 73,312
Current liabilities (363,771) (298,894)
Non-current liabilities (198,915) (273,583)
----------------------- ----------------------
Net assets acquired 1,110,681 914,601
Percentage acquired 16.12% 24.79%
----------------------- ----------------------
Purchase price 179,042 226,730
======================= ======================
F-18
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
4.2 DONA FRANCISCA ENERGETICA S.A.
On December 24, 2002, Gerdau signed a contract to purchase 199.8 million
common shares of Dona Francisca Energetica S.A. ("Dona Francisca") which
represent 30% of the total number of shares. The payment for the purchase
and the transfer of shares was made on January 10, 2003. Dona Francisca
is a non-public corporation which has as its business purposes: (a) to
build and own a hydroelectric power plant, known as Usina Hidroeletrica
Dona Francisca, (b) to operate such plant, (c) to provide technical
assistance services in its area of specialty, and (d) to participate in
other companies if related to the construction and operation of the plant
or as a temporary financial investment. With this purchase, our ownership
percentage of voting shares in Dona Francisca increased from 21.82% to
51.82%.
In accordance with an agreement between the shareholders of Dona
Francisca, the principal operational and financial decisions including
the selection of members of the Board of Directors, requires the approval
of at least 65% of voting shares. In accordance with EITF 96-16
"Investor's Accounting for a Investee When the Investor Has a Majority of
the Voting Interest but Minority Shareholder or Shareholders Have Certain
Approval or Veto Rights", because the minority interest shareholders have
certain approval or veto rights, the results of Dona Francisca have not
been consolidated, but included as an investment in subsidiary and
accounted for using the equity method of accounting.
The purchase price includes a fixed portion R$ 20.000.000 or $5,725 and a
variable portion that depends on the outcome of certain contingencies
potentially payable to the Mercado Atacadista de Energia ("MAE"). When a
final determination is made in respect to the contingency involving the
MAE, Gerdau could be required to pay up to approximately R$33,000 in
additional purchase price for the shares, which is considered contingent
consideration for accounting purposes and will be recognized as an
expense if the contingency is resolved unfavorably.
The following table summarizes the estimated fair value of assets
acquired and liabilities assumed at the date of the acquisition. No
goodwill resulted from the acquisition.
Current assets 22,054
Property plant and equipment 78,223
Other assets 29,590
Current liabilities (87,125)
-----------------
Net assets acquired 42,742
-----------------
Portion purchased - 30% 12,823
Purchase price 5,725
-----------------
Excess of fair value of assets in
relation to the purchase price
allocated, to reduce the
value of property plant and equipment 7,098
=================
4.3 MARGUSA
On November 18, 2003, the Company exchanged certain forestry holdings in
exchange for 1,776,638 newly issued shares of Maranhao Gusa S.A.
("Margusa"), a producer of pig iron obtaining a 17% interest in the total
and voting capital of Margusa. On December 2, 2003, the Company signed a
purchase agreement to buy the remaining shares of Margusa for $18 million
subject to adjustments that may result from a due diligence to be carried
by the Company during 2004. The cash portion will be paid in 8
installments with the first paid on December 2003 and the remaining 7
installments payable during 2004. Control was transferred to the Company
on January 5, 2004 which is considered the acquisition date for
accounting purposes. As at December 31, 2003, the Company recorded the
investment in Margusa at cost of $16,300, represented by a cash payment
of $2,234 (corresponding to the first installment of the eight due) and
the value of the forestry holdings transferred to Margusa of $14,066.
F-19
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
4.4 CO-STEEL
On October 23, 2002, the Company and the Canadian steelmaker Co-Steel
Inc. ("Co-Steel") combined their North American operations. In the
transaction, Co-Steel acquired all of the issued and outstanding shares
of the Gerdau North America Group (as defined below) in exchange for
shares of Co-Steel representing 74% of the shares of the combined entity.
The Gerdau North America Group is comprised of the operations of Gerdau
in Canada (the "Gerdau Canada Group" comprising the entities currently
named Gerdau Ameristeel MRM Special Sections Inc, Gerdau Ameristeel
Cambridge Inc and certain holding companies) and in the United States
(comprising the entities currently named Gerdau Ameristeel US Inc.,
Ameristeel Bright Bar Inc. and one holding company).
Subsequently, on March 31, 2003, under the terms of the Transaction
Agreement relating to the acquisition of Co-Steel, Gerdau Ameristeel
Corp. completed an exchange of minority shares of its subsidiary
AmeriSteel Corporation ("Ameristeel", currently named Gerdau Ameristeel
US Inc.) for shares of Gerdau AmeriSteel Corp. Minority shareholders of
AmeriSteel, mostly executives and employees, exchanged 1,395,041 shares
of AmeriSteel for 13,199,260 shares of Gerdau AmeriSteel, an exchange
ratio of 9.4617 to one. As a result, AmeriSteel became a wholly owned
subsidiary of Gerdau AmeriSteel, and the participation of the Company in
Gerdau AmeriSteel was reduced from 74% to 67%.
The name of Co-Steel was changed to Gerdau AmeriSteel Corporation
("Gerdau Ameristeel") as part of the transaction. For accounting
purposes, the business combination of the Gerdau North America Group and
Co-Steel on October 23, 2002 has been accounted for using the reverse
take-over method of purchase accounting. Gerdau North America is deemed
to be the acquirer and is assumed to be purchasing the assets and
liabilities of Co-Steel since the Company, the original shareholder of
the Gerdau North America Group, became the owner of more than 50% of the
voting shares of Co-Steel on a fully diluted basis. The results of
operations of Co-Steel are consolidated from the date of the transaction.
The following table summarizes the estimated fair value of assets
acquired and liabilities assumed at the date of the acquisition. No
goodwill resulted from the acquisition.
Current assets 242,252
Current liabilities (130,345)
Property, plant and equipment 389,915
Other assets (177)
Long-term debt (300,082)
Other long-term liabilities (81,386)
Net deferred income taxes 15,768
--------------
Net assets acquired 135,945
--------------
Purchase consideration, representing 51,503,960 Co-Steel shares at $2.51 per share 129,275
Plus transaction costs 6,670
--------------
135,945
--------------
The exchange on March 31, 2003 was accounted for as a step acquisition
under the purchase method of accounting whereby the purchase price was
allocated to the net assets acquired based upon their relative fair
values. Goodwill of $2.2 million was created as a result of the exchange.
On September 24, 2003, the Company purchased an additional 2,566,600
shares of Gerdau Ameristeel on the open market at a cost of $7.1 million.
After this transaction, the Company held 68.6% of the outstanding shares.
F-20
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
5 SHORT-TERM INVESTMENTS
2003 2002
------------- --------------
Investment funds 132 32,364
Investment funds administered by Banco Gerdau S.A. (related party) 45,020 97,775
Debt securities 121,947 228,758
Equity securities 69,038 8,851
------------- --------------
236,137 367,748
============= ==============
6 TRADE ACCOUNTS RECEIVABLE, NET
2003 2002
-------------- --------------
Trade accounts receivable 493,333 376,940
Less: allowance for doubtful accounts (27,476) (15,139)
-------------- --------------
465,857 361,801
============== ==============
7 INVENTORIES
2003 2002
-------------- --------------
--------------
Finished products 302,701 331,926
Work in process 111,718 87,728
Raw materials 171,038 85,682
Packaging and maintenance supplies 198,657 105,833
Advances to suppliers of materials 13,847 21,637
--------------
-------------- --------------
797,961 632,806
============== ==============
8 TAX CREDITS
2003 2002
------------- --------------
Brazilian value-added tax on sales and services - ICMS 10,565
30,677
Brazilian excise tax - (IPI) 2,201 372
Withholdings taxes 40 1,778
Brazilian tax for financing of social integration program -PIS 1,592 1,215
Others 3,443 1,024
------------- --------------
37,953 14,954
============= ==============
9 BALANCES AND TRANSACTIONS WITH RELATED PARTIES
2003 2002
--------------- ---------------
Short-term investments - Funds administered by Banco Gerdau S.A. (i) (Note 5) 45,020 97,775
Intercompany debt - MG (ii), presented under Other current liabilities 1,173 277
Loans and advances to directors, presented under Other non-current assets 1,099 1,559
Receivable from Sipar Aceros S.A., presented under Other non-current assets 8,673 3,496
Receivable from Fundacao Gerdau, presented under Other non-current assets 5,802 2,226
F-21
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
(i) Banco Gerdau is a wholly owned subsidiary of MG and is the administrator
of investment funds for the exclusive use of the Company. The fund's
investments consist of time deposits in major Brazilian banks and
treasury bills of the Brazilian government. Income earned on the
Company's investment in the fund aggregated $13,265 in 2003 and $9,469 in
2002, representing average yields of 25.8 % and 19.0 %, respectively.
(ii) Loans from MG as of December 31, 2003 and 2002 are denominated in
Brazilian reais and bear interest at the average composite borrowing rate
of the Conglomerate (20.32% as of December 31, 2003). Interest expense
related to such loans aggregated $95 in 2003, $39 in 2002 and $20 in
2001, representing average effective rates of 20.3%, 23.0 % and 22.8 %
respectively.
In addition, INDAC - Industria, Administracao e Comercio S.A., holding
company controlled by the Gerdau family and a shareholder of MG acts as
guarantor of some debt assumed by the Company in exchange for a fee of 1%
per year of the amount of debt guaranteed. Average amount of debt
guaranteed during the year ended December 31, 2003 amounted to $ 255,206
(2002 - $243,105).
During the year, the Company also paid a fee to Grupo Gerdau
Empreendimentos Ltd, an affiliate holding company controlled by the
Gerdau family, $195 (2002 - $205) for the use of the Gerdau name.
10 PROPERTY, PLANT AND EQUIPMENT, NET
2003 2002
-------------- --------------
Buildings and improvements 913,625 714,326
Machinery and equipment 2,166,415 2,006,922
Vehicles 11,567 9,540
Furniture and fixtures 23,602 32,195
Other 148,921 91,649
-------------- --------------
3,264,130 2,854,632
Less: accumulated depreciation (1,385,604) (989,415)
-------------- --------------
1,878,526 1,865,217
Land 219,887 122,135
Construction in progress 205,745 97,543
-------------- --------------
Total 2,304,158 2,084,895
============== ==============
Construction in progress as of December 31, 2003 represents principally
renewals and improvements in the manufacturing facilities of Gerdau and
Gerdau Acominas in Brazil and real state and mining rights as described
below. The Company capitalized interest on construction in progress in
the amount of $7,112 in 2003, $10,370 in 2002 and $14,228 in 2001.
As of December 31, 2003, machinery and equipment with a net book value
of $186,807 was pledged as collateral for certain long-term debt.
On December 10, 2003, Gerdau Acominas signed a purchase agreement to
purchase certain real estate and mining rights located in Miguel
Bournier, Varzea do Lopes and Gongo Soco in the state of Minas Gerais,
Brazil. The agreed upon price for the purchase is $30 million, with $7.5
million already paid by December 31, 2003. A further $7.5 million will be
payable upon the completion of the due diligence process, and the
remaining 50% in June 2004. The $7.5 million that was paid prior to
December 31, 2003 has been included in construction in progress, and the
remaining payments will be recognized when paid.
F-22
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
11 GOODWILL
2003 2002
------------------------------- ------------------------------
NORTH SOUTH NORTH SOUTH
AMERICA AMERICA AMERCIA AMERICA
-------------- -------------- ------------- ----------------
Balance at the beginning of the year 114,374 2,452 114,374 533
Goodwill arising on acquisition of minority
interest of Ameristeel Corporation 2,190 - - -
Goodwill arising on acquisition of Armacero
Industrial y Comercial Limitada. - - - 2,322
Effect of exchange rate on goodwill of operations
in South America - 515 - (403)
-------------- -------------- ------------- --------------
-------------- -------------- ------------- --------------
Balance at the end of the year 116,564 2,967 114,374 2,452
============== ============== ============= ==============
Goodwill allocated to North America at December 31, 2002 corresponds
exclusively to the acquisition of Ameristeel Corporation (currently named
Gerdau Ameristeel US Inc) in 1998. Goodwill allocated to South America
corresponds to the investment in Armacero Industrial y Comercial
Limitada.
On March 31, 2003 $2.2 million of additional goodwill was recorded for
North America as a result of the transaction described in Note 4.4.
Up to December 31, 2001 goodwill was being amortized on a straight-line
basis over 20 to 25 years, the estimated lives of related benefit. Had
goodwill not been amortized during the year ended December 31, 2001 net
income for that year would have been $ 171,353 and EPS would have been as
follows:
Basic and diluted earnings per share.
Preferred $ 0.60
Common $ 0.55
12 ACCRUED PENSION AND OTHER POST-RETIREMENT BENEFITS OBLIGATION
12.1 PENSION PLANS
The Company and other related companies in the Conglomerate co-sponsor
contributory pension plans (the "Brazilian Plans") covering
substantially all employees based in Brazil, including Gerdau Acominas
as from its consolidation. The Brazilian Plans consists of a plan for
the employees of Gerdau and its subsidiaries ("Gerdau Plan") and one
plan for employees of Gerdau Acominas and its subsidiaries ("Gerdau
Acominas Plan"). The Brazilian Plans are mainly defined benefit plans
with certain limited defined contributions. Additionally, the Company's
Canadian and American subsidiaries, including Gerdau Ameristeel, sponsor
defined benefit plans (the "North American Plans") covering the majority
of their employees. Contributions to the Brazilian Plans and the North
American Plans are based on actuarially determined amounts.
Contributions to the Brazilian Plans for defined contribution
participants are based on a specified percentage of employees'
compensation and totaled $697 in 2003, $634 in 2002 and $955 in 2001.
Contributions and expenses to defined contribution retirement plans of
employees of the subsidiaries in the United States and Canada amounted
to $2,600, $10,100 and $1,100 in 2003, 2002 and 2001, respectively.
F-22
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
BRAZILIAN PLANS
Net periodic pension cost relating to the defined benefit component of
the Brazilian Plans, which includes as from 2002 the pension plan
sponsored by Gerdau Acominas, was as follows:
2003 2002 2001
-------------- -------------- --------------
Service cost 5,374 4,867 1,989
Interest cost 16,057 14,181 5,037
Expected return on plan assets (21,712) (17,825) (4,573)
Plan participants' contributions (1,375) (1,001) -
Amortization of unrecognized gains and losses, net (1,569) (1,142) (475)
Amortization of prior service cost 941 294 -
Amortization of unrecognized transition obligation (284) 398 865
-------------- -------------- --------------
Net pension expense (benefit) (2,568) (228) 2,843
============== ============== ==============
The funded status of the defined benefit components of the Brazilian
Plans was as follows:
2003 2002
---------------
Plan assets at fair value 291,120 184,850
Projected benefit obligation 198,789 135,455
---------------
Funded status 92,331 49,395
Unrecognized net transition obligation (2,422) (1,652)
Unrecognized prior service cost 3,566 3,160
Unrecognized net gains and losses (73,903) (37,794)
---------------
Amounts recognized in the balance sheet, net 19,572 13,109
=============== ===============
Additional information required by SFAS 132 "Employers' Disclosures about
Pensions and Other Postretirement Benefits" for the Brazilian Plans is as
follows:
2003 2002
---------------- ----------------
Change in benefit obligation
Benefit obligation at the beginning of the year 135,455 55,597
Consolidation of Gerdau Acominas 119,915
Service cost 5,374 4,867
Interest cost 16,057 14,181
Actuarial loss 14,678 9,838
Benefits paid (4,997) (4,453)
Effect of exchange rate changes 32,222 (64,490)
---------------- ----------------
Benefit obligation at the end of the year 198,789 135,455
---------------- ----------------
2003 2002
--------------- ---------------
Change in plan assets
Fair value of plan assets at the beginning of the year 184,850 62,222
Consolidation of Gerdau Acominas 159,931
Actual return on plan assets 61,345 47,691
Employer contributions 3,360 2,750
Plan participants' contributions 1,375 1,001
Benefits paid (4,997) (4,453)
Effect of exchange rate changes 45,187 (84,292)
--------------- ---------------
Fair value of plan assets at the end of the year 291,120 184,850
--------------- ---------------
F-24
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
The assumptions used for the defined benefit component of the Brazilian
Plans are presented below. The rates presented below are nominal rates
and consider inflation of 6% (5% for the years ended December 31, 2002
and 2001).
2003 2002 2001
-------------------- -------------------- -------------------
Weighted-average discount rate 11.3% 10.3% 9.7%
Rate of increase in compensation 8,68% - 9,20% 9.2% 8.7%
Long-term rate of return on plan assets 12.35% 10.3% 9.7%
Brazilian Plan assets as of December 31, 2003 include shares of Gerdau
Acominas and of Gerdau in the amounts of $14,684 and $13,197,
respectively (2002 - $12,007 and $5,258, respectively).
The Brazilian plans are administrated by Gerdau - Sociedade de
Previdencia Privada ("Gerdau Plan") and Fundacao Acominas de Seguridade
Social - Acos ("Gerdau Acominas Plan"). The pension plan accumulated
benefit obligation weighted-average asset allocations at December 31,
2003 and 2002, and the target allocation for 2004, by asset category,
and the accumulated benefit obligation are as follows:
GERDAU PLAN GERDAU ACOMINAS PLAN
---------------------------------- -----------------------------------
2003 2002 2003 2002
---------------- --------------- ---------------- ---------------
Accumulated benefit obligation 26,793 19,817 129,749 82,664
ALLOCATION OF ASSETS BY CATEGORY AS OF
DECEMBER 31
Equity Securities 40.96% 23.20% 12.84% 13,60%
Fixed income 59.04% 76.80% 82.07% 79.10%
Real estate - - 3.84% 6.02%
Loans - - 1.25% 1.28%
---------------- --------------- ---------------- ---------------
Total 100% 100% 100% 100%
================ =============== ================ ===============
PLANO GERDAU
PLANO GERDAU ACOMINAS
---------------- ---------------
TARGET ALLOCATION OF ASSETS FOR 2004
Equity securities 40% 7.61%
Fixed Income 60% 87.00%
Real estate - 4.10%
Loans - 1.29%
---------------- ---------------
Total 100% 100%
================ ===============
The investment strategy for the Gerdau Plan is based on a long term
macroeconomic scenario. This scenario considers reduction in Brazil's
sovereign risk, moderate economic growth, stable levels of inflation and
exchange rates, and moderate interest rates. The devised asset mix is
composed by fixed income investments and equities. The fixed income
target allocation ranges from 60% to 100% and equities target allocation
ranges from 0% to 40%. The 2004 expected return for this asset mix is
12.35%. The expected employer contributions for 2004 are $553.
The Gerdau Acominas Plan aims to reach the investment target returns in
the short and long term, through the best relation of risk versus the
expected return. The investments determined by the investment policy
allocation targets
F-25
are: fixed income target allocation ranges from 57% to 100%, equities
target allocation ranges from 0% to 35%, real stated allocation ranges
from 0% to 5% and loans allocation range from 0% to 5%. The expected
employer contributions for 2004 are $4,231.
Brazilian plans uses a measurement date of December 31.
NORTH AMERICAN PLANS
The components of net periodic pension cost for the North American Plans
are as follows:
2003 2002 2001
--------------- -------------- ---------------
Service cost 8,330 5,606 4,947
Interest cost 20,831 12,830 10,921
Expected return on plan assets (18,505) (13,536) (12,258)
Amortization of prior service cost 461 388 282
Amortization of unrecognized gains and losses, net 956 4 (134)
--------------- -------------- ---------------
Net pension expense 12,073 5,292 3,758
=============== ============== ===============
The funded status of the North American Plans is as follows:
2003 2002
-------------- --------------
Plan assets at fair value 278,243 206,070
Projected benefit obligation 359,568 301,352
-------------- --------------
Funded status (81,325) (95,282)
Unrecognized prior service cost 2,673 2,564
Unrecognized transition liability 1,905 1,702
Unrecognized net gains and losses 39,067 52,139
Additional minimum liability (18,642) (27,763)
-------------- --------------
Accrued pension liability recognized in the balance sheet (56,322) (66,640)
============== ==============
Additional information required by SFAS No 132 for the North American
Plans is as follows:
2003 2002
------------ ------------
Change in benefit obligation
Benefit obligation at the beginning of the year 301,352 164,260
Acquisition of Co-Steel 111,530
Service cost 8,330 5,606
Interest cost 20,831 12,830
Actuarial loss 11,248 13,659
Benefits paid (14,917) (8,765)
Foreign exchange loss 32,724
Amendments 2,232
------------ ------------
Benefit obligation at the end of the year 359,568 301,352
------------ ------------
2003 2002
------------ ------------
Change in plan assets
Plan assets at the beginning of the year 206,070 133,827
Acquisition of Co-Steel 79,628
Employer contributions 18,470 10,142
Benefits paid (14,917) (8,765)
Actual return on assets 42,447 (8,762)
F-26
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
Foreign exchange gain 26,173
------------ ------------
Plan assets at the end of the year 278,243 206,070
------------ ------------
Assumptions used in accounting for the North American Plans were:
2003 2002 2001
---------------- ---------------- ----------------
Weighted-average discount rate 6.25% - 6.50% 6.5%-6.8% 7%-7.3%
Rate of increase in compensation 2.50% - 4.50% 4.3%-4.5% 2.5%-4.5%
Long-term rate of return on plan assets 7.25% - 8.40% 7.5%-9.3% 7%-9.3%
The pension plan weighted-average asset allocations at December 31, 2003
and 2002, by asset category are as follows.
ASSET CATEGORY PLAN ASSETS AT DECEMBER 31,
--------------------------------
2003 2002
--------------- -------------
Equity securities 70.4% 66.3%
Debt securities 23.9% 28.5%
Real estate 0.5% 0.5%
Other 5.2% 4.7%
--------------- -------------
Total 100% 100%
=============== =============
The subsidiaries in North America have an Investment Committee that
defines the investment policy related to the defined benefit plans. The
primary investment objective is to ensure the security of benefits that
have accrued under the plans by providing an adequately funded asset pool
which is separate from and independent of Gerdau Ameristeel Corporation.
To accomplish this objective, the fund shall be invested in a manner that
adheres to the safeguards and diversity to which a prudent investor of
pension funds would normally adhere. Gerdau Ameristeel retains
specialized consultant providers that advise and support the Investment
Committee decisions and recommendations.
The Company expects to contribute $4.6 million to its pension plans and
$980 thousand to its other postretirement benefit plans, described below,
in 2004.
North America plans uses a measurement date December 31.
12.2 OTHER POST-RETIREMENT BENEFITS
The subsidiaries in North America currently provide specified health care
benefits to retired employees. Employees who retire after a certain age
with specified years of service become eligible for benefits under this
unfunded plan. The Company has the right to modify or terminate these
benefits.
The components of net periodic pension cost for the post-retirement
health benefits are as follows:
2003 2002 2001
-------------- -------------- ---------------
Service cost 880 341 247
Interest cost 2,247 876 586
-------------- -------------- ---------------
Net post-retirement health expense 3,127 1,217 833
============== ============== ===============
F-27
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
The following sets forth the funded status of the post-retirement health
benefits:
2003 2002
---------------- -----------------
Plan assets at fair value - -
Projected benefit obligation 38,554 31,979
---------------- -----------------
Funded status (38,554) (31,979)
Unrecognized net gains and losses 1,878 690
---------------- -----------------
Accrued post-retirement health benefits recognized in the balance sheet (36,676) (31,289)
================ =================
Additional information required by SFAS N(0) 132 for post-retirement health
benefits is as follows:
2003 2002
--------------- ----------------
Change in the projected benefit obligation
Projected benefit obligation at the beginning of the year 31,979 9,068
Acquisition of Co-Steel 22,049
Service cost 880 341
Benefits paid (2,259) (1,331)
Interest cost 2,247 876
Plan participants' contributions 647 532
Foreign exchange loss 3,872
Actuarial loss 1,188 444
--------------- ----------------
Projected benefit obligation at the end of the year 38,554 31,979
=============== ================
Change in plan assets 2003 2002
--------------- ----------------
Plan assets at the beginning of the year - -
Employer contribution 1,612 799
Plan participants' contributions 647 532
Benefits and administrative expenses paid (2,259) (1,331)
--------------- ----------------
Plan assets at the end of the year - -
=============== ================
Assumptions used in the accounting for the post-retirement health benefits were:
2003 2002 2001
---------------- ------------------ ------------------
Weighted-average discount rate 6.50%-6.75% 6.50%-6.80% 7.30%
Health care - trend rate assumed for following year 9.00%-10.00% 10.00%-12.00% 8.60%
Health care - Rate to which the cost is assumed to
decline (ultimate trend rate) reached in year 2008 5.50% 5.50% 5.50% - 6.00%
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change
in assumed health care cost trend rates would have the following effects:
1 PERCENTAGE POINT INCREASE 1 PERCENTAGE POINT DECREASE
------------------------------ ------------------------------
Effect on total of service and interest cost 367 (136)
Effect on postretirement benefit obligation 3,694 (1,194)
F-28
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
12.3 SUMMARY OF AMOUNTS RECOGNIZED IN THE BALANCE SHEET
The amounts recognized in the balance sheets are as follows:
2003 2002
------------- -------------
LIABILITIES
Brazilian pension obligation (Gerdau plan) 15,681 11,941
North American pension obligation 56,322 66,640
North American obligation other than pension 36,676 31,289
------------- -------------
Accrued liability related to pension and other benefit obligation 108,679 109,870
============= =============
ASSETS
Prepaid pension cost for the Brazilian plans (Gerdau Acominas plan) 35,253 25,050
============= =============
13 SHORT-TERM DEBT
Short-term debt consists of working capital lines of credit and export
advances with interest rates ranging from 1.36% p.a. to 11.13% p.a. for
U.S. dollar denominated debt and with an interest rate of TR (taxa
referencial - a nominal interest rate) + 14.49% p.a. for reais
denominated debt. Advances received against export commitments are
obtained from commercial banks with a commitment that the products be
exported.
On October, 2003 the subsidiary GTL Trade Finance Inc. issued Euro
Commercial Paper in the amount of $100 million with maturity on October
15, 2004 and interest of 4% p.a.
F-29
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
-----------------------------------------------------
14 LONG-TERM DEBT AND DEBENTURES
Long-term debt and debentures consisted of the following as of December 31:
Annual Interest
Rate % at
December 31, 2003 2003 2002
----------------- ------------- -----------
LONG-TERM DEBT, EXCLUDING DEBENTURES, DENOMINATED IN BRAZILIAN REAIS
Working capital TJLP + 9.35% 1,319 20,559
Financing for machinery TJLP + 9.32% to 9.66% 208,651 182,258
LONG-TERM DEBT, EXCLUDING DEBENTURES, DENOMINATED IN FOREIGN CURRENCIES
(a) Long term debt of Gerdau, Gerdau Acominas and Gerdau Aza S.A.
Working capital (US$) (*) 1.35% to 11.13% 270,034 270,185
Financing for machinery and others (US$) 4.61% to 6.83% 205,107 114,982
Securitization of export receivables by Acominas (US$) 7.37% 104,971 -
Advance on export (US$) 6.63% to 7.40% 63,842 42,705
Working capital (Chilean pesos) Chilean banking rate - TAB + 10,367 8,428
1.5% a 4.49%
Financing for machinery (Chilean pesos) Chilean banking rate - TAB + 20,212 34,216
1.5% a 4.49%
(b) Long-term debt of Gerdau Ameristeel - 2003
Senior notes, net of original issue discount (US$) 10.375% 397,271 -
Senior secured credit facility (Canadian dollar-Cdn$ and US$) LIBOR + 2.0 to 3.25% 135,027 -
Industrial Revenue Bonds (US$ 3.25% to 3.75% 27,400 -
Other 7,139 -
(c) Long-term debt of Gerdau Ameristeel - 2002 Gerdau Canada Group
Bank indebtedness - 17,243
U.S. Dollar Floating Rate Term - 61,743
Canadian dollar revolving loan - 22,157
Other - 1,444
Gerdau USA Inc. ("GUSA") and subsidiaries
Ameristeel Revolving Credit Agreement - 100,800
Ameristeel - Term Loan - 68,750
Term loan - American Bright Bar - 36,795
IRB - Industrial Revenue Bonds - 3,522
Other - 809
F-30
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
-----------------------------------------------------
Annual Interest
Rate % at
December 31, 2003 2003 2002
----------------- ------------- -----------
Former Co-Steel group
Bank indebtedness - 6,136
Canadian dollar revolving loan - 30,577
U.S. Dollar Fixed Rate Reducing Term Loan - 105,849
U.S. dollar revolving loan - 59,767
Other - 3,061
-------------- -----------
1,451,339 1,191,986
Less: current portion (318,910) (397,415)
-------------- -----------
Long-term debt, excluding debentures, less current portion 1,132,429 794,571
============== ===========
Long-term debt matures in the following years:
2004 318,910
2005 191,878
2006 136,249
2007 75,501
2008 175,691
2009 and thereafter 553,110
-------------------
1,451,339
===================
LONG-TERM DEBT, EXCLUDING DEBENTURES, DENOMINATED IN BRAZILIAN REAIS
Long-term debt denominated in Brazilian reais is indexed for inflation
using the TJLP rate set by the Government on a quarterly basis.
LONG-TERM DEBT, EXCLUDING DEBENTURES, DENOMINATED IN FOREIGN CURRENCIES
(A) GERDAU, GERDAU ACOMINAS AND GERDAU AZA S.A.
The debt agreements entered into by Gerdau Acominas contain covenants
that require the maintenance of certain ratios, as calculated in
accordance with its financial statements prepared in accordance with
Brazilian GAAP. The covenants include several financial covenants
including ratios on liquidity, total debt to EBITDA (earnings before
interest, taxes, depreciation and amortization), debt service coverage
and interest coverage, amongst others.
On September 5, 2003, Gerdau Acominas concluded a private placement of
the first tranche of Export Notes in the amount of US$ 105 million. The
Export Notes bear interest of 7.37% p.a., with final due date in July,
2010, and have quarterly payments starting October, 2005.
F-31
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
(b) GERDAU AMERISTEEL DEBT
AT DECEMBER 31, 2003
On June 27, 2003, Gerdau Ameristeel refinanced its debt by issuing $405
million aggregate principal 10 3/8% Senior Notes. The notes mature July
15, 2011 and were issued at 98% of face value. Gerdau Ameristeel also
entered into a new Senior Secured Credit Facility with a term of up to
five years, which provides commitments of up to $350 million. The
borrowings under the Senior Secured Credit Facility are secured by Gerdau
Ameristeel's inventory and accounts receivable. The proceeds were used to
repay existing indebtedness. At December 31, 2003, there was $135.0
million outstanding, at interest rates considering the LIBOR interest
rate applicable as of December 31, 2003, between 3.93% and 5.50%, and
approximately $130 million was available under the Senior Secured Credit
Facility.
AT DECEMBER 31, 2002
At December 31, 2002, debt agreements were specific to: (a) the former
"Gerdau Canada Group", (b) the holding subsidiary company Gerdau USA Inc
and its subsidiaries (collectively "GUSA") and (c) the former Co-Steel
entities.
(i) GERDAU CANADA GROUP
As of December 31, 2002, Gerdau Canada Group had a total authorized
revolver facility of Canadian dollars ("Cdn$") 73 million ($46 million)
that bore interest at floating market rates approximating the bank's
prime rate (as defined in the agreement) plus 1.75% or Bankers'
Acceptance plus 2.75%. Companies in the Gerdau Canada Group pledged
accounts receivable and inventory as collateral. The revolver facility
was repaid under the refinancing as of June 27, 2003.
The total authorized Canadian term facility was Cdn $97.5 million ($61.7
million U.S. dollars) with a due date of January 15, 2004, bearing
interest at floating market rates approximating the bank's prime rate (as
defined in the agreement) plus 1.75%. Interest rate swap agreements
related to this facility were entered into with the Gerdau Canada Group's
bank as the counterparty in November 1999 that effectively fixed the rate
of interest on approximately 50% of the balance. At December 31, 2003,
the swap agreement is for $11 million and bears interest at 6.445% for a
term expiring in 2004. The aggregate fair value of the interest rate swap
agreements, which represent the amount that would be paid by the Gerdau
Canada Group if the agreements were terminated at December 31, 2003, was
$457 thousand (negative). The swap agreements were not terminated
subsequent to the refinancing.
The Canadian banking agreement, which included Gerdau Steel Inc. (the
controlling shareholder of Gerdau Ameristeel), contained various
restrictive covenants relating to maintenance of certain financial
ratios. At December 31, 2002, the Company was not in compliance with
certain covenants and requested and received a waiver of compliance. This
agreement no longer applies due to the refinancing that took place in
2003.
Collateral for the Canadian credit facility included: (i) Cdn$350 million
demand debentures given by each of Gerdau Steel Inc., Gerdau MRM Holdings
Inc., Gerdau Ameristeel MRM Special Sections Inc. and Gerdau Ameristeel
Cambridge Inc., each granting a first priority fixed charge on real
estate, machinery and equipment, a first priority floating charge on all
other assets and a first priority fixed charge on inventory and accounts
receivable to a maximum of $20 million, (ii) pledges and guaranties of
various Gerdau Canada Group members, and (iii) a guaranty by Gerdau S.A.
In addition, an "all risks" insurance policy for full insurable value on
a replacement cost basis was pledged to the lenders.
F-32
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
(ii) GUSA AND SUBSIDIARIES
GUSA's primary financial obligation outstanding as of December 31, 2002
was a $285 million credit facility (the "Revolving Credit Agreement"). It
was collateralized by first priority security interests in substantially
all accounts receivable and inventories of GUSA as well as a lien on the
Company's Charlotte Mill property, plant and equipment. The Revolving
Credit Agreement was amended in September 2000 and increased the total
facility from $150 million to $285 million, of which $100 million was a
term loan that amortized at the rate of 25% per year beginning in
December 2001. The Revolving Credit Agreement was to mature in September
2005. Loans under the Revolving Credit Agreement bore interest at a per
annum rate equal to one of several rate options (LIBOR, Fed Funds or
Prime Rate, as defined in the agreement) based on the facility chosen at
the time of borrowing, plus an applicable margin determined by tests of
performance from time to time. The effective interest rate at December
31, 2002 was approximately 3.8%. The Revolving Credit Agreement contained
certain covenants including the requirement to maintain financial ratios
and limitations on indebtedness, liens, investments and disposition of
assets and dividends. Letters of credit were subject to an aggregate sub
limit of $50 million. The credit facility was repaid under the
refinancing as of June 27, 2003.
GUSA's industrial revenue bonds ("IRBs") were issued to obtain funding to
construct facilities in Jackson, Tennessee; Charlotte, North Carolina;
Jacksonville, Florida; and Plant City, Florida. GUSA incurred an
additional $3.6 million IRB with the acquisition of the Cartersville cold
drawn facility in June 2002. The interest rates on these bonds range from
50% to 75% of the prime rate; $3.8 million matures in 2014, $20.0 million
matures in 2017, and $3.6 million matures in 2018. Irrevocable letters of
credit issued pursuant to the Revolving Credit Agreement back the IRBs.
As of December 31, 2003, the Company had approximately $51.9 million of
outstanding letters of credit, primarily for IRBs and insurance.
In order to reduce its exposure to interest-rate fluctuations, GUSA
entered into interest-rate swap agreements in August and September 2001.
The interest-rate swaps have a notional value of $55 million, with the
Company paying a fixed interest rate and receiving a variable interest
rate based on three-month LIBOR. The underlying hedged instruments were
specific tranches of LIBOR-based revolving credit and term loan
borrowings under GUSA's Revolving Credit Agreement. The swap agreements
were not terminated subsequent to the refinancing. The aggregate fair
value of the interest rate agreements, which represents the amount that
would be paid by GUSA if the agreements were terminated at December 31,
2003, is approximately $3.8 million (negative) presented under Others
non-current liabilities. The agreements have varying expiration dates
from 2004 to 2006.
(iii) FORMER CO-STEEL ENTITIES
The former Co-Steel entities at December 31, 2002 had revolving
facilities of Cdn$133.9 million and Cdn$22.2 million which could be drawn
in either Canadian or U.S. dollars. These facilities were due on January
15, 2004 and bore interest at the bankers' acceptance rate or LIBOR plus
2% to 5% depending on debt to EBITDA ratios.
The fixed rate reducing term loan at December 31, 2002 was $96.8 million
with interest at a fixed rate of 8.9% to 10.9% depending on debt to
EBITDA ratios. The terms of this facility included a make-whole provision
(in the event of prepayment) that required the Company to pay a penalty
if interest rates had decreased since the original inception of the loan.
At December 31, 2002, the amount of the make-whole provision (which was
included in the fair value adjustments related to the acquisition of
Co-Steel) was $9.1 million. This amount was recognized in 2003 due to the
refinancing. These facilities were repaid in June 2003 as part of the
refinancing.
F-33
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
DEBENTURES
Debentures include seven outstanding issuances of Gerdau and convertible
debentures of Gerdau Ameristeel as follows:
ISSUANCE MATURITY 2003 2002
----------- ------------ ----------- ------------
Third series 1982 2011 15,687
25,442
Seventh series 1982 2012
7,486 9,639
Eighth series 1982 2013 11,733
28,924
Ninth series 1983 2014 23,149
10,358
Eleventh series 1990 2020
6,662 4,837
Thirteenth series 2001 2008 - 87,765
Gerdau Ameristeel's convertible debentures 1997 2007 56.056
78,230
----------- ------------
157,102 208,866
Less debentures held by consolidated companies eliminated
on consolidation (634) (8,100)
----------- ------------
Total 156,468 200,766
----------- ------------
Less: current portion (presented under Other current
liabilities in the consolidated balance sheet) (1,048) -
=========== ============
Total debentures - long-term 155,420 200,766
=========== ============
(a) DEBENTURES ISSUED BY GERDAU
Debentures are denominated in Brazilian reais and bear variable interest
at a percentage of the CDI rate (Certificado de Deposito Interbancario,
interbank interest rate). The annual average nominal interest rates were
23.25% and 19.l1% as of December 31, 2003 and 2002, respectively. On
November 1, 2003, Gerdau bought all the thirteenth series debentures,
which contained financial covenants which require: (a) that total
consolidated financial debt does not exceed four times Earnings Before
Interest, Taxes, Depreciation and Amortization, as defined in the
agreements, and (b) that consolidated EBITDA should not be lower than 2.5
times net financial expenses, excluding the foreign exchange gains and
losses and monetary corrections. Prior series of debentures contained
financial covenants which limit distribution of dividends to no more than
30% of distributable net income if consolidated long-term debt exceeds
1.5 times shareholders' equity. All such financial covenants are measured
based on the statutory consolidated financial statements of Gerdau S.A.
prepared under Brazilian GAAP.
As of December 31, 2001, $8,073 of convertible debentures due at various
dates through 2005 were outstanding, which were convertible at the option
of the holder into Common stock and Preferred stock. On June 5, 2002 the
single holder of such convertible debentures exercised its right to
convert and 208,921,397 Common shares and 417,842,794 Preferred shares
were issued. As of December 31, 2003 there are no convertible debentures
issued by Gerdau outstanding.
(b) DEBENTURES ISSUED BY GERDAU AMERISTEEL CORP.
The unsecured subordinated convertible debentures issued by Gerdau
AmeriSteel Corp. bear interest at 6.5% per annum, mature on April 30,
2007, and, at the holders' option, are convertible into Common Shares of
Gerdau AmeriSteel Corp. at a conversion price of Cdn$26.25 per share.
Under the terms of the Trust Indenture for the Convertible Debentures, no
adjustment to the conversion price is required if Common Shares are
issued in a customary offering. The debentures are redeemable at the
option of Gerdau AmeriSteel Corp. at par plus accrued interest. Gerdau
AmeriSteel Corp. has the right to settle the principal amount by the
issuance of Common Shares based on their market
F-34
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
value at the time of redemption. The par value of the debentures is Cdn$
125 million. As part of the fair value adjustment of the assets and
liabilities of Co-Steel the debentures were revalued based on their
trading value on the Toronto Stock Exchange at the time of the
announcement of the merger. The difference between the par value and the
fair value is being amortized through April 30, 2007.
15 COMMITMENTS AND CONTINGENCIES
15.1 TAX AND LEGAL CONTINGENCIES
The Company is party to claims with respect to certain tax,
contributions and labor. Management believes, based in part on advice
from legal counsel, that the reserve for contingencies is sufficient to
meet probable and reasonably estimable losses in the event of
unfavorable rulings, and that the ultimate resolution will not have a
significant effect on the consolidated financial position as of December
31, 2003, although it may have a significant affect on results of future
operations or cash flows.
The following table summarizes the contingent claims and related judicial
deposits:
CONTINGENCIES JUDICIAL DEPOSITS
---------------------------------- ----------------------------
DECEMBER 31, DECEMBER 31,
---------------------------------- ----------------------------
CLAIMS 2003 2002 2003 2002
--------------------- ---------------- ---------------- ------------- -------------
Tax 89,424 36,198 62,140 11,537
Labor 10,248 7,166 3,546 1,854
Other 2,388 1,940 435 -
---------------- ---------------- ------------- -------------
102,060 45,304 66,121 13,391
================ ================ ============= =============
PROBABLE LOSSES ON TAX MATTERS, FOR WHICH A PROVISION WAS RECORDED
o Included in the reserve for contingencies as of December 31, 2003, is
$17,464 relating to "compulsory loans" required to be made to
Eletrobras ("Emprestimo Compulsorio Eletrobras sobre Energia
Eletrica"), the government-owned energy company, by its customers. The
Company has, along with other electricity customers, challenged the
constitutionality of these loans. In March 1995, the Supreme Court
decided against the interests of the Company. Even though the
constitutionality of the "compulsory loans" was sustained by the
Supreme Court, several issues remain pending, including the amounts to
be paid by the Company.
The Company has established a provision relating to the "compulsory
loans" as: (i) the Supreme Court has initially decided against the
interests of the Company as it relates to this matter, (ii) even
though the payment to Eletrobras was in the form of a loan, the
re-payment to the Company will be made in the form of Eletrobras
shares, and (iii) based on currently available information, the
Eletrobras shares will most likely be worth substantially less than
the amount that would be paid if the re-payment was to be made in
cash.
o $2,405 in reference to contested federal social contribution taxes -
"Fundo de Investimento Social" ("FINSOCIAL"). In spite of the matter
being ruled by Federal Supreme Court regarding the constitutionality
of the collection of 0.5% rate, some processes of the Company are
still awaiting judgment by the Superior Courts in this matter
F-35
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
o $4,966 relating to state value added tax - "Imposto Sobre Circulacao
de Mercadorias e Servicos" ("ICMS"). The most significant item being
challenged is the right to claim credits for certain processes of the
company. These matters are in progress and before the State Treasury
Department and State Justice of Minas Gerais
o $14,106 relating to "Contribuicao Social Sobre o Lucro". The balance
of the provision is in reference to discussions related to the
constitutionality of the contributions that we made in 1989, 1990 and
1992. There are some processes awaiting judgment, the majority with
the Superior Courts. Of the total provision, the Company made a
judicial deposit of $11,677, in reference to the social contribution
over the 30% limit in the reduction of net earnings by the subsidiary
Gerdau Acominas S.A. The matter is in progress with the Regional
Federal Court of 1st Region.
o $35,004 related to income tax, "Imposto Renda de Pessoa Juridica"
("IRPJ"). Of the total provision outstanding, the Company has made a
judicial deposit of $28,105, the portion that subsidiary Gerdau
Acominas will be required to pay to the IRPJ after compensation of tax
losses, without observing the limit of using tax losses of 30% of net
income.
o $6,013 regarding social security contributions (INSS). The processes
refer mainly to abrogation of liabilities, which is a matter in
discussion with the Federal Justice of Rio de Janeiro, and challenging
the INSS interpretation of charging social security contributions on
payments of participation in results, as well as services rendered for
work co-operatives, by subsidiary Gerdau Acominas. A judicial deposit,
covering substantially all of the value of these issues, has been
made.
o $816 relating to amounts of contributions to the Social Integration
Program ("PIS") and $2,400 regarding Social Contribution on Revenues
("COFINS") related to the constitutionality of Law #9,718 that
introduced changes in the base of the calculation of these
contributions. This process is before the Federal Regional Court of
2nd Region and Federal Supreme Court.
o $441 regarding a judicial discussion related to increase of FGTS
contributions, established by changes introduced by Complementary Law
#110/01. The corresponding warrant is awaiting judgment of
Extraordinary Appeals. The Company has made a deposit in escrow for
the amount provided.
o $3,487 related to "Encargo de Capacidade Emergencial - ECE", as well
as $2,024 related to "Recomposicao Tarifaria Extraordinaria - RTE",
which are tolls charged in the cost of electricity of the industrial
units of the Company. These tolls have, according to management
understanding, a nature of tax, and, being so, are incompatible with
the National Tax System as described in the Federal Constitution, and
this is the reason why its constitutionality is being questioned. The
processes are in progress in First Instance of the Federal Justice in
the States of Pernambuco, Ceara, Minas Gerais, Rio de Janeiro, Sao
Paulo, Parana, Rio Grande do Sul, as well as in the Regional Federal
Courts of 1st and 2nd Regions. The Company has currently deposited in
escrow the total amount of the questioned charges.
o $298 refers to other processes related to tax issues. Judicial
deposits have been made for most of the total amount in dispute.
o Judicial deposits, which represent restricted assets of the Company,
relate to amounts paid to the court and held in judicial escrow
pending resolution of related legal matters. The balance as of
December 31, 2003 is comprised of $62,140 related to tax
contingencies, from which $1,637relates to the Eletrobras dispute.
F-36
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
POSSIBLE LOSSES ON TAX MATTERS FOR WHICH NO PROVISION WAS RECORDED
There are other contingent tax liabilities, for which the probability of
losses are possible and, therefore, are not recognized in the provision
for contingencies. These claims are comprised by:
o The Company is a party to tax processes filed by the State of Minas
Gerais to collect presumable added value tax credits, based mainly on
sales of products to exporting companies. The total amount of the
processes is $10,788. The Company has not recognized any provision
related to these issues, due to management's understanding that this
tax is not applicable, since sales of products for export purposes are
free of added value tax.
o The Company and its subsidiary Gerdau Acominas S.A. are defendants in
tax processes filed by the State of Minas Gerais, in which demands
added value tax credits on exports of industrialized semi-finished
products. The total amount claimed is $59,139. The Company does not
account for a provision for such processes as the management believes
this tax is not applicable, since its products do not fit in the
definition of industrialized semi-finished products, as established in
federal law and, therefore, are not subject to added value tax.
o The Federal Revenue Service claims an amount of $18,954 related to
operations of subsidiary Gerdau Acominas S.A. under the drawback
concession act given by DECEX, which would not be in the Federal
Revenue Service interpretation, according to the law. Gerdau Acominas
awaits judgment of its previous administrative defense, claiming that
the operation is legal. Since the tax credit has not yet been
definitely constituted, and considering that the operation that
generated the demand fits in the requirements of concession and that
the concession act was sustained after analysis of the competent
administrative authority, management sees as remote the probability of
loss in this case, and therefore did not recognized a provision for
this contingency.
UNRECOGNIZED CONTINGENT TAX ASSETS
Management believes the realization of certain contingent assets is
possible. However, no amount has been recognized for these contingent
tax assets that would only be recognized upon final realization of the
gain:
o Among those, there is an amount of $9,200 related to an Ordinary
Action against the State of Rio de Janeiro, for breaking the Mutual
Contract of Periodic Execution in Cash, signed in the scope of the
Special Program of Industrial Development - PRODI. Due to the
insolvency of the State of Rio de Janeiro, as well as the lack of
regulation, by the State, of Constitutional Amendment #30/00, which
granted the State a 10 year moratorium for payment of non-feeding
debts, there is no expectation of realization of this credit in the
year of 2004.
o The Company is plaintiff in many ordinary actions challenging changes
in the base of calculation of PIS defined by Complementary Law #07/70,
based on the sentences of non-constitutionality of Edicts #2.445/88
and #2.449/88, and there is an expectation of recovery of the tax
credits related to the payment of the difference. Management estimates
the total amount of tax credits to be approximately $37,718.
o Based on previous decisions on early judgments at Court, the Company
and its subsidiary Gerdau Acominas S.A. have claimed to recover tax
credits of IPI. Gerdau S.A. filed administrative requests of
reimbursement, and awaits for their judgment. In the case of
subsidiary Gerdau Acominas S.A., the claim was taken to Justice, and
awaits the sentence. The Company estimates the amount reimbursable to
be approximately $136,371.
LABOR CONTINGENCIES
The Company is also a party to a number of lawsuits by employees. As of
December 31, 2003, the Company accrued $10,248 relating to such lawsuits.
None of these processes refer to amounts individually significant, and
disputes
F-37
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
involve mainly claims of overtime, health and danger bonuses.
Balances of escrow deposits related to labor contingencies, at December
31, 2003, represent $3,546.
F-38
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
OTHER CONTINGENCIES
The Company is also involved in a number of lawsuits arising from the its
ordinary course of business and has accrued $2,388 for these claims.
Escrow deposits related to these contingencies, at December 31, 2003,
amount to $435. Other contingent liabilities with remote chances of loss,
involving uncertainties as its occurrence, and therefore, not included in
the provision for contingencies, are comprised by:
o There is an antitrust proceeding pending against Gerdau S.A. which
refers to a complaint brought by two Sao Paulo's civil constructors'
unions alleging that Gerdau S.A. and the other long steel producers in
Brazil were dividing clients among themselves, therefore breaking
antitrust laws. After investigations conducted by SDE - Secretaria de
Direito Economico and based on some public hearings, the Secretary's
opinion was that a cartel existed. This conclusion was also backed by
an opinion of SEAE - Secretaria de Acompanhamento Economico that had
been previously presented. The proceeding will now be followed through
its final stage at CADE - Conselho Administrativo de Defesa Economica,
who will decide the case.
Gerdau S.A. denies being engaged in any anticompetitive conduct and
management believes, based on available information, including opinion
of its legal counselors, that the administrative process, until this
moment, had many irregularities, and some are impossible to be
corrected.
Also, SDE's opinion was issued before Gerdau S.A. had a chance to
respond to final allegations, which indicates a mistrial by SDE. The
same applies to SEAE's opinion, which does not consider the economic
aspects and is based solely on the statements of the witnesses.
These irregularities, which represent disrespect to constitutional
dispositions, will definitely affect an administrative decision based
on the conclusions presented so far by antitrust authorities. Gerdau
S.A. has been identifying and fighting all these irregularities and
will keep proceeding this way regarding the allegations against the
Company, as well as the irregular procedures in the administrative
process, believing that it will succeed in the process; if not in the
administrative scope, possibly in a Court of Law.
Therefore, the Company did not recognize any provision in this case.
According to Brazilian applicable law, the Company may be fined in
amounts up to 30% of gross sales revenue of previous fiscal years and,
if there is proof of personal responsibility of an executive, such
person might be fined in amount between 10% and 50% of the fine
applied to the Company. There is no precedent of fines higher than 4%
of gross sales revenue in the country. In a similar case involving
plain steel companies, the fines were approximately equal to 1% of
gross sales revenue.
o There is a process against Gerdau Acominas S.A., related to the
rescission of a contract of supply of slag and indemnification for
losses. The amount of the claim, at December 31, 2003, was
approximately $12,460. Gerdau Acominas S.A. contested all claims and
filed a process requesting, with the plaintiff, rescission of the
contract and indemnification for breaking the contract. The Judge
decided to rescind the contract, since the request was common to both
parties. Regarding the remaining claim of indemnification, the judge
ruled that there was reciprocal guilt and denied the request for
indemnification. This decision was sustained by the Competence Court
of Minas Gerais, and is based on proof by expert witnesses and
interpretation of the contract. The process currently remains in the
Superior Court of Justice, for trial of appeal. The expectation of
Gerdau Acominas S.A. is that remote loss, since it is difficult to be
a change in the previous decision.
o A process filed by Sul America Cia Nacional de Seguros on August 4,
2003 against Gerdau Acominas S.A. and Bank Westdeustsche Landesbank
Girozentrale, New York Branch (WestLB), having as object the
consignation of payment of the amount of $11,900, as a way for
settling the indemnification of an insurable event, which was
deposited in escrow. The insurance company alleges that it is not
certain who is to be paid and that there was resistance by the Company
to receive the amount and settle the issue. The allegations were
challenged
F-39
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
by the Bank (which claims to have no rights over the amount deposited,
a fact that clears the question raised by Sul America about who should
be paid) and by the Company (who alleges that there is no doubt about
who should be paid and that there is a justified motive to refuse
settlement, since the amount owed by Sul America is higher than the
amount deposited). After this challenge, Sul America alleged lack of
representation by the Bank, and the process is in its initial phase.
The Company's expectation, based on the opinion of its legal
counselors, is that the chance of loss is remote and that the sentence
will declare that the amount requested by the Company should be paid.
Gerdau Acominas S.A. also previously filed, in the process
aforementioned, a collection process in the amount recognized by the
insurance companies, which is still in progress. The Company expects
to succeed in this matter.
These processes are related to the accident in March 23, 2002 with the
regenerators of the blast furnace plant of the Presidente Arthur
Bernardes mill, which caused the shutdown of various activities, with
material damages to the equipments of the mill and resulted in
financial losses. The Company was insured against property and
casualty losses in relation to the equipments and against losses
related to business interruption. The report of the event, as well as
the "claim of losses", was filed with IRB - Brasil Resseguros S.A.,
and the Company received an advance of $21,460 during 2002.
In 2002, a preliminary estimate of the indemnification related to the
coverage of both property and casualty losses and losses related to
business interruption, in the total amount of approximately $38,073,
was accounted for, including the amounts advanced during 2002 of
$21,460 and an additional amount recorded as receivable for $16,613.
The amount recorded was based on the amount of the losses recognized
in our financial statements related to fixed costs incurred during the
period of partial shutdown of the activities in the mill and on the
expenditures incurred to temporarily repair the equipment. Considering
the litigation initiated in August 2003 by the insurers we have the
reduced the amount of the receivable as of December 31, 2003 to
$11,900; the amount proposed by the insures to settle the
indemnification.
Subsequently, new amounts were added to the claim, as mentioned in the
Company's challenge, but these amounts have not been accounted for.
Management believes, based on the opinion of legal counsel, that the
probability of occurrence of losses as a consequence of other
contingencies additional to those disclosed above is remote, and that
eventual losses in these contingencies would not have a material
adverse effect on the consolidated results of operations, consolidated
financial position of the Company or its future cash flows.
15.2 ENVIRONMENTAL LIABILITIES
As the Company is involved in the manufacturing of steel, it produces and
uses certain substances that may pose environmental hazards. The
principal hazardous waste generated by current and past operations is
electric arc furnace ("EAF") dust, a residual from the production of
steel in electric arc furnaces. Environmental legislation and regulation
at both the federal and state level over EAF dust in the United States
and Canada is subject to change, which may change the cost of compliance.
While EAF dust is generated in current production processes, such EAF
dust is being collected, handled and disposed of in a manner that the
Company believes meets all current federal, state and provincial
environmental regulations in the United States and Canada. The costs of
collection and disposal of EAF dust are being expensed as operating costs
when incurred. In addition, the Company has handled and disposed of EAF
dust in other manners in previous years, and is responsible for the
remediation of certain sites where such dust was generated and/or
disposed.
In general, the Company's estimate of remediation costs is based on its
review of each site and the nature of the anticipated remediation
activities to be undertaken. The Company's process for
F-40
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
estimating such remediation costs includes determining for each site the
expected remediation methods, and the estimated cost for each step of the
remediation. In such determinations, the Company may employ outside
consultants and providers of such remedial services to assist in making
such determinations. Although the ultimate costs associated with the
remediation are not known precisely, the Company estimated the total
remaining costs as at December 31, 2003 to be approximately $13.6 million
(2002 - $14.9 million), with these costs recorded as other non current
liabilities at December 31, 2003, of which the Company expects to pay
approximately $1.5 million within the year ended December 31, 2004. An
additional liability of $8.6 million was recorded in 2002 with respect to
certain environmental obligations which were triggered by the change in
control of Co-Steel in certain jurisdictions in which Co-Steel operated.
This liability was recorded at the present value of the estimated future
costs of these obligations.
Based on past use of certain technologies and remediation methods by
third parties, evaluation of those technologies and methods by the
Company's consultants and third-party estimates of costs of
remediation-related services provided to the Company of which the Company
and its consultants are aware, the Company and its consultants believe
that the Company's cost estimates are reasonable. Considering the
uncertainties inherent in determining the costs associated with the
clean-up of such contamination, including the time periods over which
such costs must be paid, the extent of contribution by parties which are
jointly and severally liable, and the nature and timing of payments to be
made under cost sharing arrangements, there can be no assurance the
ultimate costs of remediation may not differ from the estimated
remediation costs.
In April 2001, the Company was notified by the United States
Environmental Protection Agency (the "EPA") of an investigation that
identifies the Company as a potential responsible party ("PRP") in a
Superfund Site in Pelham, Georgia. The Pelham site was a fertilizer
manufacturer in operation from 1910 through 1992, lastly operated by
Stoller Chemical Company, a now bankrupt corporation. The EPA offered a
settlement to the named PRPs under which the Company's allocation was
approximately $1.8 million. The Company objects to its inclusion as a PRP
in this site and is pursuing legal alternatives, including the addition
to the allocation of larger third parties which the Company believes were
incorrectly excluded from the original settlement offer. The EPA has
filed suit with the Company named as a defendant. As the ultimate
exposure to the Company, if any, is uncertain, no liability has been
established for this site.
Carbon monoxide emissions at Gerdau Ameristeel Perth Amboy exceeded
permitted levels on several occasions during 2001 and early 2002. These
episodes were promptly reported to the New Jersey Department of
Environmental Protection (NJDEP). Gerdau AmeriSteel is conducting
investigations to determine the cause of these episodes, what steps can
be taken to reduce emissions and whether the Gerdau AmeriSteel Perth
Amboy environmental permits require modification. Discussions with the
NJDEP regarding permit and compliance issues are in a preliminary stage.
Penalty assessments of $217 thousand have been accrued.
The Company is not aware of any environmental remediation cost or
liability in relation to its operations outside United States and Canada.
OTHER CLAIMS
In the normal course of its business, various lawsuits and claims are
brought against the Company. The Company vigorously contests any claim
which it believes is without merit. Management believes that any
settlements will not have a material effect on the financial position or
the consolidated earnings of the Company.
OTHER COMMITMENTS
The Company has long-term contracts with several raw material suppliers.
The Company typically realizes lower
F-41
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
costs and improved service from these contracts. The Company believes
these raw materials would be readily available in the market without such
contracts.
F-42
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
15.3 OPERATING LEASES
The Company leases certain equipment and real property in North America
under non-cancelable operating leases. Aggregate future minimum payments
under these leases are as follows:
YEAR ENDING DECEMBER 31, AMOUNT
-------------------
2004 9,248
2005 8,481
2006 5,433
2007 4,643
2008 5,121
Thereafter 33,523
-------------------
66,449
===================
Certain of the operating lease commitments of the former Co-Steel
entities were at lease rates in excess of fair value as of the
acquisition date. Accordingly, a purchase accounting liability was
recorded by the Company for the present value of the unfavorable lease
commitments.
15.4 VENDOR FINANCING
Gerdau Acominas S.A. provides guarantees to Banco Gerdau S.A. that
finance sales to selected customers. These sales are recognized at the
time the products are delivered. Under the vendor program, the Company is
the secondary obligor to the bank. At December 31, 2003 customer
guarantees provided by the company totaled $ 13,891. Since Banco Gerdau
S.A. and Gerdau Acominas S.A. are under the common control of MG this
guarantee is not covered by the requirements of FASB Interpretation No 45
("FIN 45").
16 SHAREHOLDERS' EQUITY
16.1 SHARE CAPITAL
As of December 31, 2003, 51,468,224 shares of Common stock and 96,885,787
shares of Preferred stock are issued. The share capital of Gerdau is
comprised of Common shares and Preferred shares, all without par value.
The authorized capital of Gerdau is comprised of 240,000,000 Common
shares and 480,000,000 Preferred shares. Only the Common shares are
entitled to vote. Under the Company's By-laws, specific rights are
assured to the non-voting Preferred shares. There are no redemption
provisions associated with the Preferred shares. The Preferred shares
have preferences in respect of the proceeds on liquidation of the
Company.
As of December 31, 2002 there were outstanding 39,590,941,783 shares of
Common stock and 74,527,528,780 shares of Preferred stock. At a meeting
of shareholders held on April 30, 2003, shareholders approved a bonus to
both common and preferred shareholders of 3 shares per 10 shares held.
The bonus resulted in the issuance of 34,235,541,169 new shares
(11,877,282,535 Common shares and 22,358,258,634 Preferred shares). At
the same shareholders meeting, a reverse stock split of 1 share for each
1,000 shares held (after taking into consideration the above mentioned
bonus) was approved.
At a meeting held on November 17, 2003, the Board of Directors authorized
the acquisition of shares of the Gerdau in accordance with corporate and
statutory laws. The shares held in treasury will be sold in the capital
market or cancelled. At December 31, 2003, the Company held in treasury
345,000 preferred shares at its cost of $5,920.
F-43
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
The following sets forth the changes in the number of the Gerdau's shares
from January 1, 2001 through December 31, 2003 before the stock bonus
approved on April 29, 2004 as indicated in Note 26(b):
COMMON PREFERRED TREASURY
SHARES SHARES STOCK - PREFERRED
------------------- ------------------ ------------------
Balances as of January 1, 2001 and December 31, 2001 39,382,020,386 74,109,685,986 -
Acquisition of treasury stock - - 318,017,301
Sale of treasury stock - - (318,017,301)
Shares issued on conversion of debentures 208,921,397 417,842,794 -
------------------- ------------------ ------------------
Balances as of December 31, 2002 39,590,941,783 74,527,528,780 -
Shares issued in regards to share bonus 11,877,282,535 22,358,258,634 -
Effect of reverse 1,000 for 1 stock split (51,416,756,094) (96,788,901,627) -
Acquisition of treasury stock - - 345,000
------------------- ------------------ ------------------
Balances as of December 31, 2003 51,468,224 96,885,787 345,000
=================== ================== ==================
16.2 LEGAL RESERVE
Under Brazilian law, Gerdau is required to transfer up to 5% of annual
net income, determined in accordance with Brazilian Corporate Law and
based on the statutory financial statements prepared under Brazilian
GAAP, to a legal reserve until such reserve equals 20% of paid-in
capital. The legal reserve may be utilized to increase capital or to
absorb losses, but cannot be used for dividend purposes.
16.3 STATUTORY RESERVE
The Board of Directors may propose to the shareholders to transfer at
least 5% of net income for each year to a statutory reserve (Reserva de
Investimentos e Capital de Giro - Reserve for investments and working
capital). The reserve will be created only if it does not affect minimum
dividend requirements and its balance may not exceed the amount of paid
in-capital. The reserve may be used for absorbing losses, if necessary,
for capitalization, for payment of dividends or to repurchase shares.
On April 30, 2003 and amount of R$ 400,536 thousand (equivalent to US$
138,642 at the exchange rate of April 30, 2003) recorded as of December
31, 2002 as part of the statutory reserve was capitalized by resolution
adopted in the shareholders meeting held that day.
16.4 DIVIDENDS
Brazilian law permits the payment of cash dividends from retained
earnings calculated in accordance with the provisions of the Brazilian
Corporate Law and as presented in the statutory accounting records. As of
December 31, 2003, retained earnings corresponds to the balance of the
statutory reserve described in Note 16.3 above which amounts in the
statutory records of the Gerdau to $ 633,961 (translated at the year-end
exchange rate).
Aggregate dividends (which consisted exclusively of interest on equity)
declared by Gerdau are as follows:
2003 2002 2001
--------------- ---------------- -------------
Common shares 40,917 26,948 23,046
Preferred shares 76,900 50,730 47,851
--------------- ---------------- -------------
Total 117,817 77,678 70,897
=============== ================ =============
F-44
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
17 ACCOUNTING FOR INCOME TAXES
17.1 ANALYSIS OF INCOME TAX EXPENSE
Income tax payable is calculated separately for Gerdau and each of its
subsidiaries as required by the tax laws of the countries in which Gerdau
and its subsidiaries operate.
2003 2002 2001
----------- ----------- -----------
CURRENT TAX (BENEFIT) EXPENSE:
Brazil 95,815 37,245 34,883
United States (11,096) (8,255) (2,236)
Canada 713 (2,890) 5,414
Other countries 2,380 965 2,920
----------- ----------- -----------
87,812 27,065 40,981
----------- ----------- -----------
DEFERRED TAX (BENEFIT) EXPENSE:
Brazil (99,569) (32,971) 12,699
United States (11,488) 9,598 -
Canada (14,155) 830 1,168
Other Countries 3,287 2,036 (201)
----------- ----------- -----------
(121,925) (20,507) 13,666
----------- -----------
INCOME TAX (BENEFIT) EXPENSE (34,113) 6,558 54,647
=========== =========== ===========
17.2 INCOME TAX RECONCILIATION
A reconciliation of the income taxes in the statement of income to the
income taxes calculated at the Brazilian statutory rates follows:
2003 2002 2001
----------- ----------- -----------
Income before taxes and minority interest 525,674 228,718 219,205
Brazilian composite statutory income tax rate 34.00% 34.00% 34.00%
----------- ----------- -----------
Income tax at Brazilian income tax rate 178,729 77,764 74,530
Reconciling items:
Foreign income having different statutory rates (25,845) (5,448) (1,655)
Non-deductible expenses net of non-taxable income (6,593) (17,560) (1,277)
Reversal of valuation allowance (137,333) (12,939) -
Benefit of deductible interest on equity paid to shareholders (40,058) (31,001) (24,105)
- Other, net (3,013) (4,258) 7,154
----------- ----------- -----------
Income tax (benefit) / expense (34,113) 6,558 54,647
=========== =========== ===========
17.3 TAX RATES
Tax rates in the principal geographical areas in which the Company
operates were as follows:
2003 2002 2001
------------- ----------- ------------
BRAZIL
Federal income tax 25.00% 25.00% 25.00%
Social contribution 9.00% 9.00% 9.00%
------------- ----------- ------------
Composite federal income tax rate 34.00% 34.00% 34.00%
============= =========== ============
UNITED STATES
Composite federal and state income tax (approximate) 40.00% 40.00% 40.00%
F-45
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
CANADA
Federal income tax 22,12% 21.84% 21.84%
Provincial rate (approximate) 13.50% 15.16% 15.16%
------------- ----------- ------------
Composite income tax rate 35.62% 37.00% 37.00%
============= =========== ============
CHILE
Federal income tax 16.50% 16.00% 15.00%
17.4 ANALYSIS OF TAX BALANCES
The composition of the deferred tax assets and deferred tax liabilities
are presented below. Current assets and liabilities and non current
assets and liabilities in the table below are presented net of each tax
paying entity.
2003 2002
------------- --------------
DEFERRED TAX ASSETS
Property plant and equipment 41,788 9,687
Net operating loss carryforwards 225,369 193,276
Accrued pension costs 16,711 23,722
Other 117,735 25,094
Valuation allowance on deferred tax assets (120,846) (205,139)
------------- --------------
Gross deferred income tax assets 280,757 46,640
------------- --------------
DEFERRED TAX LIABILITIES
Net operating loss carryforwards (43,142) (24,181)
Accounting provisions not currently deductible (18,405) (25,011)
Accrued pension costs (15,981)
Property plant and equipment 155,638 95,299
Other 1,301 3,889
------------- --------------
Gross deferred income tax liabilities 79,411 49,996
------------- --------------
2003 2002
------------- --------------
DEFERRED TAX BALANCES
Deferred tax assets - current 49,451 34,585
Deferred tax assets - non-current 231,306 12,055
------------- --------------
280,757 46,640
============= ==============
Deferred tax liabilities - current 7,286 7,628
Deferred tax liabilities - non-current 72,125 42,368
------------- --------------
79,411 49,996
============= ==============
During 2003, $137,333 of the valuation allowance that was recognized in
2002 on the deferred tax assets of Gerdau Acominas was reversed directly
to income. The valuation allowance was reversed as a result of additional
positive evidence during 2003 regarding the realization of the deferred
tax assets, specifically (a) the expected generation of taxable income by
Acominas and (b) the restructuring of the Brazilian operations described
in note 4.1 which will
F-46
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
allow the tax loss carryforwards of Gerdau Acominas to be utilized by all
the steel operations of Gerdau in Brazil, which historically have
presented taxable income. Brazilian tax law allows tax losses to be
carried forward indefinitely, but the utilization of tax losses in a
given year is limited to 30% of taxable income.
The net deferred tax asset includes a non-capital loss carry forward of
approximately $73.9 million for Canadian income tax purposes that expire
on various dates from 2007 through 2010.
As of December 31, 2003, Gerdau Ameristeel had a combined net operating
loss ("NOL) carryforward of approximately $119.0 million for U.S. federal
income tax purposes that expire on various dates between 2005 and 2023.
The portion of this NOL that was generated by the former Co-Steel US
group prior to its acquisition by Gerdau Ameristeel is subject to an
annual limitation as outlined in Internal Revenue Code (IRC) Section 382.
The NOL carryforward from the predecessor company has been reduced to
reflect the Section 382 limitation. In addition, the portion of this NOL
that was generated by the former Co-Steel US group prior to its merger
with GUSA and subsidiaries is subject to the Separate Return Limitation
Year provisions contained in IRC Section 1502.
The Company believes that its deferred tax asset as of December 31, 2003
net of valuation allowance of $120,846 is more likely that not to be
realized based on combinations of future taxable income from operations
plus, in case of the operations in North America, tax-planning strategies
that can be implemented, should it become necessary to realize such
benefits.
18 EARNINGS PER SHARE (EPS)
Pursuant to SFAS No. 128, the following tables reconcile net income to
the amounts used to calculate basic and diluted EPS. All computations of
EPS presented below have been retroactively adjusted to reflect: (a) a
stock bonus of 3 shares per each 10 shares hold approved by the
Shareholders Meeting on April 30, 2003, (b) a 1-to-1.000 reverse stock
split approved by the Shareholders Meeting on April 30, 2003, and (c) a
stock bonus of 1 share per each share hold approved by the Shareholders
Meeting on April 29, 2004.
YEAR ENDED DECEMBER 31, 2003
Common Preferred Total
----------------- --------------- ---------------
(In thousands, except per share data)
BASIC NUMERATOR
Dividends declared 40,917 76,900 117,817
Allocated undistributed earnings (i) 136,130 256,217 392,347
----------------- --------------- ---------------
Net income available to Common and Preferred shareholders 177,047 333,117 510,164
================= =============== ===============
BASIC DENOMINATOR
Weighted-average outstanding shares after giving retroactive effect to
the stock bonuses and reverse stock split described above and deducting
the average treasury shares (Note 16.1 and Note 26(b)) 102,936,448 193,742,824
================= ===============
Earnings per share (in US$) - Basic 1.72 1.72
================= ===============
DILUTED NUMERATOR
ALLOCATED NET INCOME AVAILABLE TO COMMON AND PREFERRED SHAREHOLDERS
F-47
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
Net income allocated to preferred shareholders 333,117
Add:
Adjustment to net income allocated to preferred shareholders in respect
to the potential increase in number of preferred shares outstanding as
a result of options granted to acquire stock of Gerdau
(Note 24.1) 221
-----------------
333,338
=================
Net income allocated to common shareholders 177,047 Less:
Adjustment to net income allocated to common shareholders in respect to the potential increase in
number of preferred shares outstanding as a result of options granted to acquire stock of Gerdau
(Note 24.1) (221)
-----------------
176,826
=================
DILUTED DENOMINATOR WEIGHTED-AVERAGE NUMBER OF SHARES OUTSTANDING
Common Shares 102,936,448
Preferred Shares
Weighted-average number of preferred shares outstanding 193,742,824
Potential increase in number of preferred shares outstanding in respect of stock option plan,
average (Note 24.1) 304,798
-----------------
Total 194,047,622
=================
Earnings per share - Diluted (Common and Preferred Shares) 1.72
=================
YEAR ENDED DECEMBER 31, 2002
Common Preferred Total
------------------ ---------------- --------------
(In thousands, except per share data)
BASIC AND DILUTED NUMERATOR
Dividends declared 26,948 50,730 77,678
Allocated undistributed earnings (i) 53,477 100,672 154,149
------------------ ---------------- --------------
Allocated net income available to Common and Preferred
shareholders 80,425 151,402 231,827
================== ================ ==============
BASIC AND DILUTED DENOMINATOR
Weighted-average outstanding shares after giving retroactive effect to
the stock bonuses and reverse stock split described above and deducting
the average treasury shares
(Note 16.1 and Note 26(b)) 102,686,166 193,307,254
================== ================
Earnings per share (in US$) - Basic and diluted 0.78 0.78
================== ================
F-48
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2001
Common Preferred Total
--------------- --------------- ---------------
(In thousands, except per share data)
BASIC NUMERATOR
Dividends declared 23,046 47,851 70,897
Basic allocated undistributed earnings (i) 31,416 65,040 96,456
--------------- --------------- ---------------
Allocated net income available to Common and Preferred
shareholders 54,462 112,891 167,353
=============== =============== ===============
BASIC DENOMINATOR
Weighted-average outstanding shares after giving retroactive effect to
the stock bonuses and reverse stock split described above and deducting
the average treasury shares
(Note 16.1 and Note 26(b)) 102,393,254 192,685,184
=============== ===============
Basic earnings per share (in US$) 0.53 0.59
=============== ===============
Common Preferred Total
--------------- --------------- ---------------
(In thousands, except per share data)
DILUTED NUMERATOR
Allocated net income available to Common and Preferred 54,462 112,891 167,353
shareholders
Convertible securities:
Interest expense on convertible debt, net of tax (ii) 160 300 460
--------------- --------------- ---------------
Allocated diluted net income available to Common and
Preferred shareholders 54,622 113,191 167,813
=============== =============== ===============
Common Preferred
--------------- ---------------
(In thousands, except per share data)
DILUTED DENOMINATOR
Weighted-average basic outstanding shares after giving retroactive effect
to the stock bonuses and reverse stock split described above and
deducting the average treasury
shares (Note 16.1 and Note 26(b)) 102,393,254 192,685,184
Convertible securities:
Convertible debentures (ii) 528,000 1,056,000
--------------- ---------------
Weighted-average diluted outstanding shares after giving retroactive
effect to the stock bonuses and reverse stock split described above and
deducting the average treasury
shares (Note 16.1 and Note 26(b)) 102,921,254 193,741,184
=============== ===============
Diluted earnings per share 0.53 0.59
=============== ===============
(i) Through December 31, 2001 the Company calculated earnings per share
on Common and Preferred shares under the "two class method" considering
preferred shareholders were entitled to receive per-share dividends 10%
greater
F-49
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
than the per-share dividends paid to Common shareholders. Undistributed
earnings, therefore, were allocated to Common and Preferred shareholders
on a 100 to 110 basis respectively, based upon the number of shares
outstanding at the end of the period and considering items assumed to be
common stock equivalents for purposes of EPS computation. Effective as
from January 1, 2002 the Preferred shareholders no longer have the right
to the 10% differential and both Preferred and Common shareholders
receive dividends on the same basis.
(ii) For purposes of computing diluted EPS, convertible securities are
assumed to be converted into Common and Preferred shares at the beginning
of the period or from the point at which such securities were
outstanding. In accordance with Brazilian Corporate Law, on conversion of
convertible debt, a maximum of 66.67% of the debt can be applied towards
the acquisition of Preferred stock. In calculating diluted EPS,
therefore, the Company has assumed a conversion ratio for convertible
securities of 66.67: 33.33 Preferred to Common stock. During the year
ended December 31, 2002, all outstanding convertible securities had been
converted into common and preferred stock; no diluted EPS is presented
for the year ended December 31, 2002.
19 FAIR VALUE OF FINANCIAL INSTRUMENTS
Pursuant to SFAS No. 107, "Disclosures About Fair Value of Financial
Instruments", the Company is required to disclose the fair value of
financial instruments, including off-balance sheet financial instruments,
when fair values can be reasonably estimated. The Company's estimate of
the fair value of the financial instruments, which include receivables,
accounts payable, long-term debt and the liability component of the
convertible debentures, approximates the carrying value mainly due to
their short maturity.
20 DERIVATIVE INSTRUMENTS
The use of derivatives by the Company is limited. Derivative instruments
are used to manage clearly identifiable foreign exchange and interest
rate risks arising out of the normal course of business.
GERDAU AND GERDAU ACOMINAS
As part of its normal business operations Gerdau and Gerdau Acominas
obtained U.S. dollar denominated debt generally at fixed rates and
exposed to market risk from changes in foreign exchange and interest
rates. Changes in the rate of the Brazilian real against the U.S. dollar
expose Gerdau and Acominas to foreign exchange gains and losses which are
recognized in the statement of income and also change the amount of
Brazilian reais necessary to pay such U.S. dollar denominated debt.
Changes in interest rates on its fixed rate debt expose Gerdau and
Acominas to changes in the fair value of its debt. In order to manage
such risks Gerdau and Acominas enter into derivative instruments,
primarily cross-currency interest rate swap contracts. Under the swap
contracts Gerdau and Acominas have the right to receive on maturity
United States dollars plus accrued interest at a fixed rate and have the
obligation to pay Brazilian reais at a variable rate based on the CDI
rate.
Although such instruments mitigate the foreign exchange and interest rate
risks, they do not necessarily eliminate them. The Company generally does
not hold derivative instruments for trading purposes.
All swaps have been recorded at fair value and realized and unrealized
losses are presented in financial expenses in the consolidated statement
of income.
The notional amount of such cross-currency interest rate swaps amounts to
$ 459,684 ($ 785,267as of December 31, 2002) and mature between January
2004 and March 2006 (January 2003 and March 2006 as of December 31, 2002)
with Brazilian reais interest payable which varies between 71.60% and
105.00% of CDI (between 20.30% and 103.70% of CDI of December 31, 2002).
Unrealized gains on swaps outstanding as of December 31, 2003 amount to
F-50
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
$9,685 ($51,858 as of December 31, 2002) and unrealized losses amount to
$40,938 ($2,003 as of December 31, 2002).
GERDAU AMERISTEEL CORPORATION
Derivative instruments are not used for speculative purposes but they are
used to manage well-defined interest rate risks arising out of the normal
course of business. In order to reduce its exposure to changes in the
fair value of its Senior Notes, the company entered into interest rate
swaps subsequent to the June 2003 refinancing. The agreements have a
notional value of $200 million and expiration dates of July 15, 2011. The
Company receives a fixed interest rate and pays a variable interest rate
based on LIBOR. The aggregate mark-to-market (fair value) of the interest
rate agreements, which represents the amount that would be received if
the agreements were terminated at December 31, 2003, was approximately
$89 thousand.
21 CONCENTRATION OF CREDIT RISKS
In July 2002, the company Company's principal business is the production
and sale of long ordinary steel products, including crude steel; long
rolled products, such as merchant bars and concrete reinforcing bars used
in the construction industry; drawn products, such as wires and meshes;
and long specialty steel products, such as tool steel and stainless
steel. Approximately 98 % of the Company's sales during 2003 were made to
civil construction and manufacturing customers.
Approximately 40 % of the Company's consolidated sales are to domestic
Brazilian companies, 39 % to customers in the United States and Canada
and the remainder split between export sales from Brazil and sales by its
subsidiaries located in Chile and Uruguay.
No single customer of the Company accounted for more than 10% of net
sales, and no single supplier accounted for more than 10% of purchases in
any of the years presented. Historically, the Company has not experienced
significant losses on trade receivables.
22 SEGMENT INFORMATION
In July 2002, the Company announced a modification to its management and
corporate governance structure. The modification included the creation of
the Gerdau Executive Committee, which has been assigned responsibility
for managing of the business. The Gerdau Executive Committee is comprised
of the most senior officers of the Company including the President of the
Gerdau Executive Committee, which is also the Chairman of the Board of
Directors.
As the result of this modification, the Company has modified during 2002
its reportable segments under SFAS No. 131 "Disclosures About Segments of
an Enterprise and Related Information" and has defined that its
reportable segments correspond to the business units through which the
Gerdau Executive Committee manages its operations. There is
responsibility allocated to one specific member of the Executive
Committee for each of the five business operations: long steel products
in Brazil, specialty steel products in Brazil, Acominas (corresponding to
the operations of the former Acominas carried out through the mill
located in Ouro Branco, Minas Gerais), South America (which excludes the
operations in Brazil) and North America. Information for long steel
products in Brazil and specialty steel products in Brazil is presented
below under Gerdau Brazil since the operations of specialty steel
products in Brazil do not meet any of the quantitative thresholds
established by SFAS No. 131 for presenting separate information about
such segment. Segment information for the year ended December 31, 2001
has been restated to conform to the current presentation.
F-51
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
There are no significant inter-segment sales transactions and operating
income consists of net sales less cost of sales, operating costs and
expenses and financial income and expenses. The identifiable assets are
trade accounts receivable, inventories and property, plant and equipment.
2003
----------------------------------------------------------------------------------------------------
ADJUSTMENTS TOTAL AS PER
GERDAU SOUTH NORTH AND FINANCIAL
BRAZIL ACOMINAS AMERICA AMERICA TOTAL RECONCILIATIONS STATEMENTS
----------------------------------------------------------------------------------------------------
Net sales 1,459,805 785,317 169,640 1,927,839 4,342,601 188,368 4,530,969
Operating Income 183,336 204,168 38,986 (53,813) 372,677 324,486 697,163
Financial expenses (126,559) (23,591) (2,128) (62,946) (215,224) (201,729) (416,953)
Incometax (12,531) 30,164 (7,979) 36,128 45,782 (11,669) 34,113
Capital expenditures 103,243 115,643 7,702 57,041 283,629 14,126 297,755
Depreciation and amortization (64,814) (42,228) (8,779) (80,692) (196,513) 14,110 (182,403)
Identifiable assets 1,143,326 1,070,552 197,881 1,479,110 3,890,869 (322,893) 3,567,976
2002
----------------------------------------------------------------------------------------------------
ADJUSTMENTS TOTAL AS PER
GERDAU SOUTH NORTH AND FINANCIAL
BRAZIL ACOMINAS AMERICA AMERICA TOTAL RECONCILIATIONS STATEMENTS
----------------------------------------------------------------------------------------------------
Netsales 1,571,136 459,930 113,341 994,348 3,138,755 126,171 3,264,926
Operating income 276,277 10,482 13,989 28,649 329,397 251,353 580,750
Financial expenses (279,762) (138,790) (20,993) (26,507) (466,052) 173,589 (292,463)
Income tax (37,949) 11,407 (3,016) 2,188 (27,370) 20,812 (6,558)
Capital expenditures 91,072 64,351 5,621 32,806 193,850 (7,958) 185,892
Depreciation and mortization (78,502) (34,486) (6,722) (55,620) (175,330) (3,475) (178,805)
Identifiable assets 790,129 962,141 169,248 1,246,435 3,167,953 (88,451) 3,079,502
F-52
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
2001
----------------------------------------------------------------------------------------------------
ADJUSTMENTS TOTAL AS PER
GERDAU SOUTH NORTH AND FINANCIAL
BRAZIL ACOMINAS AMERICA AMERICA TOTAL RECONCILIATIONS STATEMENTS
----------------------------------------------------------------------------------------------------
Netsales 1,361,935 220,430 116,863 806,049 2,505,277 (104,139) 2,401,138
Operating income 195,718 28,599 (4,789) 24,430 243,958 148,043 392,001
Financial expenses (179,670) 5,763 (26,074) (69,365) (269,346) 102,850 (166,496)
Income tax (42,222) 34,138 (1,952) 4,001 (6,035) (48,612) (54,647)
Capital expenditures 56,324 38,779 14,824 79,091 189,018 55,003 244,021
Depreciation and mortization (76,620) (21,337) (6,998) (61,416) (166,371) 30,493 (135,878)
Identifiable assets 1,003,200 1,402,754 201,472 826,469 3,433,895 (1,316,957) 2,116,938
The segment information above has been prepared under Brazilian GAAP.
Corporate activities performed for the benefit of the Group as a whole
are not separately presented and are included as part of the information
of Gerdau Brazil. The information presented above has been translated
from Brazilian reais (the currency on which financial information is
presented to the Gerdau Executive Committee) into United States dollars.
Net sales, operating income, financial expenses, income tax, capital
expenditures and depreciation and amortization have been translated using
average exchange rates for the year while identifiable assets have been
translated at year-end exchange rates.
The Adjustments and Reconciliations column include the differences
derived from the fact that Acominas (included as part of Gerdau Brazil)
is consolidated for the full year 2002 and 2001 for the segment
information purpose while it is consolidated only as from the date of
acquisition of control in the consolidated financial statements. In
addition, the Adjustments and Reconciliations column include the
following effects:
o Net sales are presented net of freight costs while freight costs
are presented as part of Cost of sales in the consolidated
financial statements
o Operating income in the segment information includes financial
expenses, exchange gains and losses and financial income while in
the consolidated financial statements such items are not
considered in determining operating income
o Identifiable assets in the segment information include property,
plant and equipment which are presented on the basis of historical
costs of acquisition while in the consolidated financial
statements they include the effects of property, plant and
equipment acquired in business combinations at fair value
o Financial expense in the segment information include: (a) exchange
variation on foreign currency denominated debt, which is presented
as a separate line in the consolidated financial statements, and
(b) interest on certain intercompany debt which is eliminated in
the consolidated financial statements.
F-53
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
Geographic information about the Company presented on the same basis as
the segment information above is as follows:
2003
---------------------------------------------------------------------------------------------
Adjustments Total as per
South America North And Financial
Brazil (except Brazil) America Total Reconciliations statements
---------------------------------------------------------------------------------------------
Net sales 2,245,122 169,640 1,927,839 4,342,601 188,368 4,530,969
Operating income 387,504 38,986 (53,813) 372,677 324,486 697,163
Long lived assets 1,486,246 146,486 869,320 2,502,053 (197,895) 2,304,158
Identifiable assets 2,213,878 197,881 1,479,110 3,890,869 (322,893) 3,567,976
2002
---------------------------------------------------------------------------------------------
Adjustments Total as per
South America North And Financial
Brazil (except Brazil) America Total Reconciliations statements
---------------------------------------------------------------------------------------------
Net sales 2,031,066 113,341 994,348 3,138,755 126,171 3,264,926
Operating income 286,759 13,989 28,649 329,397 251,353 580,750
Long lived assets 1,266,889 123,274 760,042 2,150,205 (65,310) 2,084,895
Identifiable assets 1,752,270 169,248 1,246,435 3,167,953 (88,451) 3,079,502
2001
---------------------------------------------------------------------------------------------
Adjustments Total as per
South America North And Financial
Brazil (except Brazil) America Total Reconciliations statements
---------------------------------------------------------------------------------------------
Net sales 1,582,365 116,863 806,049 2,505,277 (104,139) 2,401,138
Operating income 224,317 (4,789) 24,430 243,958 148,043 392,001
Long lived assets 1,827,422 150,181 525,357 2,502,960 (1,118,497) 1,384,463
Identifiable assets 2,405,954 201,472 826,469 3,433,895 (1,316,957) 2,116,938
F-54
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
23 VALUATION AND QUALIFYING ACCOUNTS
Year ended December 31, 2003:
Balance at Charges to Effect of
Beginning cost and exchange Balance at
Description of year Payments Expense Reversals Rate end of year
------------------------------------------------- ------------ -------- ---------- ---------- ---------- ------------
Provisions offset against assets balances:
Allowance for doubtful accounts 15,139 - 6,714 - 5,623 27,476
Valuation allowance on deferred income tax assets 205,139 - - (137,333) 53,040 120,846
Reserves:
Provision for contingencies 45,304 (3,622) 44,361 (1,255) 17,272 102,060
Year ended December 31, 2002:
Effect of
Balance at Charges to exchange
Beginning cost and rate Business Balances at
Description of year Payments Expense Reversals changes combination end of year
------------------------------------------- ---- ----- -------- ---------- --------- --------- ----------- ------------
Provisions offset against assets balances:
Allowance for doubtful accounts 23,045 - 1,310 - (9,216) - 15,139
Valuation allowance on deferred income - - - (12,939) (85,292) 303,370 205,139
tax assets
Reserves:
Provision for contingencies 55,170 (2,243) 14,179 - (21,802) 45,304
Year ended December 31, 2001:
Balance at Charges to
Beginning cost and Deductions Balance at
Description of year Expense (a) end of year
-------------------------------------------- ---------- ----------- ---------- -----------
Provisions offset against assets balances:
Allowance for doubtful accounts 19,345 6,743 (3,043) 23,045
Reserves:
Provision for contingencies 70,395 (4,099) (11,126) 55,170
(a) Includes the effect of exchange rates on balances in currencies other
than the United States dollar.
24 STOCK BASED COMPENSATION PLANS OF SUBSIDIARIES
24.1 BRAZIL PLAN
The Extraordinary Stockholders' General Meeting of Gerdau held on April
30, 2003 decided, based on a plan approved by an Annual Stockholders'
meeting and up to the limit of authorized capital, to grant options to
purchase shares to management, employees or natural person who render
services to the Company or to entities under its control, and approved
the creation of the "Long Term Incentive Program". The Extraordinary
Stockholders' General Meeting also authorized the grant proposed by
Company's Management of 1,367,872 shares with an exercise price of R$
11.94 per share ($4.14 at the year-end exchange rate), after giving
retroactive effect to stock bonus (Note 26(b)), with 561,570 of these
shares under the regular program, with 5 years vesting term and,
exceptionally in this first year, 806,302 stock options with 3 years
vesting. The options must be exercised up to 5 years after vested.
The status of the plan as of December 31, 2003 is the following:
F-55
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
Total shares granted during the year and outstanding as of December 31, 2003 1,367,872
Exercise price per option (in U.S. dollar) 4.14
Average fair value of the options using Black Scholes method of valuation 1.29
Weighted Average Remaining Contractual Life 3.5 years
The assumptions used for estimating the fair value of the options on the
grant date following the Black & Scholes method, included in the
pro-forma disclosures in Note 3.13 were as follows:
Expected dividend yield: 7%
Expected stock price volatility: 43%
Risk-free rate of return: 8%
Expected period until exercise 3.5 years
24.2 GERDAU AMERISTEEL PLANS
Gerdau AmeriSteel has several stock based compensation plans, which are
described below. One plan was formerly administered by Co-Steel and the
remainder of the plans were formerly administered by the AmeriSteel
subsidiary.
(a) FORMER CO-STEEL PLAN
Under the former Co-Steel plan, the Stock-Based Option Plan, Co-Steel was
permitted to grant options to employees and directors to acquire up to a
maximum of 3,041,335 common shares. The exercise price was based on the
closing price of common shares on the trading date previous to the date
the options are issued. The options have a maximum term of 10 years, have
a vesting term of various periods as determined by the Plan administrator
at the time of grant, and are exercisable in installments. The options
expire on various dates up to April 13, 2008.
(b) AMERISTEEL PLANS
Under the terms of the Transaction Agreement relating to the acquisition
of Co-Steel, minority shareholders of AmeriSteel exchanged shares of
AmeriSteel stock and options for stock and options of Gerdau AmeriSteel
at an exchange rate of 9.4617 Gerdau AmeriSteel shares and options for
each AmeriSteel share or option. This exchange took place on March 31,
2003 (Note 4.4). All amounts presented in the discussion below have been
restated to reflect the historical shares at the exchanged value.
(b.1) STAKEHOLDER PLAN
The subsidiaries of Gerdau operating in North America before the
acquisition of Co-Steel administered a long-term incentive plan available
to executive management (the "Stakeholder Plan") to ensure the Company's
senior management's interest is congruent with it's shareholders. Awards
are determined by a formula based on return on capital employed in a
given plan year. Earned awards vest and are paid out over a period of
four years. Participants may elect cash payout or investments in phantom
stock of the Group or Gerdau S.A., for which a 25% premium is earned if
elected. Benefits charged to expense under this plan for the years ended
December 31, 2003 and 2002, were $150 thousand and $90 thousand,
respectively. It is not anticipated that further awards will be granted
under the plans.
F-56
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
(b.2) SAR PLAN
In July 1999, AmeriSteel's Board of Directors approved a Stock
Purchase/SAR Plan (the "SAR Plan") available to essentially all
employees. The SAR Plan authorizes 946,170 shares of common stock to be
sold to employees during three offering periods, July through September
in each of 1999, 2002 and 2005. Employees who purchase stock are awarded
stock appreciation rights ("SARs") equal to four times the number of
shares purchased SARs were granted at fair value at the date of the
grant, determined based on an independent appraisal as of the previous
year-end. The SARs become exercisable at the rate of 25% annually from
the grant date and may be exercised for 10 years from the grant date. It
is not anticipated that additional shares, options or SARs will be issued
under the current plan.
In July 2002, AmeriSteel's Board of Directors approved the issuance of
additional SARs that were granted to officers with exercise prices
granted at fair value at the date of grant. 6,244,722 SARs were
authorized and issued. The SARs become one-third vested two years from
the grant date, and one third in each of the subsequent two years from
the grant date. SARs may be exercised for 10 years from the grant date.
The SARs are recorded as a liability and benefits charged to expense
under this plan for the years ended December 31, 2003 and 2002 were $9.4
million and $0, respectively.
(b.3) EQUITY OWNERSHIP PLAN
In September 1996, AmeriSteel's Board of Directors approved the
AmeriSteel Corporation Equity Ownership Plan (the "Equity Ownership
Plan"), which provides for grants of common stock, options to purchase
common stock and SARs. The maximum number of shares that can be issued
under the plan is 4,152,286. The Company has granted 492,955 shares of
common stock and 4,667,930 incentive stock options under the Equity
Ownership Plan through December 31, 2003. All issued options and shares
of issued common stock become one-third vested two years from the grant
date, and one third in each of the subsequent two years from the grant
date. All grants were at the fair market value of the common stock on the
grant date, determined based on an independent appraisal as of the end of
the previous year-end. Options may be exercised for 10 years from the
grant date. It is not anticipated that additional shares, options, or
SARs will be issued under the current plan.
(b.4) PURCHASE PLAN
In May 1995, AmeriSteel's Board of Directors approved a Stock
Purchase/Option Plan (the "Purchase Plan") available to essentially all
employees. Employees who purchased stock were awarded stock options equal
to six times the number of shares purchased. A total of 356,602 shares
were sold under the Purchase Plan at a purchase price of $1.12 per share.
The options were granted with the exercise price equal to fair value at
the date of the grant, determined based on an independent appraisal as of
the end of the previous year-end. A total of 2,139,612 options were
granted under the Purchase Plan. No options remain available for future
grant. All options outstanding are currently vested. Options may be
exercised for 10 years from the grant date.
F-57
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
A summary of the Gerdau Ameristeel stock option plans is as follows:
Year Ended December 31, 2003 Year Ended December 31, 2002
-------------------------------- --------------------------------
Number of Weighted Average Number of Weighted Average
Shares Exercise Price Shares Exercise Price
-------------- ---------------- ------------- ----------------
Ameristeel Plans
Outstanding beginning of period 281,197 $20.37 307,664 $19.18
Exchange for options of Gerdau Ameristeel (281,197) 20.37
Granted - - 58,650 17.00
Exercised - - (17,233) 12.75
Forefeited - - (67,884) 14.02
-------------- ---------------- ------------- ----------------
Outstanding, end of period - - (281,197) $20.37
============== ================ ============= ================
Gerdau Ameristeel Plan
Outstanding, beginning of period 1,367,400 $9.30 -
Merger with Co-Steel - - 1,367,400 9.30
Options of Ameristeel Plans exchanged for Gerdau 2,660,601 2.15 - -
Ameristeel options
Granted - - - -
Exercised - - - -
Expired (421,431) 19.72 - -
-------------- ---------------- ------------- ----------------
Outstanding, end of period 3,606,570 $3.53 1,367,400 $9.30
============== ================ ============= ================
The following table summarizes information about options outstanding at December
31, 2003:
Weighted
Weighted Average Average
Number Contractual Exercise Number Exercisable
Exercise Price Range - US$ Outstanding Contractual Life Price At December 31, 2003
---------------------------------- ----------- --------------- --------- --------------------
$1.32 to $1.43 914,262 5.3 years 1.38 552,431
$1.80 to $1.90 966,740 6.8 years 1.85 446,829
$2.11 to $2.96 711,868 5.2 years 2.61 572,807
$14.39 to $17.41 (1) 349,000 3.0 years 15.64 349,000
$18.69 to $23.70 (1) 664,700 1.7 years 19.24 664,700
----------- --------------------
3,606,570 2,585,767
----------- --------------------
Note: (1) these options are denominated in Cdn dollars and have been
translated to US$ using the exchange rate as at December 31, 2003.
The assumptions used for purposes of estimating the fair value of the
options on the grant date following the Black & Scholes method to present
the pro-forma disclosures in Note 3.13. were as follows:
Expected dividend yield: 0%
Expected stock price volatility: 55%
Risk-free rate of return: 4%
Expected period until exercise: 5 years
F-58
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2003, 2002 and 2001
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
GUARANTEE OF INDEBTEDNESS OF NON-CONSOLIDATED ENTITIES
Gerdau has provided a surety to Dona Francisca Energetica S.A., in
financing contracts which amount to R$ 103,452 thousand (equivalent of
US$ 35,806 at year-end exchange rate), corresponding to 51.82% of the
debt of Dona Francisca Energetica. This guarantee was established before
December, 2002, and, therefore, is not covered by the accounting
requirements of FASB Interpretation No 45 ("FIN 45"). The guarantee may
be executed by lenders in the event of default by Don Francisca
Energetica S.A.
26 SUBSEQUENT EVENTS
(a) March 2004, the Company acquired certain assets and assumed certain
liabilities of Potter Form & Tie co., a leading supplier for fabricated
rebar and concrete construction supplies for the concrete construction
industry in the Midwest of United States, for approximately $11.1
million. The transaction will be accounted for as a business combination.
(b) The Shareholders Meeting held on April 29 2004 approved a bonus to both
common and preferred shareholders of 1 shares per 1 shares held.
* * *
F-59