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, 2004
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, 2004 was:
154,404,672 Common Shares, no par value per share
290,657,361 Preferred Shares, no par value per share
(Adjusted to reflect stock dividend effective March 31, 2005)
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
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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............................................. 31
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES............................................... 47
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS........................................ 55
ITEM 8. FINANCIAL INFORMATION.................................................................... 56
ITEM 9. THE OFFER AND LISTING.................................................................... 63
ITEM 10. ADDITIONAL INFORMATION.................................................................. 68
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............................. 79
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.................................. 81
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES........................................ 81
PART II................................................................................................... 82
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS............ 82
ITEM 15. CONTROLS AND PROCEDURES................................................................. 82
ITEM 16. AUDIT COMMITTEE FINANCIAL EXPERT........................................................ 82
PART III.................................................................................................. 86
ITEM 17. FINANCIAL STATEMENTS.................................................................... 86
ITEM 18. FINANCIAL STATEMENTS.................................................................... 86
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS....................................................... 86
2
INTRODUCTION
Unless otherwise indicated, all references herein to (i) 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) "Acominas" are references 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) "Gerdau Acominas" are
references to Gerdau Acominas S.A. after November 2003 and to Acominas before
such date, (iv) "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, (iv) "km" are to
kilometers, and (v) "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. ("Gallatin"), Bradley Steel
Processor and MRM Guide Rail, all in North America, 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 accounted using the equity accounting method.
Unless otherwise indicated, all information in this Annual Report is
stated for December 31, 2004. Subsequent developments are discussed in Item 8 -
Financial Information - 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 the 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.
Investors should not thus place undue reliance on the forward-looking
statements. The Company expressly disclaims any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statements
contained herein to reflect any change in the Company's expectations or to
reflect any change in events, conditions or circumstances on which any such
forward-looking statements is based, in whole or in part. 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
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 in this Annual Report.
The consolidated financial data for the Company on December 31, 2004, 2003,
2002, 2001 and 2000 are derived from the financial statements prepared in
accordance with U.S. GAAP.
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------------
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS EXCEPT QUANTITY OF SHARES AND AMOUNTS PER SHARE)
INCOME STATEMENT 2004 2003 2002 2001 2000
------------- ------------- ------------- -------------- ---------------
Net sales 6,952,149 4,530,969 3,264,926 2,401,138 2,771,376
Cost of sales (4,838,949) (3,445,564) (2,349,636) (1,722,228) (2,059,015)
------------- ------------- ------------- -------------- ---------------
Gross profit 2,113,200 1,085,405 915,290 678,910 712,361
Sales and marketing expenses (154,558) (146,388) (112,645) (105,801) (112,195)
General and administrative expenses (359,102) (241,854) (221,895) (181,108) (213,143)
Other operating income (expenses ), net 28,710 (824) (18,187) (7,853) 2,165
------------- ------------- ------------- -------------- ---------------
Operating income 1,628,250 696,339 562,572 384,148 384,858
Interest expense, exchange (gain) loss and
gains (losses) on derivatives, net (132,409) (254,763) (424,147) (238,269) (243,477)
Interest income 81,592 62,036 100,350 55,002 57,324
Equity in earnings (losses) of
unconsolidated companies, net 141,890 22,062 (10,057) 18,324 33,962
Gain on Gerdau Ameristeel investment 2,742 - - - -
------------- ------------- ------------- -------------- ---------------
Income before income taxes and minority 1,722,065 525,674 228,718 219,205 236,997
interest
Income taxes benefit (expense)
Current (329,229) (87,812) (27,065) (40,981) (36,725)
Deferred (77,451) 121,925 20,507 (13,666) (8,899)
------------- ------------- ------------- -------------- ---------------
Income before minority interest 1,315,385 559,787 222,160 164,558 191,373
Minority interest (157,027) (49,623) 9,667 2,795 (2,815)
------------- ------------- ------------- -------------- ---------------
Net income available to common and
preferred shareholders 1,158,358 510,164 231,827 167,353 188,558
============= ============= ============= ============== ===============
Basic income per share (i) - in US$
Common 2.62 1.15 0.52 0.35 0.40
Preferred 2.62 1.15 0.52 0.39 0.44
Diluted income per share (i) - in US$
Common 2.61 1.15 0.52 0.35 0.40
Preferred 2.61 1.15 0.52 0.39 0.43
Cash dividends declared per share (i)
- in US$
Common 0.44 0.27 0.18 0.15 0.14
Preferred 0.44 0.27 0.18 0.16 0.15
Number of Common Shares outstanding at
year end (ii) 154,404,672 154,404,672 154,404,672 153,589,880 153,589,880
============= ============= ============= ============== ===============
Number of Preferred Shares outstanding at
year end (ii) 290,657,361 290,657,361 290,657,361 290,527,776 290,527,776
============= ============= ============= ============== ===============
(i) Per share information has been retroactively restated to reflect for
all periods the effect of:, (a) the stock bonus of ten shares for three
shares held, approved in April 2003, (b) the reverse stock split of one
share for 1,000 shares held, approved in April 2003, (c) the stock
bonus of one share for every share held approved in April 2004 and (d)
the stock bonus of one share for two shares held approved in March
2005;
4
(ii) The information on the 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.
ON DECEMBER 31,
----------------------------------------------------------------------------
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
BALANCE SHEET SELECTED INFORMATION 2004 2003 2002 2001 2000
-------------- ------------- ------------- -------------- -------------
Cash 248,954 92,504 40,457 27,832 12,433
Restricted cash 6,603 1,935 15,001 - -
Short-term investments 404,512 236,137 367,748 306,065 290,449
Net working capital (1) 1,610,722 300,670 (63,579) 250,636 196,596
Property, plant and equipment 2,790,201 2,304,158 2,084,895 1,384,463 1,542,609
Total assets 6,852,249 4,770,834 4,000,301 2,952,677 3,231,758
Short term debt (including "Current 673,204 798,496 1,104,793 567,491 688,586
Portion of Long-Term Debt")
Long term debt, less current portion 1,280,516 1,132,429 794,571 630,636 717,830
Long term parent company - - 461 77
Debentures - short term 1,125 1,048 - 2,018 2,413
Debentures - long term 344,743 155,420 200,766 94,204 113,349
Shareholders' equity 2,522,585 1,403,063 865,010 1,032,720 1,065,659
Capital 1,539,204 982,601 843,959 838,214 838,214
(1) Total current assets less total current liabilities
DIVIDENDS
---------
The Company's total authorized capital stock is composed of Common and
Preferred Shares. On December 31, 2004, the Company had 154,404,672 Common
Shares and 288,297,561 Preferred Shares outstanding (excluding treasury stock),
adjusted to reflect the stock bonus effective on March 31, 2005.
The following table details dividends paid to holders of Common Shares
and Preferred Shares since 2000. The figures are expressed in Brazilian reais
and converted into U.S. dollars on the date of deliberation of the dividend.
Dividend per share figures have been retroactively adjusted for all periods to
reflect: (a) the stock bonus of ten shares for three shares held, approved in
April 2003, (b) the reverse stock split of one share for 1,000 shares held,
approved in April 2003, (c) the stock bonus of one share for every share held
approved in April 2004 and (d) the stock bonus of one share per two shares held
approved in March 2005;
Dividend per share information has been computed by dividing dividends
and interest on capital stock by the quantity of shares outstanding, which
excludes treasury stock.
DATE OF R$ PER SHARE (3) R$ PER SHARE (3) $ PER SHARE (3) $ PER SHARE (3)
PERIOD THE DELIBERATION COMMON SHARES PREFERRED SHARES COMMON SHARES PREFERRED SHARES
1st Semester 2000 (1) 06/26/2000 0.0956 0.1052 0.0523 0.0575
2nd Semester 2000 (1) 12/28/2000 0.1697 0.1867 0.0868 0.0955
1st Semester 2001 (1) 07/23/2001 0.1021 0.1123 0.0423 0.0466
2nd Semester 2001 (1) 12/20/2001 0.2462 0.2708 0.1061 0.1167
1st Semester 2002 (1) 06/28/2002 0.1795 0.1795 0.0631 0.0631
2nd Semester 2002 (1) 12/30/2002 0.4179 0.4179 0.1183 0.1183
1st Quarter 2003 (1) 03/31/2003 0.1667 0.1667 0.0497 0.0497
2nd Quarter 2003 (1) 06/30/2003 0.1133 0.1133 0.0395 0.0395
3rd Quarter 2003 (1) 09/30/2003 0.1700 0.1700 0.0582 0.0582
4th Quarter 2003 (1) 12/30/2003 0.3400 0.3400 0.1177 0.1177
1st Quarter 2004 (1) 03/30/2004 0.2133 0.2133 0.0730 0.0730
2nd Quarter 2004 (1) 06/30/2004 0.4333 0.4333 0.1394 0.1394
3rd Quarter 2004 (2) 07/31/2004 0.3067 0.3067 0.1013 0.1013
3rd Quarter 2004 (2) 11/03/2004 0.3533 0.3533 0.1248 0.1248
4th Quarter 2004 02/01/2005 0.6333 0.6333 0.2424 0.2424
1st Quarter 2005 05/03/2005 0.4500 0.4500 0.1799 0.1799
(1) Corresponds to payment of interest on capital stock.
5
(2) Corresponds to payment of both dividends and interest on capital stock.
(3) As of April 2003, and as result of the reverse stock split of one share for
1,000 shares held, approved in April 2003, dividends are paid on a per share
basis (rather than a per thousand shares basis, as was the case prior to this
date).
Law 9,249, of December 1995 establishes that a company may, at its sole
discretion, pay interest on capital stock in addition to or instead of dividends
(See Item 8 - Financial Information - Interest on Capital Stock). A Brazilian
corporation is entitled to pay its shareholders (considering such payment as
part of the mandatory dividend required by Brazilian Corporate Law for each
fiscal year) interest on capital stock up to the limit calculated as the TJLP
rate (Long-Term Interest Rate) on its shareholders' equity or 50% of the income
for the fiscal year, whichever is the greater. The payment of interest on
capital stock as described herein is subject to a 15% withholding income tax.
See Item 10. Additional Information - Taxation.
B. CAPITALIZATION AND INDEBTEDNESS
Not required.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not required.
D. RISK FACTORS
RISK FACTORS RELATING TO THE COMPANY AND THE STEEL SECTOR
IF THERE ARE CHANGES IN STEEL SCRAP PRICES OR A REDUCTION IN SUPPLY,
THE COMPANY'S PRODUCTION COSTS AND OPERATING MARGINS COULD BE ADVERSELY
AFFECTED.
The main metallic input for Gerdau's mini-mills is the scrap used in
electric arc furnaces, corresponding to 71.5% of total crude steel output in
2004. Other important raw materials include pig iron, iron ore (used in blast
furnaces and in the only DRI plant - a natural gas-based process for the
production of quality direct reduced iron), 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 (the United States is the main exporter of scrap),
scrap prices in the Brazilian market are set by internal supply and demand. The
price of steel scrap in Brazil varies from region to region, and reflects demand
and transportation costs. Gerdau Acominas is the largest consumer of steel scrap
in Brazil, sourcing it from more than 4,000 suppliers. In North America, the
metal spread, the difference between the mill's selling price and scrap raw
material cost, is currently well above the previous ten-year highs. The Company
does not know how long these levels can be maintained. Should scrap prices
increase significantly without a commensurate increase in finished steel selling
prices, the Company's profits and margins could be reduced. An increase in steel
scrap prices and the consequent reduction in the supply of scrap to Gerdau's
units would affect production costs and reduce the Company's operating margins.
See Item 4. Company Information - Business Overview.
THE INTEGRATED UNITS COULD BE ADVERSELY AFFECTED IF THERE IS AN
INCREASE IN IRON ORE PRICES OR A SHORTAGE IN THE DOMESTIC MARKET SUPPLY.
Gerdau Acominas uses iron ore to produce pig iron at the Gerdau
Acominas Ouro Branco mill as well as at its Barao de Cocais and Divinopolis
units, in the state of Minas Gerais. Iron ore is also used to produce sponge
iron at the Gerdau Usiba unit, in the state of Bahia. These four units represent
33.8% of Gerdau S.A.'s total crude steel output and 59.1% of the Brazilian
units' total production.
Since the Ouro Branco unit is Gerdau's biggest mill in Brazil, its main
metallic input for the production of steel is iron ore. This unit represents
39.3% of total crude steel output by Gerdau Acominas. 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' units, which
uses iron ore and could reduce profit margins. See Item 4. Company Information -
Business Overview.
6
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. At these units, 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 electrical power supplies would have a seriously adverse impact on
the production process in the electric arc furnace melt shops due to the absence
of an 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. Company
Information - Business Overview.
RESTRICTIVE MEASURES ON TRADE IN STEEL PRODUCTS MAY AFFECT GERDAU'S
BUSINESS BY REDUCING ITS ABILITY TO EXPORT.
Gerdau Acominas, which represents 57.1% of the Gerdau's consolidated
output, is a steel producer that supplies both the domestic market in Brazil and
the international markets. It exports to many countries, thus facing competition
from other steel producers in markets outside Brazil, as well as restrictions
imposed by importing countries, such as quotas, ad valorem taxes or increases in
import duties, any of which could adversely affect the Company's exports.
In North America, despite the increase in freight costs for the
transportation 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. This is perceived as unfair competition and has adversely
affected the Company's results. The U.S. Administration has responded to these
practices 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 the
Company's subsidiaries in North America.
The U.S. dollar has recently depreciated relative to certain European
and Asian currencies. This has acted to some extent as a deterrent to what were
previously cheap imports.
COMPLIANCE COSTS RELATED TO ENVIRONMENTAL REGULATION MAY INCREASE IF
REQUIREMENTS BECOME MORE STRINGENT. SUCH INCREASED COSTS MAY ADVERSELY AFFECT
THE RESULTS OF OPERATIONS OF THE COMPANY.
The Company's industrial plants are required to comply with a number of
laws and regulations at federal, state and municipal levels with respect to the
environment and the operation of mills in all the countries in which the Company
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. Gerdau believes
that all units are currently in compliance with local legislation.
INCREASES IN BRAZILIAN INTEREST RATES AND INFLATION MAY AFFECT THE
COMPANY'S OPERATING RESULT.
The economic variables that most significantly impact the Company's
financial results in Brazil are interest rates and inflation. In an environment
of single digit inflation and steadily declining interest rates, economic risks
to its operations are reduced, whereas high 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.
FOREIGN EXCHANGE VARIATIONS BETWEEN THE U.S. DOLLAR AND THE DIVERSE
CURRENCIES OF THE COUNTRIES WHERE GERDAU OPERATES MAY IMPACT THE COMPANY'S
RESULTS.
The results of the consolidated operation of Gerdau S.A. are influenced
by currency fluctuations. The results of the operations are all impacted by the
exchange rates between the U.S. dollar, the currency on which Gerdau prepares
its financial statements and the various functional currencies of the countries
where Gerdau operates.
Gerdau Ameristeel reports results in U.S. dollars while a portion of
net sales and operating costs are in Canadian dollars. As a result, fluctuations
in the exchange rate between these two currencies may affect operating results.
In addition, the Canadian operations compete with U.S. producers and are
becoming less competitive as the Canadian dollar strengthens relative to the
U.S. dollar.
7
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. Additional Information - D - Exchange
Controls
ITEM 4. COMPANY INFORMATION
A. HISTORY AND DEVELOPMENT
---------------------------
Gerdau S.A. is a Brazilian corporation (Sociedade Anonima) that was
incorporated on November 11, 1961. Its main executive office is located at Av.
Farrapos, 1811, Porto Alegre RS - Brazil. Its telephone number is xx 55 (51)
3323 2000.
Gerdau began operating in 1901 as the Pontas de Paris nail factory in
Porto Alegre, Brazil. In 1969, the Company changed its name to Metalurgica
Gerdau S.A., today a holding company that controls Gerdau S.A. In 104 years of
activity, the Gerdau Group has made a seminal contribution to the Brazilian
industry.
IMPORTANT EVENTS IN THE DEVELOPMENT OF THE COMPANY'S BUSINESS
-------------------------------------------------------------
At the end of World War II, Gerdau acquired Siderurgica Riograndense
S.A.("Riograndense"), a steel producer also located in Porto Alegre, to
compensate for potential raw material shortages. In February 1948, Gerdau
initiated its steel operations, which foreshadowed the successful mini-mill
model of producing steel in electric arc furnaces (EAF), using steel scrap as
the 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 (state of
Rio Grande do Sul) in 1957, consolidating the Group's vocation as a steel
producer. In 1962, steady growth in the production of nails led to the
construction of a larger and more advanced factory in Passo Fundo (state of Rio
Grande do Sul). Although the factory in Passo Fundo is no longer operating,
Gerdau still produces nails at some of its mills and the Company believes that
it 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 74 branches
including 6 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, Gerdau began
the construction of 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 majority 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 ten steel mills in the country.
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., while maintaining its headquarters in Ouro Branco (in the state
of Minas Gerais). Since the above date, Gerdau Acominas has been responsible for
all the Gerdau Group's steel activities in Brazil.
8
In 1980, Gerdau began to expand internationally with the acquisition of
Gerdau Laisa in Uruguay, followed in 1989 with the purchase of the Canadian
company, Gerdau Ameristeel Cambridge, located in Cambridge, Ontario. In 1992,
Gerdau acquired control of Gerdau AZA, Chile. Over time, Gerdau increased its
international presence by acquiring a minority interest in units in Argentina,
and most notably by acquiring interest, in North America of Gerdau Ameristeel
MRM Special Sections and the former Ameristeel Corp. In October 2002, Gerdau
carried out a reverse takeover, merging its North American assets with those of
the Canadian company Co-Steel to create Gerdau Ameristeel, which is currently
the second largest long steel producer in North America. Through its Gerdau
Ameristeel subsidiary, Gerdau acquired the assets of North Star Steel in
November 2004 and in December of the same year, reached an agreement to buy
stakes in two steel mills in Colombia. Both acquisitions represent the Company's
continuing process of internationalization.
In addition to its 22 mini-mills in Brazil and abroad and four
Brazilian integrated mills, Gerdau owns 11 fabricated reinforcing steel
facilities (branded Armafer), eight downstream operations, six service centers
for flat steel, nine fabricated reinforcing steel facilities (branded
Prontofer), six thermal cutting service centers and eight scrap yards in Brazil.
Gerdau also owns three iron ore extraction areas, two facilities for producing
solid pig iron and two proprietary port terminals in Brazil. In South America,
it owns four fabricating facilities, six commercial outlets (in Chile) and has a
minority interest in a rolling mill in Argentina (SIPAR Aceros). In North
America, it has 29 rebar fabricating facilities including the recently acquired
assets of Potter Form & Tie Co., Gate City and RJ Rebar Inc. The Company also
operates 13 units that manufacture higher value-added products and special
sections such as super light beams, elevator guide rails and epoxy coated steel
as well as 16 steel scrap-recycling operations in North America.
In 1995, Gerdau began a corporate restructuring - completed in 1997 -
whereby the 28 Gerdau group companies were merged with the Company's six
publicly listed companies, consolidating them into two: Gerdau S.A. and
Metalurgica Gerdau S.A., resulting in greater investor transparency.
On November 2003, the integration of the operations of Gerdau S.A. in
Brazil and Aco Minas Gerais S.A. - Acominas, resulted in Gerdau Acominas S.A. On
December 3, 2004, the Board of Directors of Gerdau S.A. gave approval for
management to implement a corporate reorganization of the Gerdau companies in
Brazil and in other countries in South America - this a continuation of the
process begun two years previously.
On December 29, 2004, the first act of this reorganization was put into
effect with the capitalization of the wholly-owned dormant holding company
Gerdau Participacoes S.A. with the shares of Gerdau Acominas S.A. and part of
the quotas of Gerdau Internacional Empreendimentos Ltda., previously held by
Gerdau S.A., representing, respectively, 91.5% and 22.8% of the capital stock of
these companies. The quotas brought into the capital of Gerdau Participacoes
S.A. correspond to the direct or indirect stakes of Gerdau Internacional
Empreendimentos Ltda. in the capital of Gerdau Chile Inversiones Ltda., Gerdau
Laisa S.A. and Sipar Aceros S.A. A second act was held on May 9, 2005, when
Gerdau Participacoes was merged into Gerdau Acominas S.A. Presently, management
is reviewing the final structure of this reorganization with the support of
outside consultants.
The shareholders of the companies listed in Brazil and abroad will not
be affected by the proposed reorganization. They will continue with their
current positions in the respective companies, and all their rights will be
preserved.
Gerdau S.A. has been a publicly listed company in Brazil since 1980
with an ADR listing on the New York Stock Exchange (NYSE) since March 1999. In
June 2001, Gerdau adhered to the Sao Paulo Stock Exchange's Corporate Governance
Program (Level 1). In December 2002, it listed on the Latibex, part of the
Madrid Stock Exchange dedicated to Latin American companies, with stocks traded
in Euros. Gerdau Ameristeel is listed in Canada on the Toronto Stock Exchange
and more recently began trading its shares on the New York Stock Exchange as
well.
From its beginning in Brazil in 1901, Gerdau has grown steadily to
become the 13th largest steel producer in the world in 2004 (according to the
International Iron and Steel Institute - IISI).
9
INVESTMENT PROGRAMS 2002-2004
-----------------------------
2002 - TOTAL CAPITAL EXPENDITURES: $598.0 MILLION
Gerdau's investment policy has consisted mainly of expanding through
the acquisition of financially distressed companies, albeit with quality
operations. The merger of the North American operations with the former Co-Steel
Corp. in 2002, reflected this policy and resulted in the creation of the new
company, Gerdau Ameristeel, the second largest long steel producer in the
region. This acquisition was effected through the merger of Gerdau's stakes in
companies in the United States and Canada into Co-Steel Inc., no cash
disbursement being involved.
In 2002, Gerdau invested a total of $598.0 million, 68.9% of this
investment in company acquisitions and 31.1% in the modernization of units and
in the acquisition of new fixed assets. The main investments during the year are
described below.
Gerdau became the majority shareholder in Acominas by acquiring
sufficient voting shares to command a qualified majority under the terms of its
shareholders' agreement. At an auction realized in February by the 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 and paid in October. With these two
acquisitions, Gerdau increased its stake in Acominas to 78.9%, giving it
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, in December 2002
acquiring a 22% minority stake in the company, Dona Francisca Energetica S.A.
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
an installed generating capacity of 125 MW.
The Group has invested in servicing the civil construction industry
through the expansion of technologies to boost 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 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 to generate energy. In 2002, investments at
Gerdau Acominas Ouro Branco mill amounted to $66.3 million.
The modernization of Gerdau Acos Piratini's rolling mill 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.
CHILE AND URUGUAY
In Chile, investments in Gerdau AZA were primarily aimed at optimizing
the productivity of the rolling mills, reducing costs and improving product
quality. Improvements in warehouses and product loading ramps optimized
operations and improved customer service. In 2002, capital expenditures in Chile
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.
10
CANADA AND THE UNITED STATES
In 2002, capital investment in Gerdau Ameristeel amounted to $29.5
million, relating principally to mill improvements. 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) in the Jackson mill, where the complete refurbishing
of the continuous casting unit reduced losses and improved product quality.
In the Gerdau Ameristeel Canadian units, the most significant
investment was the installation of a new gantry crane at the Cambridge unit for
enhancing the operating performance of the melt shop.
2003 - TOTAL CAPITAL EXPENDITURES: $312.5 MILLION
The Company initiated new technological upgrading programs to meet
domestic demand, most notably at Gerdau Riograndense, Gerdau Acos Finos Piratini
(hereinafter Gerdau Acos Especiais Piratini) and Gerdau Usiba.
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%.
The main investments during the year are described below.
MODERNIZATION AND UPGRADING OF INDUSTRIAL PLANTS
BRAZIL
In addition to its wire rod rolling mill, the Gerdau Acominas Ouro
Branco unit 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 cutting costs. The Company also implemented its
dephosphorization project to reduce the level of phosphorus in its steel
products. The Company has almost concluded the new billet inspection line for
guaranteeing surface quality at the Ouro Branco unit's primary rolling mill.
Investments at the Ouro Branco mill amounted to $80 million in 2003.
Other Gerdau Acominas investments in its units amounted to $151.9
million and included the conclusion of the modernization of Gerdau Acos
Especiais Piratini medium and heavy bar rolling mill and the modernization of
the melt shop, improvements at Cosigua and at other mills in Brazil as well as
the construction of a new blast furnace at the Gerdau Divinopolis mill.
CHILE AND URUGUAY
The Company extended the automation of industrial processes to the
profile finishing area at the Renca unit of the Chilean subsidiary. A new stock
and loading warehouse also optimized product delivery during 2003. 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 loading time. Investments in Chilean and Uruguayan
subsidiaries amounted to $6.9 million.
CANADA AND THE UNITED STATES
Investments in Gerdau's North American subsidiaries amounted to $55.2
million in 2003. The most significant investments in North America were a new
warehouse at the Cartersville mill, rolling mill electrical control system
upgrades at the Knoxville and Charlotte mills, a caster upgrade at the Jackson
mill and a new pollution control system at the Cambridge mill.
11
2004 - TOTAL CAPITAL EXPENDITURES: $756.7 MILLION
In 2004, the Company invested $756.7 million in acquisitions of new
businesses as well as new property, plant and equipment, increases in installed
capacity and in technological upgrades of its units in Brazil, Canada, Chile,
United States and Uruguay. The main investments during the year are described
below.
BRAZIL
Gerdau Acominas' capital expenditures amounted to $329.0 million in
2004. One of the major capital projects included investments of $77.9 million
for the construction of the Sao Paulo mill melt shop scheduled to begin
operating in May 2005 as well as other improvements at the same facility. Other
important expenditure during the last year was $100.2 million at the Ouro Branco
mill including technological upgrades of equipment and a project to increase
installed capacity by 1.5 million tons of liquid steel, expected to come on
stream in 2007. Other amounts relate to smaller improvements and technological
upgrades at other facilities in Brazil.
CHILE AND URUGUAY
The South American units spent $10.3 million on capital projects in
2004, compared to $6.9 million in 2003.
CANADA AND THE UNITED STATES
Gerdau Ameristeel spent $82.1 million on capital projects in 2004,
compared to $55.2 million in 2003. Major capital projects in 2004 included
caster upgrades of $10.0 million, mill control upgrades of $5.5 million,
warehouse and material handling improvements of $16.0 million, sub-station
upgrades of $3.5 million, reheat furnace improvements of $10.0 million and
information system upgrades of $4.0 million.
Complementary information regarding these investments is available
under the following topics "Principal Capital Expenditure Currently in Progress"
and "Acquisitions".
PRINCIPAL CAPITAL EXPENDITURE CURRENTLY IN PROGRESS
---------------------------------------------------
TECHNOLOGICAL UPDATE AT OURO BRANCO MILL
In September 2004, Gerdau Acominas announced a technological upgrading
program at its Ouro Branco mill in the state of Minas Gerais. This modernization
program is part of a project to increase the mill's installed capacity from 3 to
6 million tons in two phases. The first phase, already underway, will require
investments of roughly $1.1 billion to increase installed capacity from 3 to 4.5
million tons through the installation of a new blast furnace with 1.5 million
tons of annual installed capacity. Besides the new blast furnace, Gerdau will
also install a HPS (Hybrid Palletized Sinter), a continuous blooms and beam
blanks caster, a dephosphorization system and other additional improvements.
Part of the project will be financed by a $240 million financing
agreement guaranteed by Nippon Export and Investment Insurance (NEXI), a credit
insurance agency linked to the Japanese government, covering 97.5% of the
political risk and 95% of the commercial risk. ABN AMRO led and structured the
operation with funding from ABN AMRO Bank N.V., Bank of Tokyo-Mitsubishi and UFJ
Bank Limited. Other sources of funding have not yet been negotiated but Gerdau
expects these to be a mix of internal cash generation and other financing
currently under consideration.
NEW MILL IN SAO PAULO
On October 18, 2004, the revived project for a new steel mill in the
state of Sao Paulo was announced. The project will be in two stages and
represent an investment worth $260 million with an installed capacity of 1.3
million tons of crude steel and of 1.2 million tons of rebars for the civil
construction industry. In the first stage, investments amount to $105.0 million,
with an annual melt shop capacity of 900,000 tons and rolling mill capacity of
600,000 tons. The melt shop is to begin operating in May 2005 and the rolling
mill in April 2006.
12
Of the total amount invested, approximately 20% will be financed from
internal cash flow, 25% by suppliers and financial institutions and 55% by the
Brazilian National Bank for Economic and Social Development (BNDES).
UPDATES AT OTHER GERDAU UNITS IN BRAZIL
Together with the bigger projects listed above, Gerdau is making
certain improvements and technological updates in many other mills in Brazil as
described below:
A total of $43.0 million has been invested in expanding installed
capacity from 350,000 tons to 500,000 tons of rolled products at the Gerdau Acos
Especiais Piratini unit in Charqueadas (state of Rio Grande do Sul). This
investment was concluded at the end of the first quarter of 2005.
Gerdau Usiba, in Bahia, will be receiving investments of $88.0 million
over the next three years. The annual installed capacity for crude steel will be
increased by 320,000 tons, and for rolled products by 370,000 tons.
The Gerdau Riograndense unit is to improve its melt shop processes,
resulting in the output of a further 60,000 tons of steel per year by 2006. At
Gerdau Cearense, the installation of a new reheating furnace and the elimination
of bottlenecks, programmed for 2006, are expected to expand the unit's annual
output by 50%, from 100,000 to 150,000 tons.
ACQUISITIONS DURING 2004
------------------------
ACQUISITION OF DIACO S.A. AND SIDERURGICA DEL PACIFICO S.A. - SIDELPA
On December 23, 2004, the Company reached an agreement with the
majority shareholders of Diaco S.A., - the Mayaguez Group and the Latin American
Enterprise Steel Holding, and of Siderurgica del Pacifico S.A.- Sidelpa to buy
the shares of these two companies. Diaco is the largest producer of steel and
rebar in Colombia and Sidelpa is the country's only producer of specialty steel.
The transaction involves two steel mills, a profile and rebar mill
located in the city of Tuta, and Sidelpa, a specialty steel mill in the city of
Cali. Three rolling mills as well as a fabricated reinforcing steel facility in
Bogota were also involved in the transaction. Together, the operations have an
annual installed capacity of 460,000 tons of crude steel and 605,000 tons of
rolled products.
The completion of the transaction is subject to several prior
conditions, which had still not been met on the filing date of this annual
report. The agreement establishes a period for compliance with these conditions.
Under the terms of the agreement, once the conditions are met, Gerdau will
acquire a controlling interest in Diaco and Sidelpa. Gerdau also has committed
to acquire additional shares in Diaco within eight years.
GERDAU AMERISTEEL PUBLIC OFFERING OF COMMON SHARES
On April 14, 2004, Gerdau Ameristeel issued 26,800,000 Common Shares. The
price was set at Cnd$4.90 per share ($3.64 at the exchange rate on the date of
the transaction), the closing price of the Common Shares of Gerdau Ameristeel on
the Toronto Stock Exchange on March 31, 2004. The Company acquired all the
shares at a total purchase price of $97.8 million. As a result of the
transaction, the Company increased its interest in Gerdau Ameristeel from 69% to
72%.
On October 15, 2004, Gerdau Ameristeel issued 70,000,000 Common Shares at
a value of Cdn $5.90 per share ($4.70 per share at the exchange rate on the date
of the transaction) worth approximately $322.7 million after deducting
underwriters' fees and estimated expenses. Gerdau purchased 35,000,000 of the
Common Shares, representing 50% of the total Common Shares offered, for total
net proceeds to Gerdau Ameristeel of $161.4 million after deducting
underwriters' fees and expenses. As a result of acquiring a percentage less than
that of its previous holding in Gerdau Ameristeel, Gerdau's interest in Gerdau
Ameristeel was diluted to approximately 67%.
Subsequently, on November 18, 2004, the underwriters of the public
offering of Common Shares above exercised their over-allotment option to
purchase an additional 4,381,000 Common Shares in Gerdau Ameristeel at the
initial public offering price of Cdn$5.90 per share. As agreed in the
subscription agreement with Gerdau Ameristeel, Gerdau S.A. purchased the same
number of additional Common Shares as the underwriters pursuant to
13
the exercise of their over-allotment option at $4.70 per share, the U.S. dollar
equivalent of the public offering price. After deducting underwriters' fees and
estimated expenses, the net proceeds to Gerdau Ameristeel amounted to $39.9
million of which $19.8 million was paid by Gerdau. As a result of acquiring a
percentage below that of its previous holding in Gerdau Ameristeel, Gerdau's
interest in Gerdau Ameristeel was further diluted to approximately 66.5%.
GATE CITY AND RJ REBAR, INC
On December 10, 2004, Gerdau Ameristeel completed the acquisition of the
fixed assets and working capital of Gate City's and RJ Rebar, Inc.'s rebar
fabrication facilities in the United States Midwest with an annual production
capacity of approximately 150,000 tons. The acquisition was worth approximately
$16.4 million.
NORTH STAR ASSETS
On November 1, 2004, Gerdau Ameristeel completed the acquisition of four
long steel product mini-mills and four downstream facilities, referred to as
North Star Steel, from Cargill Incorporated. This acquisition increased mill
manufacturing capacity by approximately 2.0 million tons of finished long steel
products. The facilities were acquired in the United States and consist of four
long steel product mini-mills and four downstream units. The purchase price was
$266.0 million in cash plus the assumption of certain liabilities and changes in
working capital from April 30, 2004 to the closing date. $181.0 million of the
purchase price was for working capital computed on April 30, 2004. On November
1, 2004, working capital of the acquired business had increased by $51.8
million. This amount was accrued on December 31, 2004 and paid subsequent to
year-end.
ASSETS AND LIABILITIES OF POTTER FORM & TIE CO.
In March 2004, Gerdau Ameristeel concluded the acquisition of certain
assets and assumed certain liabilities of Potter Form & Tie Co., a leading
supplier of fabricated rebar and concrete construction supplies for the concrete
construction industry in the Midwest of United States, this acquisition
amounting to approximately $11.1 million. As a result of this transaction, $1.4
million of goodwill was recorded.
Additional information regarding acquisition during 2004 is set forth
in Item 18. Financial Statements - Note 4.
B. BUSINESS OVERVIEW
--------------------
OVERVIEW
Gerdau's strategy focuses on the decentralized production of long steel
using electric arc furnace (EAF) mini-mills and integrated mills with blast
furnaces, continuous casting technology being used in both processes. The Ouro
Branco mill also uses the conventional casting technology. 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 given both countries' high transportation and freight
costs. Gerdau is therefore able to supply its customers and source raw materials
locally. From 1970 to 1990, Gerdau concentrated on building market share in
Brazil by increasing its installed capacity and by acquiring existing mills,
typically seeking those with management problems where the Company's main
contribution would be its management skills rather than capital. Gerdau Acominas
is currently the third largest crude steel producer in Brazil, according 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 management restructuring 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 annual nominal
capacities of 7.6 million tons of crude steel and 6.9 million tons of rolled
products 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 central regions of Canada. Following the
acquisition of North Star assets, completed in November 2004, Gerdau Ameristeel
has 14 long steel units and a strategic shareholding of 50% in Gallatin.
14
Gerdau also owns one mill each in Argentina, Uruguay and Chile. Gerdau
holds a minority stake of 38% in the Argentine mill, which does not produce
crude steel. The other two mills in Chile and Uruguay have a combined installed
capacity 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 slabs, blooms and billets 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 and shorter
than billets, and are used to manufacture products such as springs,
forged parts, shapes and seamless tubes.
Slabs: Slabs are bars similar to billets in length but shorter in
height and larger in width. They 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.
COMMON LONG ROLLED PRODUCTS
Rolled products represent a major portion of Gerdau's production. In
2004, common steel rolled products accounted for 68.1% of the Company's
consolidated shipments (43.6% by non-Brazilian companies and the remaining 24.5%
by Gerdau Acominas, 17.9% of the latter going to the domestic market and 6.6% to
the export market). 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 6.7% of the Company's consolidated shipments. 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 Especiais 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 its
customers' production lines at lower operating costs.
15
FLAT PRODUCTS
The Gerdau Acominas Ouro Branco mill produces slabs, the input for flat
steel coils, and other flat steel products. In 2004, flat steel products
accounted for 10.0% of the 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 at
its six flat steel service centers.
With the merger of the former Co-Steel mills and its joint venture
company (Gallatin, located in Kentucky), Gerdau Ameristeel acquired the capacity
to supply flat steel to its customers. The Gallatin mill is a joint venture with
Dofasco, Canada, a leading flat steel producer, and has a nominal installed
capacity of 1.4 million tons of flat steel per year. Each partner in the joint
venture has a 50% stake.
LIST OF PRODUCTS
-----------------
CIVIL CONSTRUCTION
Annealed wire
GG-50, CA-25 and CA-60G concrete reinforced bars (rebar)
POP prefabricated light columns and meshes
Ribbed mesh
Stirrups
Structural shapes
Transfer bars
Truss frames
Tube mesh
Wire fences
Wire rod
INDUSTRIAL PRODUCTS
Angle
Billets
Bright electrode, industrial and polished wires
Channel, I-beams and T-shapes
Cold drawn round, square and hexagonal bars
Flat, round and square bars
Galvanized wire rope
Piatina - Cold drawn flat bar
Ribbed T profile
Star profile
Structural shapes
Tribar
Welding electrode
Welding wire
Wire rod
SPECIAL SECTION PROFILES (MANUFACTURED IN CANADA)
Elevator guide rails
Grader blades
Light rails
Smelter bars
Superlight I-beams
16
AGRICULTURAL PRODUCTS
Arcorfix and tutor - products for fruit crops
Cercafix post-spacing wire
Gripple joiner and tensioner
High-strength steel fence posts
Oval-shaped wire, galvanized wire and barbed wire
Plastic-coated galvanized wire
Staple for fences
Wire and posts for electrified fences
Wire and wire rope for agricultural products
Wire rod
Wire rope for corrals
NAILS
Bulk nails - construction
Bulk nails - carpentry
Bulk nails - packaging
Bulk nails - shipping industry
SPECIALTY STEEL
Round and square rolled bars
Round, square and rectangular forged bars
Wire rod
Tools steel
Chain link fabric
Forged bars and blooms
Round, square and flat rolled bars
STAINLESS STEELS
Round and square rolled bars
Round, square and rectangular forged bars
Wire rod
MINING
Grinding balls
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 sections, including elevator guide rails and super light
beams. Gerdau provides its customers with higher added value products at 44
rebar fabricating facilities (11 Armafer service centers in Brazil, four in
South America and 29 Fabrication shops in North America) and flat steel service
centers (six in Brazil).
17
SEASONALITY OF THE COMPANY'S MAIN BUSINESS
------------------------------------------
The Company's sales are not subject to significant seasonal variation.
Performance is more dependent on the development of the segments that contribute
directly to the Gross Domestic Product of the countries in which Gerdau
operates. In Brazil, second and third quarter shipments tend to be stronger than
those in the other two quarters. In North America, demand is influenced by
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 produce the steel product at the required specifications. 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 Brazilian mills. The
component proportions of this mixture may change in line with price and
availability at the time of production so as to optimize raw material costs, the
ratio of steel scrap to pig iron varying from 60%-40% to 90%-10%.
The Company's mills in the United States use 100% steel scrap. In the
event of steel scrap prices exceeding acceptable levels, 2004 being a case in
point, the mills seek alternate input sources. These include pig iron from
Margusa, a solid pig iron producer owned by Gerdau, in the Northeast of Brazil
located close to the coast and nearest port, with an annual installed plant
capacity of 200,000 tons. Gerdau uses Margusa's output to supply its plants in
the Northeast of Brazil, although a smaller quantity has been exported to some
of 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 more than 4,000 scrap
suppliers that deliver their materials to its yards. The Company believes that
it is the largest buyer of scrap in Brazil. The pig iron used in the
steel-making process is produced at Gerdau Acominas's pig iron mills, Gerdau
Contagem in the state of Minas Gerais and Margusa in the state of Maranhao. Part
of the pig iron used at Gerdau's mills is also sourced from other companies. In
2004, Gerdau Acominas produced 25% of its pig iron requirements internally.
Due to the nature of the raw materials employed, Gerdau Acominas does
not use long-term supply contracts. Its mini-mills purchase their scrap directly
on demand using mainly obsolescence scrap. Scrap and other raw materials are
priced in Brazilian reais and input prices are not therefore directly affected
by currency fluctuations.
Due to its size, Gerdau Acominas' Ouro Branco mill has a different
strategy for sourcing raw materials, employing long-term contracts to guarantee
supplies. The unit's main raw materials include: (i) coal, imported from Canada,
Australia and the United States; (ii) ferro-alloys, of which 100% is purchased
in the domestic market; and (iii) iron ore, the most critical raw material,
which is sourced both from large mining companies and from small and medium
sized suppliers strategically located close to the plant. These three inputs
account for more than 45% of all plant purchases.
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 its steel scrap in the domestic market and is the
only significant buyer of this input in Uruguay.
Gerdau Ameristeel has consistently obtained adequate supplies of raw
materials and is not dependent on any one supplier. It believes there are an
adequate number of alternative suppliers in the marketplace should it need to
replace an existing one.
18
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 ferro alloys are also important. Its Brazilian mills use a mixture of scrap
and pig iron, due to the low yield of steel scrap in Brazil. By contrast, the
North American mini-mills normally use 100% steel scrap.
Although international steel scrap prices are determined by the U.S.
domestic market (since the United States is the main scrap exporter), the price
of steel scrap in Brazil varies from region to region and is influenced by
demand and transportation costs. Gerdau Acominas is the largest consumer of
steel scrap in Brazil with more than 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
production processes themselves. Gerdau Acominas uses mainly obsolescence scrap
while the North American plants use mainly industrial scrap.
In Brazil, the largest 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's mills are located.
Obsolescence scrap is delivered directly to the mills by scrap dealers. 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, based on 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. With the large number of
consumers leading to fierce competition, 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.
Gerdau Metalicos is the business unit that collects and supplies scrap
to the industrial units and is the Latin American leader in steel scrap
recycling. It reuses millions of tons of Brazilian scrap every year, accounting
for significant gains through process optimization, reduced energy consumption,
greater 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 more
than 4,000 suppliers that generate thousands of jobs. Gerdau Metalicos has
stowage yards (collection points) for scrap in strategic locations throughout
Brazil and uses several mobile presses that travel the country, 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
a mega-shredder 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 represented
approximately 47% of mill production costs in 2004. Scrap is a commodity, the
availability of which 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 16 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 where operating results are closely linked to the cost of steel scrap
and scrap substitutes, the primary mini-mill input. Steel scrap prices are
relatively higher during winter months due to the impact of weather on
collection and supply efforts. While realized selling prices for end products
cannot always be adjusted on a short-term basis to recover the cost of increases
in steel
19
scrap prices, they generally accompany 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
consumption has pushed up the prices 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. This is also the case with 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 higher pig iron
yields. 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 75% of Gerdau Acominas' pig iron requirements are purchased from
other companies, 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), the entire production of which is used internally to
manufacture steel products.
The Company does not have any Brazilian contracts for the supply of pig
iron, negotiating amounts and delivery conditions directly on the spot market.
The price of pig iron may fluctuate in line with its international market price,
given that a large portion of production in Brazil 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.
Scrap availability is a major factor in Gerdau Ameristeel's ability to
operate. Direct reduced iron, hot briquetted iron and pig iron can be a
substitute for a limited portion of the steel scrap used in electric arc furnace
steel production. Gerdau Ameristeel does not employ significant quantities of
scrap substitutes in its mini-mills except for pig iron used for its chemical
properties in the Perth Amboy rod making facility and to manufacture certain
special sections.
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. Gerdau Contagem and Margusa also use iron ore in
order to produce solid pig iron. The Company has acquired iron ore from MBR,
Companhia Vale do Rio Doce and other smaller suppliers.
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 2004, 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 2004, representing 84% of metallic inputs,
with steel scrap representing 12% of inputs, and cold pig iron 4%.
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 in blast furnace mills, and natural gas, used at the DRI unit.
20
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 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.
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 and permitting 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 to replace an existing one
arises.
ENERGY
Steel production is an energy intensive process, especially in EAF
mills. Power and, to a lesser extent, natural gas used in some mills are a
significant component of steel production costs.
In Brasil, Gerdau's units hold contracts with a series of electricity
suppliers and are not dependent on any single contract. (Regarding energy
supply, see Item 4B - Business Overview). Energy is currently supplied to our
industrial units under two types of contract:
I - Contracts in which we are "Captive Consumers", at the following
units: Gerdau Riograndense, Gerdau Acos Especiais Piratini, Gerdau Guaira,
Gerdau Cosigua, Gerdau Usiba, Gerdau Aconorte and Gerdau Cearense. These
contracts are with public companies or holders of public concessions from the
government. Under these contracts, demand and consumption are contracted between
the parties and tariffs are defined by ANEEL. The captive consumers may purchase
part of its energy on the free market.
II - Contracts in which Gerdau is a "Free Consumer" at the Ouro Branco,
Divinopolis and Barao de Cocais units. These three mills have energy contracts
with CEMIG, the state of Minas Gerais electric energy utility, with rates
defined and adjusted according to pre-established indices. The distribution
contracts are also with CEMIG and revised annually by ANEEL. Ouro Branco reduces
its exposure to the energy market by meeting a significant part of its energy
needs through self-generation, using top blast furnace gases.
In terms of natural gas, all units are supplied under long-term
contracts. The units in Minas Gerais do not have access to natural gas.
In Chile and Uruguay, both energy and natural gas are contracted on a
long-term contract basis. During the year, Gerdau Laisa (Uruguay) replaced fuel
oil with natural gas.
In North America, there are two kinds of energy markets: regulated and
deregulated. In regulated market, the contracts are hold with authorized public
utilities and the tariffs are defined to each region, through long-term contract
basis. In deregulated market, the price of power changes every 5 minutes (spot
market price) to reflect the actual cost to produce the power. 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. The company does not have long-term natural gas supply contracts and
therefore is subject to market variables and price swings.
21
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.
Should electricity supplies be 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 reduction targets were set by the federal government), the
events and their consequences are discussed with the respective energy
concessionaires while operating capacity is kept at emergency levels to protect
staff and equipment.
In the event of rationing, decisions and procedures will be implemented
by the Government's regulatory agency. These may have a materially adverse
impact on the Company's results, with a consequent reduction in production in
the light of the availability of electricity and readjustments to delivery
schedules. Although such problems are not common in Brazil, some small units of
Gerdau may choose, as an alternative, to use generators to compensate for the
energy shortage. During the 2001 period of electric power rationing, Gerdau
overcame the crisis by reallocating production among its 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 critical period ended.
In terms of natural gas, the units of Rio Grande do Sul, Parana and Sao
Paulo are supplied by imported natural gas, through GASBOL (Gasoduto
Brasil-Bolivia), whereas the other units are supplied by the national natural
gas. In the event of natural gas rationing it would be possible the equipment
adaptation to use fuel oil and GLP.
MARKETING CHANNELS
------------------
Gerdau S.A. sells its products in various markets, including
construction, manufacturing industry and other markets. 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.
GERDAU S.A. CONSOLIDATED SHIPMENTS
DESTINATION BY REGION
(1,000 tons) 2004 2003 2002
TOTAL 11,873 11,453 8,971
BRAZIL 6,711 6,639 5,778
Domestic 3,881 3,376 3,874
Exports 2,830 3,263 1,904
NORTH AMERICA 4,724 4,466 2,884
SOUTH AMERICA 439 348 309
GERDAU S.A. CONSOLIDATED 2004 2003 2002
NET SALES BY REGION
($ million)
TOTAL 6,952 4,531 3,265
BRAZIL 3,623 2,598 2,112
NORTH AMERICA 3,010 1,811 1,054
SOUTH AMERICA 319 122 99
22
BRAZILIAN OPERATIONS
In 2004, the Company's Brazilian operations through Gerdau Acominas,
accounted for 56.5% of overall group shipments. Brazilian sales amounted to 6.7
million tons, of which 3.9 million tons were delivered to the domestic market
and 2.8 million tons to the export market.
The Company's operations in Brazil consist of three segments: Long
Steel, Gerdau Acominas (Ouro Branco mill) and Specialty Steel (Gerdau Acos
Especiais Piratini). Each operation is divided into Business Units, which are
defined by product line or market characteristics for establishing commercial
strategies for the domestic market. The 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
Each Business Unit (Area de Negocios) provides national coverage with a
single sales policy and local execution. Business Units with the most sales to a
particular customer are allocated responsibility for Company relations with that
customer, except for Gerdau Exportacao (GEX- Exports). Approximately 20% of the
production negotiated by the Business Units is distributed through Comercial
Gerdau, the Company's largest distribution channel with 74 stores throughout
Brazil, servicing 155,000 customers in 2004. Other important distribution
channels are the 6,000 independent distributors to which Gerdau sells its
products, giving it 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 access to Gerdau's information system. These representatives are
provided with computers and telephones to better service their customers and
expedite orders placed.
Gerdau Acominas minimizes delays by delivering its products directly to
customers through third-party companies, under Gerdau's supervision. Sales
trends in both the domestic and export markets are forecasted monthly on the
basis of historical data for the three preceding months. Gerdau Acominas uses
its own information system to remain current on 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 optimize inventory
levels in the light of changing demand, as keys to its success.
The Ouro Branco mill has certain specific characteristics in its
operations arising from generally selling its products to rolling mills and
other companies that use slabs, blooms and billets as raw material to
manufacture finished products such as springs, structural and forged products.
The unit's customers are thus larger than others serviced by Gerdau Acominas'
units, except for Gerdau Acos Especiais Piratini. The Ouro Branco mill delivers
its products directly to its costumers.
Gerdau Acos Especiais Piratini operates in the specialty steel market
and its sales force and production facility are independent of the Brazilian
long steel business unit. Gerdau Acos Especiais Piratini produces engineering
steel, tool steel and stainless stell.About 80% of its sales goes to the
automotive industry. In order to meet the continuous need for innovation, Gerdau
Acos Especiais Piratini is constantly developing new products in partnership
with its customers, such as micro alloyed stells for diesel engines with high
power and low emission, clean steels for application in bearings, steels with
improved machinability characteristics, which allow higher machining speeds and
lower tooling replacement, among others.
RETAIL
Gerdau Acominas sells its products nationwide through the Comercial
Gerdau network of 74 stores including six flat steel service centers. In
addition to Gerdau products, Comercial Gerdau sells flat products produced by
other companies in Brazil. In 2004, domestic market sales of flat steel products
amounted to 298,700 tons.
23
EXPORTS
Since 2003, Gerdau has begun exporting the larger part of its
production following the consolidation of its Brazilian operations, the decline
in domestic market sales and higher international prices. In 2004, exports
accounted for 42.2% of Gerdau Acominas' total shipments. Export activities are
coordinated by the Business Unit responsible for selling products directly to
end overseas users and indirectly through trading companies. The sales are
negotiated worldwide (i) primarily FOB (Free on Board) and (ii) guaranteed by
sight letters of credit opened by customers through first class European and
American banks.
In 2004, Gerdau Acominas' Brazilian exports generated $1,094 million in
revenues. The new strategy mentioned above combined with favorable steel product
prices in the international markets, has allowed Gerdau to develop its client
base in a more evenly distributed manner throughout the world with exports going
to Africa, Europe, South, Central and North America and Asia. Despite the
significant portion of exports to Asian countries - more than 30% of total
exported volumes -, China is not material to Gerdau's sales due to the country's
high level of volatility in finished steel consumption.
Gerdau Acominas' exports have become an even more significant portion
of its sales. Consequently, Gerdau Acominas has been making efforts to improve
logistics strategies for overcoming Brazilian infrastructure limitations. In
2004, exports were dispatched from 13 mills and downstream facilities to more
than 70 countries aboard 365 ships using the services of 18 different ports.
Although Gerdau Acominas deals primarily in commodities, it is aware of
the importance of quality control. The Company's technicians conduct random
visits to customers to check the quality of the products that it exports to
ensure user satisfaction with products purchased indirectly from Gerdau.
FOREIGN OPERATIONS
In South America, Gerdau AZA sold 378,500 tons of finished products in
2004, representing a 29.4% increase compared to 2003. Gerdau AZA has a 53% share
of the Chilean merchant bar and rebar market. 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 track their orders on the Internet, together with
product inventories, and credit and payment status. They can also access their
purchase record as well as generate quality certificates and place orders.
Gerdau Laisa, Uruguay, has approximately 300 registered customers
classified as retail, wholesale and end-consumers, which distribute its products
all over the country. Uruguayan customers can also use an e-business channel.
Among Gerdau's South American subsidiaries, Gerdau AZA in Chile relies
on a network of 140 independent distributors to sell its products along with its
own six sales outlets. Gerdau Laisa, in Uruguay, sells its products directly to
small-consumers at retail prices.
Gerdau's foreign operations supply their respective domestic markets,
with the exception of the Canadian operations, which sell a significant portion
of their production to the United States.
In general, the Tampa sales office centralizes and processes sales of
mill-finished products to U.S. customers while the Whitby sales office performs
the same function with Canadian customers. Gerdau Ameristeel also has a sales
office in Selkirk that processes sales of special sections.
The relevant sales offices are responsible for booking orders, mill
scheduling and inventory management. Gerdau Ameristeel has about 86 employees
dedicated to marketing and sales, a quarter of whom are located in the field
close to the 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
customer needs 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 pricing.
24
TERMS OF SALES
Gerdau Acominas' domestic sales are usually made on a 21-day settlement
CIF (Cost Insurance and Freight) basis. Comercial Gerdau, the retail arm of
Gerdau Acominas in Brazil sells on a 26-day settlement basis, either CIF (Cost
Insurance and Freight) or FOB (Free on Board).
Domestic customers are subject to a credit approval process. The
concession of credit limits is by a corporate-level system (SAP R/3), which can
be accessed by all Business Units. The credit and collection department is
responsible for credit evaluation, definition and monitoring in accordance with
the limits policy. This policy has the active participation of Business Units
officers related to the client.
At Comercial Gerdau, in particular, the criteria for retail sales also
include practices such as the use of credit cards serviced in Brazil.
Gerdau Acominas' exports are guaranteed via letter of credit and/or
pre-payment before the product is shipped. Exceptionally, exports to Gerdau
subsidiaries may be sold on credit at market interest rates.
As a result of the implementation of these policies, the Company's bad
provision for doubtful accounts was an insignificant percentage of its
consolidated accounts receivable (0.7%) on December 31, 2004. Thanks to the
implementation of the Integrated Risk Management Project, Gerdau has improved
its credit approval controls and enhanced the reliability of its sales process
through the use of risk indicators and internal controls.
Gerdau Ameristeel's credit terms to customers are generally based on
customary market conditions and practices. Gerdau Ameristeel's business is
seasonal with orders in the June and September quarters tending to be stronger
than those of the March and December quarters, due primarily to weather-related
slowdowns in the construction industry.
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 its entire product range. Gerdau
Acominas believes that its business diversification and decentralization provide
a competitive edge over its major competitors where operations are more
centralized.
Gerdau Acominas is the largest Brazilian long steel producer with a
48.7% market share according to the IBS (Brazilian Steel Institute). Belgo
Mineira is the second largest producer in Brazil with roughly 34.8% of the
market. Belgo Mineira was originally an integrated steel company, but now also
has mini-mill plants.
By contrast, Gerdau Acominas Ouro Branco mill supplies blooms and
billets almost exclusively to a well-defined domestic market and a loyal
customer base, which has been purchasing regularly from the unit for more than
ten years. Competition from CST (Companhia Siderurgica de Tubarao), and more
recently, Cosipa (Companhia Siderurgica Paulista) in the slab market is stiffer.
In foreign markets, the Ouro Branco mill faces strong competition in high
quality products from Eastern European suppliers (mainly from Russia and the
Ukraine), Italy and Japan. The Company's unit is nevertheless highly competitive
due to its long experience and high product quality, its on-time delivery record
and technical assistance to customers. The Ouro Branco mill thus has a
diversified client list of traditional customers in all the 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 imports. Gerdau AZA has
a 53% share of the Chilean domestic construction market and CAP - Compania Acero
Del Pacifico, a 44% share, with imports accounting for the remaining 3% 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.
25
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 the mills and merchant bar deliveries
within a 500-mile radius. Some products, such as special sections produced by
the Manitoba mill (MRM Special Sections), are shipped over greater distances, or
even exported.
Except in unusual circumstances, customer delivery expenses are limited
to freight charges from the nearest competitive mill. The company absorbs any
incremental freight charges, when they occur.
Gerdau Ameristeel's principal competitors are Commercial Metals
Corporation, Marion Steel Company, Nucor Corporation, Roanoke Electric Steel
Corporation, Sheffield Steel Corporation, Steel Dynamics Inc., Bayou Steel
Corporation and Chaparral Steel Company in the United States. Gallatin Steel
Company competes with numerous other integrated and mini-mill flat steel
producers.
Despite the commodity nature 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 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 is not subject to any specific regulation that materially affects its
business.
C. ORGANIZATIONAL STRUCTURE
---------------------------
GERDAU GROUP
------------
Gerdau S.A. is a non-operational holding company (since November, 2003
when Gerdau S.A.'s Brazilian assets were integrated with Acominas, creating
Gerdau Acominas S.A.) controlled by a holding company, (Metalurgica Gerdau
S.A.). Gerdau S.A. consolidates the results of five operating companies: Gerdau
Acominas S.A., Gerdau Ameristeel Corp (Canada) and its subsidiaries (United
States and Canada), Gerdau AZA (Chile), Gerdau Laisa (Uruguay) and Seiva
(Brazil), operating in the forestry business.
The Company's investments in Sipar Aceros S.A. in Argentina (in which
it holds a 38% stake), those in Gallatin, Bradley Steel Processor and MRM Guide
Rail in North America, 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 accounted in the
Company's financial statements using the equity accounting method.
SIGNIFICANT SUBSIDIARIES
-------------------------
The table below shows the main companies and investments maintained
directly or indirectly by Gerdau on December 31, 2004:
COMPANY COUNTRY STAKE IN VOTING STAKE IN TOTAL
CAPITAL CAPITAL
Gerdau Ameristeel Corp. and subsidiaries Canada 67% 67%
Ameristeel Bright Bar Inc. USA 67% 67%
Gerdau Ameristeel MRM Special Sections Inc. Canada 67% 67%
Gerdau Ameristeel Perth Amboy Inc. USA 67% 67%
Gerdau Ameristeel Sayreville Inc. USA 67% 67%
Gerdau Ameristeel US Inc. USA 67% 67%
26
Gerdau Acominas S.A. Brazil 92% 92%
Gerdau AZA S.A. Chile 100% 100%
Gerdau Laisa S.A. Uruguay 99% 99%
Maranhao Gusa S.A. - Margusa Brazil 100% 100%
Seiva S.A. - Florestas e Industrias and subsidiaries Brazil 97% 97%
The operating companies that are fully consolidated or accounted
according to the equity method in the financial statements of Gerdau S.A. are
described below:
GERDAU ACOMINAS
Gerdau Acominas has ten mills in Brazil, distributed throughout the
country. In the state of Rio Grande do Sul, it owns the Gerdau Acos Especiais
Piratini and the Gerdau Riograndense units. In the state of Parana, it 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.
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 an annual production capacity of 70,000 tons of crude
steel and 72,000 tons of rolled products.
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 a 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
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 rebar market to be about 53%.
SIPAR
Gerdau entered the Argentinean market in December 1997. Following the
financial and corporate restructuring of its operations in Argentina due to the
prevailing economic environment, the Company currently holds a 38.2% stake in
Sipar, a rolling mill with an annual installed capacity of 240,000 tons.
GERDAU AMERISTEEL
In September 1999, Gerdau acquired 75% of Ameristeel from Kyoei Steel
Ltd. of Japan. At that time, Ameristeel operated four mills on the East Coast:
one unit in Florida, two in Tennessee, and one in North Carolina. In 2000,
Gerdau acquired an additional 12% stake from Kyoei, increasing its overall 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 with Co-Steel
to create Gerdau Ameristeel. As a result of this merger, Gerdau's interest in
Gerdau Ameristeel was reduced to 67%.
In November 2004, Gerdau Ameristeel acquired from Cargill Incorporated,
the fixed assets and working capital of four long steel product mini mills,
three wire rod processing facilities and a grinding ball facility in Duluth,
Minnesota, which are referred to as North Star Steel.
Currently, Gerdau Ameristeel has a nominal annual capacity of 7.6
million tons of crude steel and 6.9 million tons of rolled products. Gerdau S.A.
now holds a stake of 66.5% following the public offering in October 2004 and the
exercising of the over-allotment option in November 2004. The Company is the
second largest producer of long steel in North America and is listed on the
Toronto Stock Exchange and the New York Stock Exchange, under the ticker symbols
GNA.TO and GNA, respectively.
27
OTHER BUSINESSES
----------------
SEIVA S.A. - FLORESTAS E INDUSTRIAS
Seiva was incorporated on December 29, 1971 to implement reforestation
projects in accordance with Decree 1,134/70. Seiva's 55 employees (in December
2004) are responsible for the development, implementation, and maintenance of
the Company's pine reforestation projects.
DONA FRANCISCA ENERGETICA S.A.
Dona Francisca Energetica S.A. (DFESA) is an operational hydroelectric
power plant with a nominal capacity of 125 MW, located in the center of the
state of Rio Grande do Sul.
DFESA's corporate purpose is to operate, maintain and maximize the use
of the Dona Francisca Hydroelectric Plant energy potential.
In conjunction with the state power utility, Companhia Estadual de
Energia Eletrica - CEEE, Dona Francisca shareholders participate in a consortium
(Consorcio Dona Francisca) formed in accordance with 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.'s shareholders are: Gerdau S.A.
(51.8%), Companhia Paranaense de Energia - COPEL (23.0%), Celesc (23.0%), and
Desenvix (2.2%).
GERDAU ACOMINAS MINING RIGHTS
Gerdau Acominas has added 15 mining concessions covering 7,000 hectares
to its business following the acquisition of land and mining rights from the
Votorantim Group. These mines are located at Miguel Bournier, Varzea do Lopes
and Gongo Soco, in the state of Minas Gerais. According to the results of
preliminary prospecting reports, mineral reserves represent an estimated 500
million tons of ore. Complementary surveys are to be carried out to detail the
full potential of the mines, which are intended to provide feedstock to the Ouro
Branco mill and believed to represent at least 100 years of potential iron ore
supply. The privileged location of these mines in the state of Minas Gerais iron
belt and in the vicinity of the Ouro Branco mill is expected to contribute to
the long-term competitiveness of this unit.
MARGUSA
Margusa - Maranhao Gusa S.A. has an annual installed capacity of 200,000 tons
of pig iron. The mill is located 50 km from Sao Luis and 48 km from a coastal
port. The acquisition is part of the Company's strategy to ensure 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
---------------------------------------------------------
NEW SPECIALTY STEEL MILL IN RIO DE JANEIRO
------------------------------------------
As announced last December, $293.0 million is planned to be invested by
2007 in the construction of a new specialty steel mill in Rio de Janeiro. The
new unit is intended to meet the demand from the automotive industry. Its annual
installed capacity is expected to be 800,000 tons of crude steel and 500,000
tons of rolled products.
ENHANCEMENT OF INSTALLED CAPACITY AT GERDAU COSIGUA
---------------------------------------------------
The Company will invest $174.0 million up to 2007 in the expansion of
its Gerdau Cosigua mill in the state of Rio de Janeiro. Gerdau Cosigua's annual
crude steel capacity is to be increased from 1.2 to 1.8 million ton, and rolled
products, from 1.3 to 1.6 million tons. With this investment, the Gerdau Cosigua
mill will enlarge its capability to supply the metallurgical and the civil
construction industries as well as the agriculture and ranching sectors.
28
ENVIRONMENTAL ISSUES
Gerdau S.A is in compliance with government environmental regulations.
The Company believes that there are no environmental issues that might affect
its use of the fixed assets described below.
MATERIAL TANGIBLE FIXED ASSETS
Gerdau's principal properties of installations for the production of
steel, rolled products and drawn products. The following is a list showing the
location, capacity and type of installation, as well as the types of products
manufactured:
29
LOCATION OF PLANTS, CAPACITY, EQUIPMENT AND PRODUCTS
(thousand tons/year)
PIG IRON/ ROLLED DRAWN
LOCATION OF PLANTS SPONGE IRON CRUDE STEEL PRODUCTS
CAPACITY CAPACITY CAPACITY
Aconorte - 250 240
Agua Funda - - 305
Barao de Cocais (1) 330 350 200
Cearense - 130 110
Cosigua - 1,400 1,320
Divinopolis (1) 360 600 550
Guaira - 510 130
Gerdau Acominas (1) 2,800 3,000 655
(Ouro Branco)
Piratini - 375 390
Riograndense - 440 400
Usiba (1) 460 520 430
Contagem 240 - -
Margusa 200 - -
BRAZIL 4,390 7,575 4,730
AZA - 440 465
Laisa - 70 72
SOUTH AMERICA - 510 537
Whitby - 871 726
Cambridge - 327 290
Manitoba - 349 327
Cartersville - 780 581
Charlotte - 417 318
Jackson - 608 544
Jacksonville - 581 581
Knoxville - 499 472
St. Paul - 544 499
Calverty City - - 295
Wilton - 318 295
Beaumont - 771 726
Perth Amboy - 816 726
Sayerville - 726 544
NORTH AMERICA - 7,607 6,924
GERDAU TOTAL 4,390 15,692 12,191
LOCATION OF PLANTS PRODUCTS
CAPACITY EQUIPMENT PRODUCTS
Aconorte 85 EAF mini-mill, rolling mill, drawing mill, nail and Rebar, merchant bars, wire rod, drawn
clamp factory products and nails
Agua Funda - Rolling Mill Rebar and merchant bar
Barao de Cocais (1) - Integrated/blast furnace, LD converter and rolling Rebar and merchant bar
mill
Cearense - EAF mini-mill, rolling mill Rebar and merchant bar
Cosigua 290 EAF mini-mill, rolling mill, drawing mill, nail and Rebar, merchant bars, wire rod, drawn
clamp factory products and nails
Divinopolis (1) - Integrated/blast furnace, EOF converter and rolling Rebar and merchant bar
mill
Guaira - EAF mini-mill, rolling mill Billet, rebar, merchant bar
Gerdau Acominas (1) - Integrated with blast furnace Billets, blooms, slabs, rebar, merchant
(Ouro Branco) bars, wire rod and heavy structural shapes
Piratini - EAF mini-mill, rolling mill Specialty steels
Riograndense 130 EAF mini-mill, rolling mill, drawing mill, nail and Rebar, merchant bars, wire rod, drawn
clamp factory products and nails
Usiba (1) 30 Integrated with DRI, EAF mini-mill, rolling mill, Rebar, merchant bars, wire rod, drawn
drawing mill products
Contagem - Blast furnace Pig iron
Margusa - Blast furnace Pig iron
BRAZIL 535 - -
AZA - EAF mini-mill, rolling mill Rebar and merchant bar
Laisa - EAF mini-mill, rolling mill Rebar and merchant bar
SOUTH AMERICA - - -
Whitby - EAF mini-mill, rolling mill Structural shapes, rebar and merchant bar
Cambridge - EAF mini-mill, rolling mill Rebar and merchant bar
Manitoba - EAF mini-mill, rolling mill Special sections, merchant bar and rebar
Cartersville - EAF mini-mill, rolling mill Merchant bar, structural shapes and beams
Charlotte - EAF mini-mill, rolling mill Rebar and merchant bar
Jackson - EAF mini-mill, rolling mill Rebar and merchant bar
Jacksonville - EAF mini-mill, rolling mill Rebar and wire rod
Knoxville - EAF mini-mill, rolling mill Rebar
St. Paul - EAF mini-mill, rolling mill Rebar and merchant bar
Calverty City - Rolling Mill Merchant bar
Wilton - EAF mini-mill, rolling mill Rebar and merchant bar
Beaumont - EAF mini-mill, rolling mill Rebar, wire rod and reinforcing mesh
Perth Amboy - EAF mini-mill, rolling mill Wire rod products
Sayerville - EAF mini-mill, rolling mill Rebar
NORTH AMERICA - - -
GERDAU TOTAL 535 - -
Note (1): While EAF (electric arc furnace) mills produce crude steel from raw
materials such as steel scrap or pig iron, 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.
30
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A. OPERATING RESULTS
OVERVIEW
The year 2004 was, perhaps, the best in the history of steel making at
Gerdau. International demand, led by China, and the resumption of economic
growth in Brazil, saw record profits at the Group's companies. The Chinese
influence in the steel and raw materials' markets has changed the status quo
with prices of inputs increasing significantly and driving steel product prices
to levels never seen before.
The world steel industry set a new record producing one billion metric
tons in 2004, prompting forecasts that world output will continue to increase
with China in the lead. The restructuring of the steel sector in recent years
has been one of the key factors driving this expansion. The elimination of
several inefficient mills in 2002 and 2003 and the consolidation process
promoted by the major world steel companies have helped to rationalize
international sales and prices.
SIGNIFICANT FACTORS MATERIALLY AFFECTING THE COMPANY'S RESULTS
DEMAND
Sales in 2004 reached 11.9 million tons, 3.7% greater than those of
2003. Sales in North America totaled 4.7 million tons, 5.8% more than in the
previous year. Units in Chile and Uruguay shipped a total of 438.600 tons, an
increase of 25.9%. At Gerdau Acominas, the company in which the Brazilian
operations are concentrated, domestic shipments were the highlight of 2004, the
consequence of greater consumption by the civil construction sector and a strong
growth in the demand from the industrial sector. With shipments totaling 3.9
million tons and representing 57.8% of Company sales in Brazil, this volume was
15.0% greater than that of 2003. The solid demand in the domestic market more
than compensated for the year-on-year decrease of 13.3% in export volumes.
Exports contributed 42.2% of sales from the Brazilian units and generated
revenues of $1.1 billion in the fiscal year.
Sales from the overseas operations combined with exports from Brazil
represented 67.3% of the consolidated volume in 2004, compared to 70.5% in 2003.
PRODUCTION CAPACITY
Gerdau's growth objective is to consolidate its position as a leader in
the Americas in long steel production. Recent acquisitions and agreements
reaffirm the Company's faith in the continent's growth potential and have
encouraged the search for new opportunities. Consequently, during 2004 the
Company agreed to acquire operations in Colombia and concluded purchases in
North America.
In North America, Gerdau Ameristeel's acquisition of the North Star
assets made a significant contribution to the expansion of the Company's
geographical coverage of the United States Midwest and South. The North Star
Steel assets have the capacity to produce approximately 2.0 million short tons
of long steel and transform up to 300,000 short tons into greater value-added
products. With this acquisition, the North American operations now have a total
capacity of approximately 6.9 million metric tons of rolled products. These
assets were acquired for less than $50 per ton of installed capacity while the
average cost to build a greenfield plant would normally exceed $200 per ton.
The production of slabs, blooms and billets rose to 12.7 million tons
in 2004, 9.3% more than in 2003. Rolled product output, the subsequent stage in
the production chain, reached 9.5 million tons, a growth of 14.4% compared to
the volume for the previous year. This performance was partially due to the
consolidation of output from North Star Steel for the months of November and
December.
31
GERDAU S.A. CONSOLIDATED VARIATION
PRODUCTION 2004 2003 2004/2003
(1,000 tons)
SLABS, BLOOMS AND BILLETS*
Brazil 7,284.5 6,975.9 4.4%
North America 5,035.7 4,344.2 15.9%
South America 428.2 346.8 23.5%
TOTAL 12,748.4 11,666.9 9.3%
ROLLED PRODUCTS*
Brazil 4,338.7 3,890.6 11.5%
North America 4,759.1 4,107.2 15.9%
South America 402.6 309.3 30.2%
TOTAL 9,500.4 8,307.1 14.4%
* The rolling process relies on raw materials produced at the melt shops such as
slabs, blooms and billets. Part of these products is sold directly to external
customers and the remainder used in the rolling process.
The Brazil units produced 7.3 million tons of steel annually, a volume
4.4% greater than in 2003 and corresponding to 57.1% of the consolidated output.
In North America, production was 15.9% greater, reaching 5.0 million tons (39.5%
of the total). The companies in Chile and Uruguay produced 428,200 tons (3.4% of
the total), posting a growth of 23.5%.
The Gerdau companies' production of rolled products in Brazil amounted
to 4.3 million tons in 2004, an increase of 11.5%. In North America and South
America, production grew 15.9% and 30.2%, respectively, to reach 4.8 million
tons and 402,600 tons, reflecting the good economic performance of these
regions.
SIGNIFICANT EVENTS AFFECTING FINANCIAL PERFORMANCE DURING 2004
In addition to increased sales and prices, the results of operations of
Gerdau were positively impacted by a series of events that resulted in a
year-on-year improvement in net income. Some of the most relevant events are
described below.
- During 2004 Gerdau enhanced its presence in important markets such as
the North American Mid-West through the acquisition of assets in this
region. In November, Gerdau Ameristeel concluded the acquisition of the
fixed assets and working capital of North Star Steel (four long steel
producing mills, three wire-rod processing facilities and a unit
producing grinding balls for the mining industry). In December, Gerdau
Ameristeel also concluded the acquisition of assets from Gate City
Steel, Inc. and RJ Rebar, Inc and in June 2004, the acquisition of
substantially all the assets of Potter Form & Tie Co., headquartered in
Belvidere, Illinois. These units are suppliers of fabricated rebars,
with and without epoxy coating, to the Midwest and South regions of the
USA.
- The results for 2004 were impacted positively by a gain of $43.5
million ($28.7 million, net of taxes), accounted as Other Operating
Income following the final settlement of a lawsuit in which Gerdau S.A.
challenged payment of PIS taxes on the grounds of the
unconstitutionality of executive laws 2,445/88 and 2,449/88. - See Item
18. Financial Statements - Note 16.
- The provision for income tax and social contribution in fiscal year
2004 was impacted by the recognition of $168.9 million in fiscal
credits arising from tax losses generated in previous years. - See Note
18. Financial Statements.
- Equity pick up was $141.9 million in the full year, originated mainly
from the positive results of the Gallatin, Bradley Steel Processors and
MRM Guide Rail joint ventures. The same factors that contributed to the
positive results at Gerdau S.A., such as good market conditions, high
international steel prices and strong demand also favorably impacted
the financial results of these steel companies.
32
IMPACT OF INFLATION AND FLUCTUATIONS IN EXCHANGE RATES
Gerdau's results and its financial position depend largely on the
situation of the Brazilian economy, notably (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
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. Following the implementation of the Real Plan, the
Brazilian GDP increased, rising by 4.4% in 2000, 1.4% in 2001, 1.5% in 2002,
decreasing by 0.2% in 2003 and increasing again by 5.2% in 2004.
The following table presents Brazilian inflation and the performance of
the Brazilian currency against the U.S. dollar for the periods shown. For a
discussion of the foreign exchange rate in Brazil generally see "Item 10.D.
Exchange Controls - Exchange Rates."
January to Year Ended December 31
May
2005 2004 2003 2002 2001 2000
Inflation (INPC base) 2.67% 6.13% 10.38% 14.74% 9.44% 5.27%
Inflation (IGP-M) 2.19% 12.42% 8.69% 25.30% 10.37% 9.96%
Appreciation (devaluation) of $ versus -9.44% -8.13% -18.23% 52.27% 18.67% 9.30%
Brazilian real
In a positive economic environment, the real appreciated against the
U.S. dollar throughout 2004 leading to a significant improvement in Brazilian
country risk and a gradual reduction in interest rates.
At the end of 2002 and the beginning of 2003, higher inflation
generated a divergence in the frequency and size of price and wage adjustments,
resulting in an erosion of purchasing power. This gap has narrowed significantly
due to recent low inflation rates and increased consumer demand.
A portion of Gerdau's trade accounts receivable, trade accounts payable
and debt is denominated in currencies different to the respective functional
currency of each subsidiary. Gerdau Acominas' functional currency is the
Brazilian real. Gerdau Acominas has foreign currency denominated assets and
liabilities, mainly in U.S. dollars, its financial position and results being
affected by changes in the exchange rate of the Brazilian real in relation to
the U.S. dollar. In 2004 and 2003, Gerdau's results were affected by the
appreciation of the Brazilian real against the U.S. dollar, generating losses in
its U.S. dollar-denominated trade accounts receivable from exports, and
generating gains in the U.S. dollar denominated trade accounts payable and also
debt. Despite the reduction of net debt balances (defined as short and long term
debt less short term investments, restricted cash and cash and cash equivalents)
during 2004 compared to 2003, the appreciation of the real, together with the
increase in the balance of trade accounts receivable and trade accounts payable,
also generated a net foreign exchange gain during 2004, duly recorded in the
income statement. Gerdau's financial statements are 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 the consolidated
statements presented in U.S. dollars.
33
NET INCOME FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
The table below contains information for various income statement
items, expressed as a percentage of net sales for each of the respective years:
FISCAL YEAR ENDING DECEMBER 31,
2004 2003 2002
Net Sales 100.0% 100.0% 100.0%
Cost of Sales (69.5%) (76.0%) (72.0%)
Gross Profit 30.5% 24.0% 28.0%
Sales and Marketing Expenses (2.2%) (3.2%) (3.5%)
Financial expenses and Financial income, net (0.7%) (4.3%) (9.9%)
General and Administrative Expenses (5.2%) (5.3%) (6.8%)
Operating Income 23.5% 15.4% 17.2 %
Net Income 16.6% 11.3% 7.1%
The table below contains information for various income statement items,
expressed in US$ millions:
FISCAL YEAR ENDING DECEMBER 31,
2004 2003 2002
Net Sales 6,952 4,531 3,265
Cost of Sales (4,839) (3,446) (2,350)
Gross Profit 2,113 1,085 915
Sales and Marketing Expenses (115) (146) (113)
Financial expenses and Financial income, net (51) (193) (324)
General and Administrative Expenses (359) (242) (222)
Operating Income 1,628 696 562
Net Income 1,158 510 232
FISCAL YEAR ENDED DECEMBER 31, 2004 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 2003
SHIPMENTS
Consolidated shipments in 2004 totaled 11.9 million tons, 3.7% higher
than sales in 2003. In North America, 4.7 million tons were sold, 5.8% more than
in the previous year. The Chilean and Uruguayan units posted volumes of 438,600
tons, an increase of 25.9%. Operations in Brazil were responsible for 56.5% of
the consolidated shipments of 6.7 million tons.
GERDAU S.A. CONSOLIDATED VARIATION
SHIPMENTS 2004 2003 2004/2003
(1,000 tons)
BRAZIL
Domestic market 3,881.4 3,376.1 15.0%
Exports 2,829.7 3,263.4 (13.3%)
TOTAL 6,711.1 6,639.5 1.1%
ABROAD
North America 4,723.7 4,465.6 5.8%
South America 438.6 348.4 25.9%
TOTAL 5,162.3 4,814.0 7.2%
CONSOLIDATED TOTAL 11,873.4 11,453.5 3.7%
34
Shipments to domestic customers were the highlight of 2004 at Gerdau
Acominas due to higher consumption from the civil construction sector and strong
industrial demand. Shipments totaled 3.9 million tons for the year, 15.0% higher
than sales in 2003 and 57.8% of Gerdau Acominas' total deliveries.
Robust domestic market demand, coupled with preferential service to
customers in Brazil, fully offset the reduction in exports, which were 13.3%
lower than the previous year in volume terms. Exports accounted for 42.2% of the
total sales of the Brazilian operation, generating a net total of $1.1 billion
for the year.
In North America, the increase in tons reflects stronger steel demand
compared with 2003 in addition to two months' shipments of approximately 153,420
tons by recently acquired mills.
GERDAU S.A. CONSOLIDATED
SHIPMENTS BY PRODUCT LINE 2004
(%)
Slabs, Blooms and Billets 20%
Long Rolled Products 68%
Draw Products 7%
Specialty Steel 3%
Flat Steel (Resale) 2%
TOTAL 100%
CONSOLIDATED TOTAL TONS 11,873.4
Overseas sales in addition to the Brazilian exports accounted for 67.3%
of consolidated shipments, against 70.5% in 2003.
The Company's net sales reached $6,952.1 million in 2004, 53.4% more
than 2003 ($4,531.0 million). Of this amount, 52.1% ($3,623.0 million) came from
operations in Brazil, 43.3% ($3,009.8 million) from the North American units,
and 4.6% ($319.2 million) from the companies in Chile and Uruguay. The better
results from the operations abroad, the increase in international market prices
and the recovery in domestic demand, in addition to the consolidation of new
units acquired in 2004, all contributed to this performance.
GERDAU S.A. CONSOLIDATED VARIATION
NET SALES 2004 2003 2004/2003
($ millions)
Brazil 3,623,0 2,597.8 39.5%
North America 3,009.9 1,811.2 66.2%
South America 319.2 122.0 161.6%
CONSOLIDATED TOTAL 6,952.1 4,531.0 53.4%
The average net price was $589.7/ton, an increase from $397.5/ton in
2003.
COST OF SALES AND GROSS PROFIT
Gross margin reached 30.4% in 2004, against 24.0% in 2003. This
reflected improved margins from the Brazilian operations following adjustments
in sale prices due to higher raw material costs and increased international
market prices, strongly favoring exports and the North America business. Gross
profit reached $2,113.2 million in 2004, against $1,085.4 million in 2003, a
growth of 94.7%.
OPERATING INCOME
Operating expenses (sales and marketing, general and administrative and
other expenses) increased 32.3% in 2004, compared to 2003, against a growth of
53.4% in net sales, the ratio of sales and marketing plus general and
35
administrative expenses to net sales falling from 8.6% to 7.4%. This reduction
reflects mainly lower export volumes (reducing port costs) and lower expenses at
Gerdau Ameristeel. In 2004, consolidated operating expenses, excluding other
operating expenses, were $513.7 million against $388.2 million in 2003.
The gains resulting from the final non-appealable court ruling in favor
of Gerdau and Gerdau Acominas in a lawsuit brought against the payment of PIS
taxes based on the unconstitutionality of Decree-Laws 2445/88 and 2449/88 and
totaling $43.5 million, were booked under Other Operating Income in 2004.
FINANCIAL EXPENSES AND FINANCIAL INCOME
In the fiscal year 2004, net financial expenses (which comprise
financial income, financial expenses, foreign exchange gains and losses and
gains and losses with derivatives) totaled $50.8 million, against $192.7 million
in the previous year. This decrease in expenses is due mainly to the increase in
financial investments, as a result of the greater cash generation in the period,
and to a reduction in the debt cost. Additionally, the maturity, during 2004, of
the majority of the cross-currency rate swap contracts kept in 2003 and the fact
that no new contracts were celebrated, resulted in reduction of losses on
derivatives in 2004.
EQUITY INCOME (LOSSES) FROM UNCONSOLIDATED COMPANIES, NET
Equity pick up was positive in $141.9 million, originating mainly from
positive results of the 50% joint ventures in Gallatin, Bradley Steel Processors
and MRM Guide Rail and reflecting the good performance of the steel making
business.
PROVISION FOR INCOME TAX
In 2004, provision for Income Tax and Social Contribution was affected
by the recognition of deferred tax assets corresponding to tax loss carry
forwards in the amounts of $120.3 million and $48.6 million by Gerdau Acominas
and Gerdau Ameristeel, respectively. This reflects a review of the probability
of realizing these tax loss carryforwards considering current levels of
profitability against an amount of $137.3 million recorded by Gerdau Acominas in
2003.
NET INCOME
In 2004, consolidated net income amounted to $1,158.4 million, 127.1%
higher than $510.2 million in 2003. As already mentioned, there was a
substantial contribution to this profit from the overseas operations and the
better margins on exports thanks to the increase in international market prices.
Net margin (defined as net income divided by net sales) went up from 11.3% in
2003 to 16.7% in 2004.
FISCAL YEAR ENDED DECEMBER 31, 2003 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
2002
Results for the fiscal year 2003 reflect the consolidation of Acominas
and Co-Steel for the full year, whereas in 2002, the results of Acominas were
only consolidated from February 2002, and those of Co-Steel from October 2002.
Other factors that contributed to performance were the improved level of
activity at the Ouro Branco mill, following the accident in March 2002, which
disrupted production until September 2002, and improved international prices and
demand.
NET SALES
Net sales in 2003 amounted to $4,531.0 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 $397.5/ton, which increased from $363.9/ton
in 2002.
Of total net sales, the Brazilian operations accounted for $2,597.8
million, a 23.0% increase relative to the fiscal year 2002. Sales of the South
American operations increased by 22.7% to $122.0 million, while the net revenues
of the Gerdau Ameristeel operation increased by 71.9% from $1,053.8 million to
$1,811.2 million over the same period, following the full consolidation of its
nine North American operations, a significant increase in regional prices and an
36
improvement in market conditions.
COST OF SALES AND GROSS PROFIT
Cost of sales as a percentage of net revenues increased to 76.0% in
2003 from 72.0% in 2002, representing an increase of 46.6% in absolute terms
against a 38.8% increase in net revenues. This result produced a decline in
gross margin for 2003 to 24.0% from 28.0% in the previous year, particularly due
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% to
$1,085.4 million.
OPERATING INCOME
Operating expenses (sales and marketing, general and administrative
expenses) rose 16.1% in 2003 to $388.2 million. In spite of this increase,
however, operating expenses (excluding other operating expenses) fell as a
percentage of net sales to 8.6% in 2003 from 10.2% in 2002. In 2003, operating
income rose 23.8% relative to the preceding year, to $696.3 million, although
the increase in cost of sales led to a fall in operating margin over the same
period from 17.2% to 15.4%.
FINANCIAL EXPENSES AND FINANCIAL INCOME
In 2003, net financial expenses (which comprise financial income,
financial expenses, foreign exchange gains and losses and gains and losses on
derivatives) amounted to $192.7 million, 40.5% below that of the previous year.
This figure represents financial expenses of $219.4 million, foreign exchange
gains of $162.2 million, loss on derivatives of $197.6 million and financial
income of $62.0 million. The reduction in net financial expenses in 2003 was
principally due to the foreign exchange gain from the appreciation of the
Brazilian real against the U.S. dollar, together with the increase in assets
denominated in U.S. dollar, mainly trade accounts receivable, influenced by
increased exports from Brazil.
EQUITY INCOME (LOSSES) FROM UNCONSOLIDATED COMPANIES, NET
Equity pickup of $22.1 million in 2003 resulted from earnings from
unconsolidated companies in Argentina, Chile, the United States and Brazil, most
of this figure being generated by Gallatin and Dona Francisca Energetica S.A. In
2003, equity pickup included Gallatin's net income for the full period of 12
months, whereas in 2002, equity pickup 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 equity pickup for that year, while in 2003, its operations
generated a net income.
PROVISION FOR INCOME TAX
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 the corporate reorganization in November
2003. This amount reflects tax losses generated in previous years at the former
Acominas plant. The Company is permitted to offset these against taxable income
generated by its Brazilian steel operations, which include from November 2003,
those formerly owned by Gerdau S.A. and transferred to Gerdau Acominas as a
result of the corporate reorganization.
NET INCOME
Due to higher sales, lower operating expenses, lower net financial
expenses and the income tax credit, net income amounted to $510.2 million in
2003, a year-on-year increase of 120.1%. Net margin rose to 11.3% from 7.1% in
2002.
37
B. LIQUIDITY AND CAPITAL RESOURCES
Net cash generated by operating activities amounted to $350.5 million,
$468.5 million and $1,147.0 million for the years ended December 31, 2002, 2003
and 2004, respectively, giving a cumulative total for the three years of
$1,966.0 million. Net cash generated by operating activities was one of the main
sources of liquidity used by the Company. Cumulative short and long-term
financing amounted to $4,466.5 million for the three-year period contributing
$1,186.1 million in 2002, $1,998.0 million in 2003 and $1,290.0 million in 2004
towards the Company's liquidity requirements. Disposals of fixed assets
generated cumulative proceeds of $8.3 million for the years 2002, 2003 and 2004.
In 2004, the main uses of capital resources were: $441.0 million for
investment in fixed assets, $298.4 million for the acquisition of businesses in
North America, $1,273.2 million for repayment of maturing short and long-term
debt and $275.6 million for distribution of dividends. In 2003, the main uses of
capital resources were: $297.8 million for investment in fixed assets, $2,126.5
million for repayment of maturing short and long-term debt and $122.3 million
for the distribution of dividends. In 2002, the main uses of capital resources
were: $185.9 million for investment in fixed assets, $824.9 million for
repayment of maturing short and long-term debt and $74.3 million for
distribution of dividends. Resources invested in fixed assets from 2002 to 2004
($924.7 million) were used to modernize the Company's industrial plants and
subsidiaries and to upgrade their technology.
Between December 31, 2003 and December 31, 2004, net working capital
(current assets less current liabilities) increased by $1,310.0 million, from
$300.7 million in 2003 to $1,610.7 million in 2004. Between December 31, 2002
and December 31, 2003, net working capital increased by $364.2 million from a
negative $63.6 million in 2002 to a positive $300.7 million in 2003. The
increase in 2004 was primarily due to (i) the increase in financial investments,
as a result of the greater cash generation in the period, (ii) an increase in
inventory and accounts receivable as a result of higher steel output and sales
and (iii) the consolidation of assets from North Star operations in the period.
On October 15, 2004, Gerdau Ameristeel issued 70,000,000 Common Shares
at a value of Cdn$5.90 per share ($4.70 per share at the exchange rate on the
date of the transaction) totaling net proceeds of approximately $322.7 million
after deducting underwriters' fees and estimated expenses. Gerdau purchased
35,000,000 of the Common Shares, representing 50% of the total Common Shares
offered, for net proceeds totaling $161.3 million after deducting underwriters'
fees and expenses.
Subsequently, on November 18, 2004, the underwriters of the public
offering of Common Shares above exercised their over-allotment option to
purchase an additional 4,381,000 Common Shares of Gerdau Ameristeel at the
initial public offering price of Cdn$5.90 per share. As agreed in a subscription
agreement with Gerdau Ameristeel, Gerdau S.A. purchased the same number of
additional Common Shares as the underwriters pursuant to the exercise of their
over-allotment option at $4.70 per share, the U.S. dollar equivalent of the
public offering price. The net amount to Gerdau Ameristeel after deducting
underwriters' fees and estimated expenses amounted to $39.9 million, of which $
20.0 million was paid by Gerdau.
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 total borrowings (total debt excluding debentures and
loans from the parent company) stood at $1,953.7 million and $1,930.9 million as
of December 31, 2004 and 2003, respectively. On the same dates, balances of
short-term investments and cash and cash equivalents (including "Restricted
cash") stood at $659.5 million and $330.6 million, respectively.
Total debt amounted to $2,299.6 million in 2004 and $2,088.6 million in
2003. Net debt (defined as short and long-term debt plus debentures less
short-term investments, restricted cash and cash and cash equivalents) decreased
from $1,758.0 million in 2003, to $1,640.1 million in 2004 due to the greater
cash generation, improved domestic demand for steel, coupled with the rise in
international market prices.
38
In 2004, net financial expense amounted to $50.8 million against $192.7
million in 2003. This improvement is due to the greater cash generation (due to
the improvement in steel product demand). Additionally, net financial expense in
2004 reflected foreign exchange gains ($30.8 million) due to the appreciation of
the Brazilian real, which impacted U.S. dollar denominated assets and
liabilities, most notably trade accounts receivable, debt and trade accounts
payable and to a lesser extent, the gains generated from derivative operations
($1.2 million). Furthermore, the maturity, during 2004, of the majority of the
cross-currency rate swap contracts kept in 2003 and the fact that no new
contracts were celebrated, resulted in reduction of losses on derivatives in
2004.
The following table profiles the Company's debt on December 31, 2004 and 2003 (in thousands of U.S. dollars):
2004 2003
SHORT TERM:
SHORT-TERM DEBT:
Debt denominated in reais 1,724 29,527
Debt denominated in foreign currency 411,186 450,059
TOTAL SHORT TERM DEBT 412,910 479,586
CURRENT PORTION OF LONG-TERM DEBT:
Debt denominated in reais 70,616 49,470
Debt denominated in foreign currency 189,678 269,440
TOTAL CURRENT PORTION OF LONG-TERM DEBT 260,294 318,910
Debentures(a) 1,125 1,048
Short-term debt, parent company(a) - 1,173
SHORT-TERM DEBT PLUS CURRENT PORTION OF LONG-TERM DEBT, DEBENTURES AND PARENT COMPANY 674,329 800,717
LONG TERM:
LONG-TERM DEBT, LESS CURRENT PORTION:
Debt denominated in reais 179,362 160,500
Debt denominated in foreign currency 1,101,154 971,929
TOTAL LONG TERM DEBT 1,280,516 1,132,429
Debentures 344,743 155,420
LONG-TERM DEBT PLUS DEBENTURES 1,625,259 1,287,849
TOTAL DEBT PLUS DEBENTURES, CURRENT PORTION OF LONG-TERM DEBT AND PARENT COMPANY 2,299,588 2,088,566
Short-term investments, restricted cash, cash and cash equivalents 659,529 330,576
NET DEBT PLUS DEBENTURES, CURRENT PORTION OF LONG-TERM DEBT AND PARENT COMPANY 1,640,059 1,757,990
(a) Recorded under "other current liabilities".
On December 31, 2004, the Company's total debt plus debentures, the
current portion of long term debt and parent company debt amounted to $2,299.6
million. Of this balance, $512.6 million (22.3%) was denominated in Brazilian
reais and $1,787.0 million (77.7%) in foreign currency.
SHORT TERM
As of December 31, 2004, the Company's short-term debt amounted to
$412.9 million. Of this total, $1.7 million related to financing in reais and
$411.2 million in foreign currencies. The current portion of the Company's
long-term debt and debentures amounted to $261.4 million, of which $70.6 million
in reais and $190.8 million in foreign currencies. In 2004, short-term debt plus
the current portion of long-term debt, debentures and financing from the parent
company amounted to $674.3 million, representing a reduction of 15.8% relative
to 2003, due to the restructuring of Gerdau Acominas' debt profile.
The main sources of Gerdau's short-term financing are working capital
loans and pre-export advances.
LONG TERM
Long-term debt including debentures amounted to $1,625.3 million as of
December 31, 2004. Of this total, $1,280.5 million represented loans from
financial institutions, of which $179.4 million was denominated in reais and
$1,101.2 million in foreign currency. Of total long-term debt, $344.7 million
represents debentures, of which $83.8 million was denominated in foreign
currency and $260.9 million in reais.
39
Approximately 55.1% of the $1,101.2 million of long term loans
denominated in foreign currency, excluding the current portion of long-term debt
and debentures, was contracted by the Company and its Brazilian subsidiaries and
44.9% by the Company's foreign subsidiaries.
Information on the terms of long-term debt costs is presented in Item
18. Financial Statements - Note 15 Long-Term Debt and Debentures. For additional
information, see Item 11. Quantitative and Qualitative Disclosures about Market
Risks.
Gerdau S.A. has entered into financial agreements to fund and improve
its debt profile. The most significant financial agreements contracted in 2004
are described below.
In June 2004, Gerdau Acominas concluded the issue of a second tranche
of $128 million under its Securitization program. This second tranche was placed
with a final maturity of 8 years (April 2012) and annual interest of 7.321%.
A Euro commercial paper program was completed in October 2004 worth
$110 million, maturing October 12, 2005 with a coupon of 3.0% per year.
In December 2004, the Gerdau Group, through Gerdau Acominas signed a
$240 million financing agreement. ABN AMRO Bank led and structured the
transaction which was funded by ABN AMRO Bank N.V., Bank of Tokyo-Mitsubishi and
UFJ Bank Limited. The full term of the loan is seven years with a grace period
of two years and five years' amortization. Nippon Export and Investment
Insurance (NEXI), a credit insurance agency linked to the Japanese government,
covers 97.5% of the political risk and 95% of the commercial risk. Political
risk reflects Brazilian government policies on cross-border payments, while
commercial risk reflects the Company's ability to meet its commitments. The
first tranche of $32.0 million of this agreement was placed in January 2005 at a
cost of funding of LIBOR + 0.5% per year. The agreement has a two-year grace
period from the contract signature date, semi-annual amortization and a final
maturity date in 2011.
The Company is subject to limitations on debt levels, the granting of
encumbrances on its properties and the payment of dividends under certain
circumstances, in accordance with the terms of its debentures and its loans from
the Brazilian National Bank for Economic and Social Development (BNDES). These
limitations are applicable to the refinancing agreements for Gerdau Ameristeel
(Senior Notes and Senior Secured Credit Facility) as well as trade finance
credit lines, bank loans, commercial paper and suppliers' credits. Most of the
financial agreements contracted by Gerdau S.A., which includes the NEXI
operation, a Euro commercial paper and Export Receivables Notes, have covenants
based on certain limits such as (i) Financial Debt divided by Earnings before
Interest, Taxes, Depreciation and Amortization - EBITDA (defined as gross profit
minus general, sales and marketing and administrative expenses plus depreciation
and amortization) of less than four and (ii) Earnings before Interest, Taxes,
Depreciation and Amortization - EBITDA divided by Net Financial Expenses
Excluding Monetary and Foreign Exchange Variations of higher than three.
Under the Export Receivables Notes Program, the Company has to maintain
a Consolidated Minimum Net Worth of R$ 3,759.2 million.
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 income, 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, all of which is held in treasury, limits the
Company's consolidated financial debt to no more than four times Earnings before
Interest, Taxes, Depreciation and Amortization - EBITDA for the last twelve
months. 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.
The terms of the Company's BNDES debt require that the current
liquidity ratio (consisting of current assets divided by current liabilities) is
at least 0.8 and that Financial Debt divided by Earnings before Interest, Taxes,
Depreciation and Amortization -EBITDA is less than four. 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
40
additional debt, issuing redeemable 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.
All covenants described above are based on (i) 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. Management believes that on December 31,
2004, 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
whereby 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). In December 2004, the total amount swapped was $143.0
million (notional amount) of which $58.2 million has been treated, pursuant to
EITF 02-02 on a combined basis as if the loans had been originally denominated
in reais. Part of the Company's cash flow from operations is denominated in
Brazilian reais and part in U.S. dollars. See Item 18. Financial Statements -
Note 21 Derivatives Instruments. Such cash flows from operations may be used to
service this debt. There can, however, be no assurance that cash flows from
operations will be sufficient to service foreign currency debt obligations,
denominated principally in U.S. dollars. It is thus possible that exchange rate
fluctuations may have a material adverse effect on the Company's business,
financial condition and results of operations. See Item 10.D - Exchange
Controls.
The Company's long-term debt with financial institutions, including
debentures, is scheduled to be amortized as follows:
GERDAU S.A. CONSOLIDATED
AMORTIZATION
($ million)
2006 195.0
2007 292.5
2008 209.0
2009 117.9
2010 75.3
After 2010 735.6
TOTAL 1,625.3
The amounts described above include the Gerdau Ameristeel convertible
debentures that mature in 2007 ($83.8 million) and a further five Gerdau S.A.
debentures issues ($260.9 million) with different maturity dates after 2010.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENCES, ETC.
Due to the specialized nature of its business, Gerdau Acos Especiais
Piratini is the only unit that has been investing uninterruptedly in
technological upgrading and in research and development (R&D). This unit is
active in the automotive segment and maintains an R&D department responsible for
new products and the optimization of existing processes. These product
development projects are headed by specialists who use quality tools such as '6
Sigma', statistical procedures for improving the assessment of process
variables, and 'Quality Function Deployment', a methodology through which the
technicians are able to identify the full spread of customer requirements. In
the other plants, production and quality teams are responsible for developing
new products to meet customer and market needs.
As is common with mini-mill steel makers, Gerdau usually acquires
technology in the market, since steel-making technology is readily available for
purchase.
International machinery manufacturers and steel technology companies
supply most of the sophisticated production equipment used by the Company. Such
suppliers generally sign technology transfer agreements with the purchaser and
provide extensive technical support and staff training for the installation and
commissioning of the
41
equipment. Gerdau has technology transfer agreements with Nippon Steel, Sumitomo
Steel, Thyssen, Daido Steel and BSW.
D. TREND INFORMATION
Gerdau's business focuses on the production of long steel and the
distribution of steel products in general at its operations located in North and
South America. One of the Company's strategies is the development of business on
a regional basis aiming at the fulfillment of its raw material requirements and
the selling of its production to clients mostly located close to the operating
units.
According to this concept, availability of the Company's inputs, such
as scrap, pig iron, iron ore and coal, and local demand are very important
factors in the performance of the operating units, although not necessarily
critical to the consolidated performance. The steel industry, especially the
long steel segment, irrespective of the country in which a company operates, is
strongly influenced by global and regional macroeconomic elements. The Gerdau
Group prepares its performance forecasts based on these elements.
Gerdau's operations in Brazil are concentrated under Gerdau Acominas.
Based on the volumes shipped in the first quarter of 2005 and the following
months of this year, the Company believes that demand, when compared to the
volumes shipped in 2004, should be reduced in the Brazilian domestic market as a
consequence of the Country's macroeconomic conditions.
Based on the expectation of reducing deliveries to the domestic market,
Gerdau has the capacity to further increase its exports. Exports in 2004 rose
sharply due to increased international prices and global demand. In the first
quarter of 2005, the Company's Brazilian exports fell by 12% in relation to the
fourth quarter of the previous year and 1.5% compared to the first quarter of
2004. Based on the perspectives of the domestic market, the Company believes
that tonnage exported will tend to increase over the next quarters.
International prices, which are expected to fall although remaining at high
levels, may be a reason for exports to continue to contribute strongly to
revenues in the second quarter and the current year, despite the depreciation of
the U.S. dollar vis-a-vis the Brazilian real in the period.
The Company believes that among its inputs of scrap, pig iron, coal and
iron ore, the trend in scrap and pig iron prices will be downwards, given that
prices have already fallen on the international markets. This reflects reduced
purchases following the intervention by the Chinese government to control steel
product prices as well as increased controls on imports to avoid logistical and
raw material supply bottlenecks.
Gerdau expects industrial units with blast furnace facilities to
experience higher production costs, notably due to higher iron ore and coal
prices imposed earlier in the year. Although percentage price increases were
high, Gerdau Acominas is seeking alternatives to reduce the impact of these
costs. An example is the installation of a Hybrid Pelletized Sinter - HPS unit
with the use of a mix of iron ore qualities.
The Company believes that conditions are favorable for production costs
to remain the same or even fall in relation to 2004. The inputs where price
trends are downwards (scrap and pig iron) represent a much larger proportion of
costs than the inputs (iron ore and coal), which have increased.
At a macroeconomic level, Gerdau believes that exchange rates and
inflation will remain stable in Brazil, according to Central Bank estimates.
Based on the same source, interest rates should be lower than the current levels
by the end of the year with the economy growing around than 3%.
The North American operations reported an improvement in the first
quarter 2005 earnings due to higher spreads (difference between selling prices
and scrap cost), as well as increased sales volume as a result of the
consolidation of the recently acquired mills and the seasonal improvement for
the period. Sales volumes for the first quarter of 2005 increased by 22%
compared to the last quarter of 2004. Although prices have been slightly lower
due to a reduction in input costs, Gerdau Ameristeel successfully maintained the
metallic spread at the same levels as 2004, which may be indicative of
continuing positive results for the current year.
Imports to the United States also increased in the last months of 2004
as a result of stronger demand. However, in 2005, the American government began
monitoring the volume of imported products placing restrictions on imports,
42
especially those of wire rod. While the demand for rebars and merchant bars
remains strong, the Company believes wire rod sales may weaken during 2005.
The outlook for the Company's South American operations is also
positive. In Uruguay, estimates for the economy are good and the International
Monetary Fund (IMF) is forecasting a GDP growth of 5%. Chile is the most stable
country in South America in which Gerdau operates. According to IMF estimates,
GDP is expected to grow about 6% with an increasing demand for steel products.
Overall, the trend is for positive results in 2005, the outlook for the
year being similar to 2004 both for Gerdau's operations in Brazil and
overseas.
E. OFF-BALANCE SHEET ARRANGEMENTS
The Company 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 Item 19. Financial Statements and Exhibits - Note 26(a),
Gerdau has guaranteed 51.82% of the debt of Dona Francisca Energetica S.A., an
unlisted corporation that owns and operates a hydroelectric power plant, known
as Usina Hidroeletrica Dona Francisca. The debt amounts to R$97.3 million
(equivalent to $36.6 million at the year-end exchange rate). The percentage of
this guarantee corresponds to Gerdau's 51.82% stake in Dona Francisca
Energetica. In addition, the Company has issued guarantees to Banco Gerdau S.A.
for $25.7 million relating to loans by the bank to the Company's customers for
purchasing the Company's products.
F. DISCLOSURE OF CONTRACTUAL OBLIGATIONS
CONTRACTUAL OBLIGATIONS
($ thousands) PAYMENTS DUE BY PERIOD
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
Long-Term Debt Obligations -
including Debentures (1) 1,625,259 696,537 193,194 735,528
Operating Lease Obligations 14,530
76,641 18,886 13,183 30,042
Capital Expenditures (2) 113,091
161,559 48,468 - -
Unconditional Purchase Obligations (3)
88,374 88,374 - - -
Pension Funding Obligations (4) 26,068 26,068 - - -
TOTAL 1,977,901 242,063 , 763,711 206,377 765,570
43
(1) Total amounts are included in the December 31, 2004 consolidated
balance sheet. See Note 15 Long-term Debt and Debentures in the consolidated
financial statements
(2) Purchase obligations for capital expenditures correspond to and are
related to capital projects as well as accrued acquisition costs corresponding
to North Star assets, the latter worth $51.8 million. This amount was accrued on
December 31, 2004 and paid subsequent to year end. The amount of $109.8 million
related to capital projects corresponds to agreements where we have irrevocably
committed with suppliers to acquire equipment. As the equipment had not been
received by December 31, 2004, the liability was not yet been recorded in our
financial statements of this date.
(3) The majority of other purchase obligations are for inventory and
operating supplies and expenses used in the ordinary course of business.
(4) Pension funding obligations are included only for 2005 as the
amount of funding obligations beyond the next year cannot be determined.
On December 23, 2004, the Company reached an agreement with the
majority shareholders of Diaco S.A ("Diaco"). - the Mayaguez Group and Latin
American Enterprise Steel Holding, and of Siderurgica del Pacifico S.A. -
Sidelpa ("Sidelpa"), to buy the shares currently owned by those parties in Diaco
and Sidelpa. Diaco is the largest producer of steel and rebar in Colombia, and
Sidelpa is the country's only producer of specialty steel. The conclusion of the
transaction is subject to satisfying several prior conditions that had not been
met on December 31, 2004. The agreement establishes a period for compliance with
these conditions. Under the terms of the agreement, once the conditions are met,
Gerdau will acquire a controlling interest in Diaco and Sidelpa. Gerdau also has
committed to acquire additional shares in Diaco within eight years. Since the
prior conditions had not been met on December 31, 2004 or on the date of filing
of this Annual Report, the total amount involved is not shown in the chart
above.
G. SAFE HARBOR
See Cautionary Statement with Respect to Forward-Looking Statements.
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 the operation
of the Company 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 currency re-measurement
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
44
The consolidated financial statements presented in this Annual Report
were prepared in accordance with accounting principles generally accepted in the
United States of America. Their preparation 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 the operation of the Company often requires it to make
judgments regarding the effects on the financial condition and results of
operations that are inherently uncertain. Actual results may differ from those
estimated under different variables, assumptions or conditions.
CURRENCY RE-MEASUREMENT
The Company has selected the United States dollar as its reporting
currency. The U.S. dollar amounts have been translated or re-measured, as
appropriate, following the criteria established in Statement of Financial
Accounting Standards (SFAS) 52, Foreign Currency Translation from the financial
statements expressed in the local currency of the countries where Gerdau and
each subsidiary operate.
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. Their 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 on the date of the transaction. Translation gains and
losses resulting from the translation methodology described above are recorded
directly in "Cumulative other comprehensive loss" in shareholders' equity. Gains
and losses on foreign currency denominated transactions are included in the
consolidated statement of income.
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 a valuation allowance and when the amount of the valuation
allowance was estimated.
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 prorated
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 on the balance sheet date on high quality fixed
income investments with maturities that match the expected maturity of
obligations
45
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 on 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, while 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 plan expenses and liabilities. These factors include
discount rate assumptions, 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 participant life spans.
ENVIRONMENTAL LIABILITIES
The Company has made provisions for potential environmental liabilities
based on best estimates for potential clean-up and compensation costs for known
environmental sites. The Company employs a staff of 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 133 - 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 foreign
exchange and interest rate markets in Brazil observed during 2004 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 had settled the transaction on December 31, 2004. On
December 31, 2004 the unrealized loss on cross-currency interest rate swaps
amounted to $14.8 million.
46
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 (69) has worked for the Gerdau Group since 1954. He and
his brothers, Germano, Klaus and Frederico, started their careers 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 (CEO). He holds a degree in Law from the Federal
University of Rio Grande do Sul.
GERMANO HUGO GERDAU JOHANNPETER (73) has worked 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 (70) has worked 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 (63) has worked 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 master's degree in Business, Finance, Costs and Investments from the
University of Cologne, Germany.
ANDRE PINHEIRO DE LARA RESENDE (54) was elected as an Independent Board Member
in 2002. He graduated in Economics from the Pontifical Catholic University in
Rio de Janeiro (PUC), and holds a master's 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 National Bank for Economic and Social Development (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 (66) was elected as an 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.
OSCAR DE PAULA BERNARDES NETO (59) was elected as an 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 consultative
board of Telesystem International Wireless (TIW) and Bunge Alimentos S.A. in
Brazil. He is also a member of the boards of RBS (media network), CheckForte,
Satipel and Alcoa in Brasil, and Delphi Corp. in the United States.
47
CARLOS JOAO PETRY (64) has worked 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 (42) has worked for the Gerdau Group since 1980. He was
recently appointed Executive Vice President of the Gerdau Executive Committee,
and is responsible for its North American operations, in the position of COO -
Chief Operating Officer. He holds a degree in Business Administration from the
Pontifical Catholic University of Rio Grande do Sul.
CLAUDIO JOHANNPETER (42) 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 appointed
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 Chief Financial Officer (CFO) and Investor Relations Executive
Officer 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 previously held a position as an executive officer 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 Commercial Process, comprised of Marketing,
Sales, Supplies and Logistics and Transportation. He graduated in Economics from
Mackenzie University in 1968.
RICARDO GEHRKE (48) joined the Company in 2004 as Executive Vice President of
the Gerdau Executive Committee, responsible for the Business Operation Long
Steel Brazil. He graduated in Business Administration from the Pontifical
Catholic University of Rio Grande do Sul. Ricardo held a position as executive
officer at Exxon Company, in Brazil and in the United States.
FILIPE AFFONSO FERREIRA (39) joined the Company in 2004 as Controlling Executive
Vice President, member of the Gerdau Executive Committee and responsible for the
Controlling (Accounting and Audit) and Information Technology processes. He
graduated in Business Administration from the Pontifical Catholic University of
Campinas - SP. Filipe Ferreira also held positions as executive officer at
Magneti Marelli, Alcoa and Mars Inc. in Brazil and other countries in Latin
America.
EXPEDITO LUZ (53) has worked 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 obtained a master's degree in Law from the Columbia Law School in
New York in 1980.
PAULO FERNANDO BINS DE VASCONCELLOS (60) 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 (63) 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.
48
ELIAS PEDRO VIEIRA MANNA (50) 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
master's degree in Materials Engineering from the Federal University of Santa
Catarina in 1982.
As of April 5, 2005, Elias Pedro Vieira Manna is no longer Executive Officer of
Gerdau S.A.
SIRLEU JOSE PROTTI (63) joined the Company in 1967, and became an Executive
Officer in 1981. Sirleu graduated in Economics from the Pontifical Catholic
University of Rio Grande do Sul in 1966.
DIRCEU TARCISIO TOGNI (56) has worked for the Gerdau Group since 1974 and was
promoted to Executive Officer in 2002. Dirceu Togni graduated in Mechanical
Engineering from the Federal University of Rio Grande do Sul, in 1974, and
received post graduation degrees in Work Safety Engineering (1979) and Business
Management (2001).
MARCIO PINTO RAMOS (45) was elected executive officer of Gerdau S.A at the Board
of Directors meeting held on April 5, 2005. He graduated in Mechanical
Engineering from the Federal University of Rio Grande do Sul and holds an MBA
from Purdue University, USA. He has also held a position as an executive officer
at Effem do Brasil (Mars Inc.) and Telet Claro Digital.
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 with respect to the election of its managers. There
are no pending legal proceedings to which any Company Board Member or Executive
Officer is a party against 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 semi-annual and annual goals. The achievement
of these goals is measured against clearly specified standards that are intended
to motivate individuals and teams.
The Human Resources policy is based on the acknowledgement and
recognition of co-workers as strategic to the business.
The Company conducts evaluations based on several different
methodologies, including competence mapping, to track the managerial skills of
its executives. Competence mapping aims to identify the degree of alignment of
executives with the Company's strategies and business management and to monitor
individual development.
In 2004, Gerdau S.A. paid a total of $25.3 million to its Directors and
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 EBITDA (as defined for the purposes of calculating
variable remuneration) versus planned EBITDA (as defined for the purposes of
calculating the variable remuneration), on the performance of the unit to which
the executive is related, and on personal performance. Each of these factors
influence 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
49
the former Acominas and its subsidiaries ("Gerdau Acominas Plan"). The Brazilian
Plans are mainly defined benefit plans with certain limited defined
contributions. The 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.
During 2004, Gerdau's contribution to the Gerdau Plan with respect to
the executive officers amounted to $18.500 (Basic income program) and an
additional $51.900 to the supplementary fund. This sum includes only that
portion of contributions for executives who do not currently receive retirement
benefits from the Company. These benefits are in no way different from those
offered to the other employees of the Company.
On April 30th, 2003, Gerdau S.A.'s shareholders approved a new
compensation program for executives with strategic positions in the Company
known as the Long Term Incentive Program. This new compensation program consists
of call options on the Company's Preferred Shares, granted on an annual basis,
representing 20% of the annual base salary of each executive and, for the
Directors and Executive Offices, an additional entrance bonus equivalent to 30%
of the annual salary (the latter was eliminated as from April 28, 2005). This
program aims to attract and secure the long-term commitment of executives by
allowing them to share in the growth of the Company, thereby enhancing the sense
of participation in the business. (See Item 10. Additional Information - B.
Memorandum and Articles of Association).
Also in April 2003, for the first time, Gerdau S.A. granted stock
options to Directors and Executive Officers of its companies in Brazil. This
program consisted of stock options granted on 842,520 Gerdau S.A. Preferred
Shares, which can be exercised from January 1, 2008 and stock options granted on
1,209,687 Preferred Shares, which can be exercised from January 1, 2006. Both
stock options must be exercised by December 31, 2012.
In December 2003, the stock option program was extended to Senior
Managers of Gerdau companies in Brazil. At this time, the Company granted stock
options on 513,374 Gerdau S.A. Preferred Shares, which can be exercised from
January 1, 2009 and stock options on 7,289 Preferred Shares, which can be
exercised from January 1, 2007. Both options must be exercised by December 31,
2013.
In December 2004, in the third edition of the program, the Company
granted stock options on 444,784 shares to the Directors, Executive Officers and
Senior Managers eligible for the program. These options may be exercised from
January 1, 2010. The Company also granted options on 27,439 shares, which can be
exercised from January 1, 2008. All those options must be exercised by December
31, 2014.
Again in December 2004, the Company granted stock options on 298,390
shares, equivalent to 10% of the basic annual salary, in recognition of the
positive corporate earnings for the year. This special and specific edition of
the program was authorized on this occasion only, for Directors, Executive
Officers, Senior Management and Managers or their equivalents, comprising 366
individuals. These options can be exercised during the period from January 1,
2008 to December 31, 2014.
The Compensation and Succession Committee approved the December 2003
stock option grants in 2004 and the December 2004 stock option grants in 2005.
The stock option grants distributed to the Directors and Executive
Officers are as follows (see Consolidated Financial Statements - Note 25.1 for a
complete summary of the stock option plan):
Beginning of vesting period Apr/03 Apr/03 Dec/03 Dec/04 Dec/04 Accumulated
To be exercised from: Jan/08 Jan/06 Jan/09 Jan/10 Jan/08 Number of
Must be exercised by Dec/12 Dec/12 Dec/13 Dec/14 Dec/14 Shares
Exercise price per share R$7.96 R$7.96 R$20.33 R$31.75 R$31.75
TOTAL OPTIONS GRANTED TO DIRECTORS 624,398 882,494 245,508 225,720 124,998 2,103,118
AND EXECUTIVE OFFICERS
50
Share figures have been retroactively adjusted for all periods to reflect the
bonus issue of one share for each share held approved in April 2004 and the
bonus issue of one share for every two shares held in April 2005, approved in
March 2005.
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 sacrificing 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 required to
formalize its new corporate governance structure.
The Gerdau Executive Committee is now responsible for coordinating
the activities of the executive officers and managing the Company's business,
the purpose being to build on the Company's relationship with the market and
accompany best corporate governance practices. 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. The Board may have up to ten members.
Three independent members will also 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
COMPENSATION AND SUCCESSION COMMITTEE: Gerdau has established a Compensation and
Succession Committee as part of the new corporate governance structure. This
committee guides executive compensation practices and is responsible for
nominating candidates for senior executive positions on the Board. It is
composed 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 - North America 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 process in order to
maximize results.
51
PRESIDENT
Jorge Gerdau Johannpeter
VICE PRESIDENTS
Frederico Carlos Gerdau Johannpeter
Carlos Joao Petry
Andre Bier Johannpeter
Claudio Johannpeter
Osvaldo Burgos Schirmer
Domingos Somma
Ricardo Gehrke
Filipe Affonso Ferreira
SECRETARY-GENERAL
Expedito Luz
STRATEGY AND EXCELLENCE COMMITTEES: The Strategy Committee has been installed to
provide 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 Transportation, and Scrap Purchasing. Support Processes are those
which provide backup 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, Management Technology 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.
On November 28, 2003, the shareholders of Gerdau S.A. and Aco Minas
Gerais - 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. This new
structure led to the transfer of most executive officers of Gerdau S.A. to
Gerdau Acominas, which since then has been the Gerdau Group's sole steel
manufacturing company in Brazil.
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 Ordinary General Meeting of Shareholders while members of
the Gerdau Executive Committee and executive officers are elected at meetings of
the Board of Directors.
BOARD OF AUDITORS
Under the Brazilian Corporate Law, the board of auditors ("Conselho
Fiscal") is a corporate body independent of management and company's external
auditors. The board of auditors has not typically been equivalent to or
comparable with a U.S. audit committee; its primary responsibility has been to
monitor management's activities, review the financial statements, and report its
findings to the shareholders. Pursuant to an exemption under Section 10A-3 of
the new SEC rules on the audit committees of listed companies, a foreign private
issuer (such as the Company) is permitted not to have a separate audit committee
composed of independent directors if it has a Board of Auditors established and
selected pursuant to home country legal or listing provisions expressly
requiring or permitting such a board and if such a board meets certain
requirements. Pursuant to this exemption, a board of auditors can exercise the
required duties and responsibilities of a U.S. audit committee to the extent
permissible under Brazilian Corporate Law. To comply with the new SEC rules, the
Board of Auditors must meet the following standards: it must be separate from
the full board, its members must not be elected by management, no executive
officer may be a member, and Brazilian
52
law must set forth standards for the independence of the members. In order to
qualify for exemption, the Board of Auditors must, to the extent permitted by
Brazilian law:
|X| be responsible for the appointment, retention, compensation and
oversight of the external auditors (including the resolution of
disagreements between management and the external auditors regarding
financial reporting);
|X| be responsible for establishing procedures for the receipt, retention
and treatment of complaints regarding accounting, internal accounting
controls or auditing matters, and procedures for the confidential,
anonymous submission by employees of concerns regarding questionable
accounting or auditing matters;
|X| have the authority to engage independent counsel and other advisors as
deemed necessary, to carry out its duties; and
|X| receive appropriate funding from the company for payment of
compensation to the external auditors, for any advisors and ordinary
administrative expenses.
As a foreign private issuer, the Company has decided to modify its
Board of Auditors to comply with the exemption requirements. Accordingly, the
Ordinary General Meeting of Shareholders held in April 28, 2005, amended the
Company's by-laws to modify the duties of the Board of Auditors and the Board of
Directors, on the same date approving the delegation of certain additional
responsibilities to the Board of Auditors. The Board of Auditors operates
pursuant to a charter ("regimento interno") that contemplates the activities
described above to the extent permitted by Brazilian law and is compliant with
the requirements of the Sarbanes-Oxley Act, the pertinent regulations, and the
requirements of the New York Stock Exchange and the "Conselho Fiscal". Because
Brazilian Corporate Law does not permit the board of directors to delegate
responsibility for the appointment, retention and compensation of the external
auditors and does not provide the board or the board of auditors with the
authority to resolve disagreements between management and the external auditors
regarding financial reporting, the board of auditors cannot fulfill these
functions. Therefore, in addition to its oversight responsibilities, the board
of auditors may only make recommendations to the board of directors with respect
to the appointment, retention and compensation of the external auditors.
Likewise, the board of auditors may only make recommendations to management and
the board with regard to the resolution of disagreements between management and
the external auditors. This limited scope of authority is a key difference
between the board of auditors and the customary authority of an audit committee
as a full committee of the board of directors.
Under the Brazilian Corporate Law, members of the board of
auditors may not also be members of the board of directors or the executive
committee, or who are employees of the company or employees of a controlled
company or of a company of this group, or a spouse or relative of any member of
the company's management. In addition, the Brazilian Corporate Law requires that
members of the board of auditors receive a remuneration at least 10% of the
average amount paid to each executive officer. The Brazilian Corporate Law
requires that a board of auditors be composed of a minimum of three and a
maximum of five members and their respective alternates.
As part of the adaptation of its Board of Auditors to the new
regulations, the Company has installed a permanent (standing) Board of Auditors
composed of three members and their alternates who are elected at the Ordinary
General Meeting of Shareholders with term of office to run until the next
Ordinary General Meeting of Shareholders following their election, reelection
being permitted. Under the Brazilian Corporate Law, holders of Preferred Shares
have the right to elect through a separate vote, one member of the board of
auditors to represent their interests. Likewise, minority groups of shareholders
that hold at least 10% of the voting shares also have the right to elect one
member of the board of auditors through a separate vote. However, irrespective
of circumstances, the common shareholders have the right to elect the majority
of the members of the board of auditors. Set forth below are the names, ages and
positions of the members of the Company's Board of Auditors and their respective
alternates, as of April 28, 2005.
YEAR FIRST
NAME AGE POSITION ELECTED
Egon Handel 65 Effective member 2005
Carlos Roberto Schroder 65 Effective member 2005
Pedro Carlos de Mello(1) 53 Effective member 2005
Eduardo Grande Bittencourt 67 Alternate 2005
Domingos Matias Urroz Lopes 67 Alternate 2005
Lucineide Siqueira do Nascimento (1) 54 Alternate 2005
(1) Elected by minority shareholders
53
The Board has determined that Egon Handel is an "audit committee
financial expert" within the meaning of the rules adopted by the SEC concerning
disclosure of financial experts.
D. EMPLOYEES
The following table presents information on the geographical
distribution of Gerdau's employees:
DIRECT BRAZIL OVERSEAS TOTAL
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
2004 16,067 7,110 23,177
OUTSOURCED* BRAZIL OVERSEAS TOTAL
2004 9,193 275 9,448
* `Outsourced' correspond to employees of third-party service providers of
Gerdau which provide, as employees of those providers, services directly to
Gerdau in areas that are not the core business of Gerdau .
As of December 31, 2004, the Company employed 23,177 at its industrial
units excluding the two joint ventures, Sipar and Gallatin Steel. Of this total,
69% are based in Brazil and the remainder at units in South and North America,
which have 524 and 6,586 employees, respectively. Employee numbers in Brazil
grew considerably in 2002 due to the full consolidation of Acominas. In North
America, the number of employees increased in 2002 as a result of the
incorporation of employees of Co-Steel into Gerdau Ameristeel Corp. and in 2004
due to the consolidation of North Star Steel into Gerdau Ameristeel.
As labor unions in Brazil are organized on a regional rather than a
national basis, the Company has no nationwide agreements with its employees.
Gerdau believes that its employee pay and benefits structure is comparable to
general market conditions. The Company 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 consequently has what it believes to be a comparatively low employee
turnover rate. Given its strong emphasis on employee training, the Company seeks
to manage necessary production curtailments through the rescheduling of vacation
periods 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.
Approximately 40% of Gerdau Ameristeel employees are represented by the
United Steelworkers of America (USWA) and other unions under different
collective bargaining agreements. The collective bargaining agreements have
different expiration dates beginning in March 2005. The collective bargaining
agreements with employees at the Beaumont, Cambridge, St. Paul and Wilton mini
mills and the Memphis, Tennessee wire rod processing facility expire in 2005.
The company and its workforce had been working without a labor agreement in
Beaumont since March 31, 2005, and had been negotiating since January 18, 2005.
On May 26, 2005 Gerdau Ameristeel ceased operations at this mill in an effort to
encourage the United Steelworkers of America (USWA) labor union to act on the
company's "last, best and final" agreement offer presented to the union
committee on May 9, 2005.
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 May
31, 2005, considering the retroactively adjusted offer of one bonus share
54
for every two shares held, approved in March 2005. None of the directors or
executive officers indicated below own more than 1% of the company's capital for
each class of share. If the stock options granted to each executive officer were
added to the total below, their individual stakes would not exceed the 1% limit.
SHAREHOLDER COMMON SHARES % PREFERRED SHARES %
Jorge G. Johannpeter 171 0.00% 6,885 0.00%
Frederico C. G. Johannpeter 174 0.00% 20,889 0.01%
Germano G. Johannpeter 285 0.00% 133,881 0.05%
Klaus G. Johannpeter 333 0.00% 4,377 0.00%
Affonso Celso Pastore - 0.00% 3 0.00%
Andre Lara Resende - 0.00% 3 0.00%
Oscar de Paula Bernardes Neto - 0.00% 5,430 0.00%
Andre Bier Johannpeter - 0.00% - 0.00%
Carlos Joao Petry 1,227 0.00% - 0.00%
Claudio Johannpeter 10,530 0.01% 100,932 0.03%
Domingos Somma 93 0.00% 26,793 0.01%
Filipe Affonso Ferreira - 0.00% - 0.00%
Osvaldo B. Schirmer - 0.00% 41,524 0.01%
Ricardo Gehrke - 0.00% - 0.00%
Paulo F. B. Vasconcellos 12 0.00% 1,065 0.00%
Dirceu Tarcisio Togni - 0.00% 1,035 0.00%
Marcio Pinto Ramos - 0.00% - 0.00%
Expedito Luz - 0.00% 9,984 0.00%
Francesco Saverio Merlini - 0.00% 234 0.00%
Sirleu Jose Protti - 0.00% 30,834 0.01%
TOTAL 12,825 0.01% 383,869 0.13%
ITEM 7. MAJOR SHAREHOLDERS AND RELATED-PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
On May 31, 2005, the Company's capital stock was made up of 154,404,672
Common Shares and 288,297,561 Preferred Shares outstanding (excluding treasury
stock). Of the two classes of share traded in the market, only the Common Shares
carry voting rights. Under the terms of the Company's bylaws, however, specific
rights are assured to the non-voting Preferred Shares. See the bylaws of Gerdau
S.A. attached to this annual report.
The table below presents certain information dated May 31, 2005,
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. 116,929,714 75.73 73,547,865 25.30
Sta.Felicidade Com. Exp.de Prod. Sid. Ltda.* - - 8,945,148 3.08
Grupo Gerdau Empreendimentos Ltda.* 2,136,945 1.38 41,920 0.01
INDAC - Industria, Administracao e Comercio S.A.* 2,914,137 1.89 - -
Members of the Board of Directors and Executive 12,825 0.01 383,869 0.13
Officers as a group (20 members)
* Controlled by or affiliated with Metalurgica Gerdau S.A.
55
Metalurgica Gerdau S.A. is a holding company that controls directly and
indirectly all Gerdau companies in Brazil and abroad. Metalurgica Gerdau and its
subsidiaries hold 75.73% of the voting capital stock of Gerdau S.A. and thus
have the ability to control the Company's Board of Directors as well as its
management and operations. On December 9, 2004, Metalurgica Gerdau S.A. and its
subsidiary Santa Felicidade Com. Imp. Exp. Prod. Sid. Ltda., reduced their
stakes in the voting capital stock of Gerdau S.A. by 3.89% and 6.12%,
respectively, through an auction at the Sao Paulo Stock Exchange.
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 annual interest at LIBOR + 3% 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
name and payments relating to loan guarantees.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
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 companies, Gerdau S.A. and its subsidiaries are
party to proceedings with respect to tax, labor and civil matters, most of them
arising in the regular course of business.
Based on advice from legal counsel, management believes 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 of December 31, 2004.
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.
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:
56
o The Company recognized in its contingency reserve of December 31,
2004, a provision of $19 million relating to `compulsory loans' that
all consumers were obliged to make to Eletrobras ("Emprestimo
Compulsorio Eletrobras sobre Energia Eletrica"), the government-owned
energy company. The Company has, together 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) although the payment to Eletrobras was
in the form of a loan, the Company will be repaid in Eletrobras shares;
(ii) the conversion to Eletrobras shares will be based on their book
value; and (iii) based on currently available information, the market
value of Eletrobras shares is well below their book value.
o $6.5 million related to amounts for state value added tax ("Imposto
Sobre Circulacao de Mercadorias e Servicos" - ICMS), the majority of
which is related to credit right claims involving the Finance Secretary
and the State Courts of First Instance in the state of Minas Gerais.
o $7.5 million referring to discussions with administrative authorities
in relation to Corporate Income Tax (IRPJ).
Gerdau Acominas has a claim in which it argues that the limit for
offsetting tax loss carryforwards of 30% of net earnings is
unconstitutional. The Company had traditionally lodged court deposits
equivalent to the tax effect of fully offsetting tax loss carryforwards
(Social Contribution on Net Income - Contribuicao Social sobre o Lucro,
CSLL, and Corporate Income Tax - Imposto de Renda Pessoa Juridica,
IRPJ). Considering several unfavorable rulings against other companies
seeking the right to pay IRPJ/CSLL after full offset of tax loss
carryforwards rather than having that offset limited to 30% of taxable
income, in September 2004, Gerdau Acominas decided to discontinue
making the deposits, transferring the amount already in judicial escrow
accounts ($127.7 million) to the Federal Government as payment. Since
September 2004, the Company has been observing the offset limit.
Nevertheless, the Company has not withdrawn the lawsuit and awaits a
decision from the Federal Regional Court of the First Region. In the
event that the Federal High Court of Justice changes its understanding
and rules in the Company's favor, the amount of taxes paid in excess of
those due will be applied against future tax liabilities.
o The Company has made a contingent provision for social security
contributions (INSS), amounting to $9.3 million. These claims refer
mainly to the annulment of liabilities and are under review in the
Federal Court of First Instance in the state of Rio de Janeiro. Gerdau
Acominas has also filed other lawsuits that challenge INSS decisions to
charge social security contributions on profit sharing payments, as
well as services provided by work cooperatives. The Company has
nevertheless made court escrow deposits that substantially cover the
entire contingent liability.
o The Company has challenged the constitutionality of charging a total
of $14.5 million, relating to the Emergency Capacity Charge (Encargo de
Capacidade Emergencial - ECE) and the Extraordinary Tariff
Recomposition (Recomposicao Tarifaria Extraordinaria - RTE), which are
tariffs charged for supplying energy to the Company's industrial units.
Management believes that these tariffs are of a tax nature and are thus
incompatible with the National Tax System as described in the Federal
Constitution. The claims are currently under review in the Federal
Justice of First Instance of the states of Pernambuco, Ceara, Minas
Gerais, Rio de Janeiro, Sao Paulo, Parana and Rio Grande do Sul, as
well as in the Regional Federal Courts of the First and Second Regions.
The Company has made escrow deposits equivalent to the total amount of
these claims.
Court deposits, which represent restricted assets of the Company, refer
to amounts held in court escrow accounts until the final decision of the
corresponding legal issues. On December 31, 2004, the balance of such deposits
stood at $34.3 million.
There are other contingent liabilities for which the probability of
loss is considered possible, but not probable, and for which provisions were not
recorded. These include:
57
o Lawsuits filed by the state of Minas Gerais to collect presumed state
value-added tax (ICMS) credits, based mainly on sales by exporting
companies, with claims amounting to $12.3 million. Management
understands that this tax is not applicable since sales of products for
export purposes are exempt from value-added tax. The Company has
therefore not recognized any provision related to these issues.
o The Company and Gerdau Acominas are defendants in tax claims filed by
the state of Minas Gerais for state value-added tax (ICMS) credits on
exports of industrialized semi-finished products. Gerdau Acominas is
also plaintiff in a claim to cancel a similar tax levy. The total
amount of this contingency is $94 million. The Company has not made a
provision for such claims. It believes that this tax is not applicable,
since the products do not fit the definition of industrialized
semi-finished products as established in federal complementary law, and
therefore are not subject to value-added tax.
o The Federal Revenue Service has submitted a claim for $25.7 million,
relating to operations of Gerdau Acominas under the drawback concession
granted by DECEX, the Foreign Trade Department. The Federal Revenue
Service understands that this concession is not in accordance with the
law. Gerdau Acominas is awaiting judgment of its preliminary
administrative defense, which claims that the operation is legal.
Last January, Gerdau Acominas was notified of an unfavorable decision
concerning its defense. An appeal was presented, which is currently
awaiting a ruling.
The tax assessment has not been finally confirmed. The operation that
generated the demand complies with the requirements of the drawback
concession and, also, the concession was granted after due analysis by
the competent administrative authority. As a consequence, the Company
believes a favorable ruling is possible, considering the matter will
only be definitively judged after Court's analysis, and, therefore, has
not established a provision.
Management believes that it may be able to realize certain contingent
assets. However such realization is not considered probable. Contingent tax
assets will be recognized as a gain if and when a final non-appealable ruling is
issued in favor of the Company and the credit is payable in the same fiscal
year.
o Court-ordered debt security issued in favor of the Company by the
state of Rio de Janeiro for the payment of $10 million arising from an
ordinary lawsuit regarding non-compliance with the Loan Agreement for
Periodic Execution in Cash, a tax incentive program under the Special
Industrial Development Program - PRODI.
Due to the default by the state of Rio de Janeiro, as well as the
non-regulation of Constitutional Amendment 30/00, which granted the
state government a ten-year moratorium for payment of securities to
cover non-alimony court-order debt, there was no expectation of
realization of this credit in 2004 or in 2005.
o The Company and its subsidiaries have filed four ordinary proceedings
challenging changes in the basis for calculating PIS under
Complementary Law 07/70 due to rulings of unconstitutionality of Decree
Laws 2,445/88 and 2,449/88. In 2004, the High Court of Justice reached
a favorable decision (non-appealable) in two proceedings and as a
consequence, tax credits of $43.5 million were recognized and are being
used to pay federal taxes.
In March 2005, the Company received a favorable final decision in the
third action, the corresponding tax credit amounting to $18.8 million.
The last such proceeding is still pending, but based on the precedents,
the Company expects to recover tax credits of $7.3 million.
o Based on previous preliminary court rulings, the Company and Gerdau
Acominas and Margusa Maranhao Gusa S.A. expect to recover IPI tax
credits. Gerdau S.A. and Margusa have filed administrative requests
for reimbursement, and are awaiting judgment of these requests. In the
case of Gerdau Acominas the claims were filed directly to the courts
and a ruling unfavorable to Gerdau Acominas was issued. The Company
currently awaits the results of an appeal, estimating that the amount
reimbursable is $148.4 million
58
II) LABOR CONTINGENCIES
o The Company is also a party to a number of lawsuits by ex-employees.
As of December 31, 2004, the Company had made provisions of $18,676
relating to such claims. None of these individual actions entail
significant amounts, and the lawsuits mainly involve claims due to
overtime and health and workplace conditions. On December 31, 2004, the
balances of court escrow deposits relating to labor contingencies,
amounted to $7.8 million.
III) CIVIL CONTINGENCIES
The Company is involved in a number of lawsuits for which management
believes the possibility of loss is remote, and 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 syndicates in the state of Sao
Paulo, alleging that Gerdau S.A. and other long steel producers in
Brazil were dividing customers among themselves and thus violating
antitrust laws.
Following investigations conducted by the National Secretariat of
Economic Law (Secretaria de Direito Economico - SDE) and based on a
number of public hearings, the Department decided that a cartel
existed.
A previous ruling by the Secretariat for Economic Monitoring
(Secretaria de Acompanhamento Economico - SEAE) also supported this
conclusion. The process is in its last stage at the Administrative
Council for Economic Defense (Conselho Administrativo de Defesa
Economica - CADE), the Treasury Department agency responsible for
ruling on competition issues, for a final decision.
Proceedings are now suspended by a court injunction awarded in a
lawsuit proposed by Gerdau S.A.. The purpose of the injunction is to
annul the administrative proceedings based on numerous irregularities
in the administrative process. The lawsuit is currently at its first
stage.
The Administrative Council for Economic Defense (CADE) and the Federal
Government are challenging the injunction.
The Company denies any anti-competitive conduct and believes that on
the basis of the available information, including the opinion of its
legal counsel, the administrative process conducted by the SDE includes
many irregularities, some of which are inadmissible. For example, the
SDE investigations did not follow the due process of the law,
representatives of this agency orienting some of the witnesses that
testified in the case. The SDE also issued its ruling before Gerdau
S.A. had a chance to respond to the closing arguments, indicating a
bias on the part of the SDE. The same considerations apply to the
SEAE's ruling, which does not consider the economic issues of the case
and is based solely on witnesses' testimony.
These irregularities also include non-compliance with related
constitutional provisions and will undoubtedly affect an administrative
decision based on the conclusions presented so far by the antitrust
authorities. Gerdau S.A. has pointed out and opposed all of these
irregularities and will continue to reject the allegations as well as
the irregular procedures of the administrative process, believing that
it will ultimately be successful, if not in the administrative process,
then in a court of law.
The Company has thus made no provisions in this case. According to
Brazilian law, fines up to 30% of gross sales revenue in the prior
fiscal years may be applied against the Company and, if the personal
responsibility of an executive is proven, such an executive could be
penalized by 10% to 50% of the fine applied to the Company. There are
no precedents in Brazil for fines of more than 4% of gross sales
revenues. In a similar case involving flat steel companies, the fine
was approximately 1% of gross sales revenue.
o A claim against Gerdau Acominas relating to the rescinding of a
contract for the supply of slag and indemnification for losses. As of
December 31, 2004, this claim amounted to approximately $13.9 million.
Gerdau Acominas has contested all claims and filed a counterclaim for
the termination of the contract and
59
indemnity for breach of contract. The judge ruled that the contract be
rescinded since the request was common to both parties, at the same
time ruling that the indemnity claim was unfounded.
This ruling was upheld by the Court of Civil Appeals of the state of
Minas Gerais (CCAMG), and is based on expert evidence and
interpretation of the contract.
As mentioned above, the CCAMG upheld the decision to rescind the
contract and accepted the appeal of Gerdau Acominas to condemn the
supplier to pay the costs of slag removal, overruling the supplier's
plea.
The supplier appealed to the High Court of Justice, the appeal being
refused. This was followed by an Instrument Appeal, which had its merit
overruled, but was partially accepted, the High Court ordering the
CCAMG to "point out which section of the contract was breached by the
supplier". The matter was reexamined as determined by the High Court of
Justice. On March 15, 2005, the court handed down its decision pointing
clearly to a breach of contract by the supplier. The decision was based
on the examination of the evidence and interpretation of the contract,
thus significantly reducing the chances of success of further appeals
on the part of the supplier. In the light of these events, Gerdau
Acominas' believes the possibility of loss is remote.
o A civil lawsuit was filed by Sul America Companhia Nacional de
Seguros, an insurance company, against Gerdau Acominas and the New York
branch of Westdeutsche Landesbank Girozentrale (WestLB), a bank, for
the payment $12.9 million, which was deposited with the court to settle
an insurance claim lodged by Gerdau Acominas.
Sul America pleads uncertainty as to whom payment should be made and
alleges that the Company is resisting in receiving and settling it. The
lawsuit was contested by both bank (which claimed to have no right over
the amount deposited), as well as the Company, (which claimed
inexistence of uncertainty and justification to refuse payment, since
the amount owed by Sul America is higher than stated). Following this
plea, Sul America claimed fault in the bank's representation. This
matter is already settled, Gerdau Acominas collected the amount
deposited in December 2004. The process is expected to enter the expert
evidence phase, mainly to determine the amount finally due.
Based on the opinion of its legal counsel, the Company believes 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 lawsuit relates to an accident on March 23, 2002 with the blast
furnace regenerators at the Presidente Arthur Bernardes mill, which
caused the shutdown of various activities, material damages to the
mill's equipment and loss of profits. The equipment, as well as loss of
profits arising from the accident, was covered by an insurance policy.
The report on the accident, as well as the loss claim, was filed with
IRB - Brasil Resseguros S.A., and the Company received an advance
payment of $23.3 million in 2002.
In 2002, a preliminary and conservative estimate of indemnities
relating to the coverage of both property and casualty losses and loss
of profits in the total amount of approximately $41.4 million was
recorded, based on the amount of the fixed costs incurred during the
period of partial shutdown of the steel mill and on the expenditures
incurred in temporarily repairing the equipment. This estimate is close
to the amount of the advance received of $23.3 million plus the amount
proposed by the insurance company as a complement for settlement of the
indemnity of $12.9 million. Subsequently, new amounts were added to the
discussion as demonstrated in the Company's appeal, although they were
not accounted for. Once a final legal ruling is handed down, the
amounts will be duly booked to the Company's accounts.
Based on the opinion of legal counsel, the Company believes that losses
from other contingencies are remote and that any eventual losses would
not have a material adverse effect on the consolidated results of
operations or on the consolidated financial position of the Company.
60
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. The law
requires a minimum payout of 25% of adjusted net income. Under the Company's
bylaws, this percentage has been fixed at no less than 30% of the adjusted net
income for distribution for each fiscal year. (See Item 10. Additional
Information - 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 institution providing the Company with custodial services
("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 the Law for each fiscal year until such reserve reaches an amount equal to
20% of the company's paid-in capital. On December 31, 2004, in accordance with
Brazilian GAAP, Gerdau S.A.'s legal reserve amounted to R$326.0 million ($122.8
million, using the year-end exchange rate) or 9.4% of total paid-in capital of
R$3,471.3 million ($1,307.8 million, using the year-end exchange rate).
According to Law 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 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 requires that
such rights be granted to the common minority shareholders (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 rights 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 bylaws to provide for the
tag-along rights as described above, the Company now pays the stated minimum
dividend of 30% of Adjusted Net Profit to all shareholders, from January 1, 2002
dividends paid to preferred shareholders no longer being subject to a minimum
10% premium over those paid to holders of common shares.
As a general requirement, shareholders who are non-resident in Brazil
must have their Brazilian company investments 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 Bank ("Depositary"). The holder of Preferred Shares
will be the registered holder recorded in the preferred shares register.
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 CAPITAL STOCK
Law 9,249 of December 1995, provides that a company may, at its sole
discretion, pay interest on capital stock in addition to, or instead of,
dividends. A Brazilian corporation is entitled to pay its shareholders interest
on capital stock
61
up to the limit of an amount computed as the TJLP (Long-Term Interest Rate) rate
of return on its interest on capital stock 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. Additional Information
- Taxation
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 bylaws, the Company had been paying
dividends twice a year in the form of interest on capital stock. On March 31,
2003, the Board of Directors approved a new policy for paying dividends and
interest on capital stock on a quarterly basis.
Since 1999, dividends have been paid to holders of the Company's Common
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 - Key Information - Selected Financial Data.
B. SIGNIFICANT CHANGES
50% STOCK DIVIDEND
On March 31, 2005, the Board of Gerdau S.A. approved a capital stock
increase, effective on April 11. The capital stock was increased from
R$3,471,312,349.01 to R$5,206,968,523.52 (Brazilian GAAP) by means of the
incorporation of investment reserves and working capital, with the issuance of
new shares, assigning 50 (fifty) bonus shares to each lot of 100 (one hundred)
(according to the ratio of one share for every two shares) shares owned on April
11, 2005, date of record of the incorporation of the above mentioned reserves.
The value assigned to the bonus shares, as defined by the Brazilian Internal
Revenue Secretariat's regulation IN/SRF 25/2001, article 25, paragraph 1, was
R$11.70 per share.
ACQUISITION OF SHARES ISSUED BY GERDAU S.A.
On May 30, 2005, the Board of Directors of Gerdau S.A. met in
accordance with statutory requirements and the terms of CVM Instruction 10/80
and 268/97 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 cancellation.
These shares will be acquired using cash funds backed by existing
profit reserves up to the adjusted limit of 6,500,000 Preferred Shares,
representing 3.16% of outstanding stock, which amounted to 205,393,936 adjusted
shares on April 30, 2005.
This authorization will remain in force for 30 days from that date
beginning May 31 2005, it being the responsibility of the Officers of the
Company to determine the quantities of shares and appropriateness of each
operation.
The transaction will be carried out in 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.
UBS Corretora de Cambio e Valores Mobiliarios S.A.
The total shares to be acquired and canceled will be announced after
the end of the buyback period.
62
DIRECTORS
At the Board of Directors meeting on May 30, 2005, Mario Longhi was
elected Vice President of Gerdau S.A. and member of Gerdau Executive Committee.
Mario Longhi holds a degree in Metallurgical Engineering from the Maua
Technological Institute in Sao Paulo. He also held positions as executive
officer at Alcoa.
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. All
price information presented in this section has been retroactively restated to
reflect the effects of the stock bonus approved in March 2005.
CLOSING PRICES GGBR4 - ANNUAL BASIS
Adjusted for dividends
YEAR BRAZILIAN REAIS PER SHARE US DOLLARS PER SHARE
HIGH LOW HIGH LOW
2000 5.21 2.57 2.91 1.30
2001 4.66 2.48 2.26 0.89
2002 7.68 4.40 2.91 1.38
2003 18.56 6.45 6.42 1.77
2004 32.83 15.53 11.85 4.97
Source: Economatica
CLOSING PRICES GGBR4 - QUARTERLY BASIS
Adjusted for dividends
YEAR BRAZILIAN REAIS PER SHARE US DOLLARS PER SHARE
HIGH LOW HIGH LOW
2003
1Q 7.44 6.45 2.20 1.77
2Q 10.06 6.57 3.52 2.00
3Q 13.92 9.30 4.81 3.15
4Q 18.56 12.32 6.42 4.22
2004
1Q 21.02 16.15 7.37 5.47
2Q 23.62 15.53 7.56 4.97
3Q 32.83 22.70 11.02 7.38
4Q 32.16 24.80 11.85 8.69
2005
1Q 36.08 25.99 13.49 9.63
Source: Economatica
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CLOSING PRICES GGBR4 - MONTHLY BASIS
Adjusted for dividends
BRAZILIAN REAIS PER SHARE US DOLLARS PER SHARE
YEAR
HIGH LOW HIGH LOW
2004
December 32.16 28.20 11.85 10.16
2005
January 30.89 25.99 11.58 9.63
February 33.38 26.73 12.86 10.19
March 36.08 28.48 13.49 10.54
April 29.85 23.42 11.24 8.95
May 25.95 21.00 10.57 8.57
Source: Economatica
In the above tables, share prices have been retroactively adjusted for
all periods to reflect: (a) a bonus issue of three shares for each share held,
approved in April 2003, (b) a reverse stock split of one share for each 1,000
shares held, approved in April 2003, (c) a bonus issue of one share for each
share held, approved in April 2004 and (d) a bonus issue of one share for every
two shares held, approved in March 2005.
Common and Preferred Shares are traded in the market, but only the
Common Shares have voting rights. Under the terms of the Company's bylaws,
however, specific rights are assured to the non-voting Preferred Shares. See
Gerdau S.A.'s bylaws comprising an exhibit of this document.
The following table presents high and low market prices for Gerdau
S.A.'s ADRs as traded on the New York Stock Exchange (NYSE) for the indicated
periods.
CLOSING PRICES GGB - ANNUAL BASIS
Adjusted for dividends
YEAR US DOLLARS PER SHARE
HIGH LOW
2000 3.97 2.02
2001 3.00 1.20
2002 3.59 1.77
2003 6.82 2.07
2004 12.13 5.31
Source: Bloomberg
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CLOSING PRICES GGB - QUARTERLY BASIS
Adjusted for dividends
YEAR US DOLLARS PER SHARE
HIGH LOW
2003
1Q 2.53 2.07
2Q 3.93 2.28
3Q 5.35 3.64
4Q 6.82 4.76
2004
1Q 7.89 6.30
2Q 8.17 5.31
3Q 11.29 8.00
4Q 12.13 9.36
2005
1Q 13.58 10.13
Source: Bloomberg
CLOSING PRICES GGB - MONTHLY BASIS
Adjusted for dividends
YEAR US DOLLARS PER SHARE
HIGH LOW
2004
December 12.11 10.75
2005
January 11.61 10.13
February 13.16 10.75
March 13.58 10.96
April 11.10 9.42
May 10.65 8.89
Source: Bloomberg
The above tables show the lowest and highest market prices of Gerdau's
shares since 2000. Share prices have been retroactively adjusted for all periods
to reflect: (a) a bonus issue of three shares for each share held, approved in
April 2003, (b) a reverse stock split of one share for each 1,000 shares held,
approved in April 2003, (c) a bonus issue of one share for each share held,
approved in April 2004 and (d) a bonus issue of one share for every two shares
held, approved in March 2005.
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
65
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 places a ceiling on
individual orders of R$ 100,000 and price variations are limited to 2% (above or
below) the closing quote of the day.
Since March 17, 2003, market making activities have been allowed on the
BOVESPA, although there are no specialists or market makers for the Company's
shares on this exchange. The 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 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 - CBLC (Companhia Brasileira de
Liquidacao e Custodia), 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 CVM, which has
authority over stock exchanges and the securities markets generally, and by the
Brazilian Central Bank, 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 6,385 of December 7, 1976, as amended) and the Brazilian
Corporate Law (Law 6,404 of December 15, 1976, as amended).
Law 10,303 of October 31, 2001, amended Law 6,385/76 and Law 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 member and alternate (considering that until April 2005, the
representative of such shareholders shall be chosen from a three-name list
prepared by the 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 permitted to trade on the stock market if they have at
least one of the rights mentioned as follows: (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) tag-along rights
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.
66
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 to the corporation.
On March 5, 2002, the CVM issued Regulation 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 stock 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 trading day. In 2004, 80.0 million ADRs were
traded, a figure 240.4% higher than in 2003, representing a trading volume of
$1.3 billion, equivalent to a daily average of $5.1 million.
LATIBEX - MADRID STOCK EXCHANGE
Since December 2, 2002, Gerdau S.A.'s 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) 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 2004, a total of 479,100 Gerdau
Preferred Shares were traded on the Madrid Stock Exchange (Latibex),
representing a trading volume of 6.2 million Euros.
67
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 filed on June 30, 2004 (Commission file number 1-14878).
The items listed below refer to significant changes to the by-laws, since the
date of the Company's last annual report on Form 20-F. 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 second paragraph
with the following text and consequent renumbering of the ensuing paragraphs:
Article 4(0), paragraph 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".
The Shareholders' Meeting held on April 28, 2005, resolved to alter
item 5.1 to provide more flexibility to the stock option plan through the
introduction of a range, as follows: "5.1. The granting of call options shall
only apply to GERDAU Preferred Shares, in an amount equivalent from 10% (ten per
cent) to 20% (twenty per cent) per year of the basic annual salary of each of
the EXECUTIVES selected to take part in the PROGRAM. For this program, the basic
annual salary of these EXECUTIVES shall be defined as equal to 13 (thirteen)
times the monthly salary paid by the company in the month of December". In
addition it resolved to eliminate the conditions of the "Long Term Incentive
Plan" which had authorized the granting to an individual elected as director or
executive officer for the first time the three-year mandatory vesting period
option.
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 6.404/76, which regulates corporations in Brazil.
In general terms, article 153 of the Corporate Law establishes that in
exercising his/her duties, a company director or officer shall employ the care
and diligence which an active person of integrity normally employs in the
administration of his/her own affairs.
Article 154, paragraph 2 of the Corporate Law, states that directors
and officers shall not: a) perform an 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/her own advantage or for the advantage of any entity
in which he/she/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 unless
according to the Company's by-laws or a General Shareholders' Meeting.
In more specific terms, as outlined in the paragraph 1 of article 156
of the same law, a director or an officer may only perform transactions with the
Company under reasonable and fair conditions, identical to the conditions
prevailing
68
in the market, or in situations under which the Company would contract with
third parties, including occasional loan agreements between the Company and its
directors or officers.
Article 152 of the Corporate Law states that the General Shareholders'
Meeting shall establish the financial compensation of directors and officers as
well as any benefits and representational allowances.
Article 146 of Law 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 as to 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 (Information regarding the differentiated corporate
governance levels was included in the Registration Statement on Form 20-F dated
June 30, 2004 - Commission file number 1-14878).
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 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 a single contract, or a series of related
contracts, with or without the same purpose, equals or exceeds R$ 200,000.00
within any one-year period, or equals or exceeds an amount equal to one percent
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 accelerated expiration and any influence that such a 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 the Gerdau Group and
its employees, as described in item 16 B of this document, and also available at
www.gerdau.com.br
Gerdau's 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 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
interests 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
For information concerning material contracts regarding acquisition of
assets, see Item 4 - Company Information and Item 5 - Operating and Financial
Review and Prospects. None of these contracts exceeds 15% of the Company's
consolidated fixed assets.
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.
69
NEXI
In December 2004, Gerdau, through Gerdau Acominas signed a $240 million
financing agreement. ABN AMRO Bank led and structured the transaction which was
funded by ABN AMRO Bank N.V., Bank of Tokyo-Mitsubishi and UFJ Bank Limited. The
full term of the loan is seven years with a grace period of two years and five
years' amortization. Nippon Export and Investment Insurance (NEXI), a credit
insurance agency linked to the Japanese government, covers 97.5% of the
political risk and 95% of the commercial risk. Political risk reflects Brazilian
government policies on cross-border payments, while commercial risk reflects the
Company's ability to meet its commitments. The first tranche of $32.0 million of
this agreement was placed in January 2005 at a cost of funding of LIBOR + 0.5%
per year. The agreement has a two-year grace period from the contract signature
date, semi-annual amortization and a final maturity date in 2011.
EURO COMMERCIAL PAPER
Gerdau issued a Euro Commercial Paper program for a total amount of
$110 million in October 2004. The program matures on October 12, 2005 with the
securities bearing an annual coupon of 3.0%.
EXPORT RECEIVABLES NOTES
On September 4, 2003, Gerdau Acominas 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. The initial tranche was placed with an annual coupon of
7.37% and final maturity in July 2010. The operation has a 2-year grace period
and amortization will be quarterly, beginning in October 2005. The operation was
awarded a "BBB-" rating by Fitch Ratings. The certificates are backed by
receivables representing future sales of steel products by Gerdau Acominas.
On June 3, 2004, Gerdau Acominas 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 an annual coupon of 7.321%. The notes
have a quarterly amortization schedule starting in July 2006. At the time of
pricing (May 24, 2004), this represented a yield of 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 representing future sales of steel products by Gerdau
Acominas.
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: The Senior Secured Credit Facility
provides commitments 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
70
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, 2004, borrowings were $27.000, and there
was $295.0 million available under the Senior Secured Credit Facility
compared to $135.0 million borrowed and $130.3 million available on
December 31, 2003.
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 by excess
availability from time to time. The Senior Secured Credit Facility
contains restrictive covenants that limit the Company's ability to
engage in specific types of transactions without the consent of the
lenders. These covenants may limit Gerdau Ameristeel ability to, among
other things: incur additional debt, issue redeemable stock and
preferred stock, pay dividends on its Common Shares, sell or otherwise
dispose of certain assets and enter into mergers or consolidations.
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.
Interest on the notes accrues at 10 3/8% per annum (10.75% effective
rate) and 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, together with 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 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 1,289 of the National Monetary Council ("Annex IV Regulations").
Currently, this mechanism is regulated by Resolution 2,689, of January 26, 2000,
of the National Monetary Council and by CVM Instruction 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. Pursuant to 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
71
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 1,927 of the National Monetary Council, which is the Amended
and Restated Annex V to Resolution 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 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 Resolution 2,689 by a foreign investor, the same holder may not be able to
convert into foreign currency and remit the proceeds outside Brazil 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 overseas 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
Before March 2005, there were two legal foreign exchange markets in
Brazil, the Commercial Market and the Floating Market. The Commercial Market was
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 overseas. The Commercial Rate was the commercial
exchange rate for Brazilian currency into U.S. dollars as reported by the
Central Bank. The Floating Rate was the prevailing exchange rate for Brazilian
currency into U.S. dollars, and was applicable to transactions to which the
Commercial Rate did not apply.
Through the medium of Resolution 3,265 of March 4, 2005 (which took
effect on March 14, 2005), the National Monetary Council introduced a single
foreign exchange market and abolished the legal differences between the referred
Commercial and Floating Markets. Among the modifications to foreign exchange
market rules is a greater freedom to
72
remit funds abroad through the foreign exchange market. On the other hand, the
so-called "CC5-Accounts", which are bank accounts in reais held in Brazil by
foreign entities, may no longer be used to transfer funds on behalf of third
parties. Since these changes are very recent, it is not possible to more
definite as to the impact of Resolution 3,265's provisions on the Brazilian
foreign exchange market, but it is expected that there will be a generally
positive effect by reducing currency exchange transaction costs.
The Company will make all cash distributions on Preferred Shares in
reais and consequently exchange rate fluctuations may affect the U.S. dollar
amounts received by the holders of Preferred ADRs on conversion by the
Depositary. Fluctuations in the U.S. dollar/real exchange rate may also affect
the U.S. dollar equivalent of the Preferred Share price in reais 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
Preferred Shares and Preferred ADRs. It does not purport to be a comprehensive
description of all the tax considerations that may be relevant to a decision to
purchase such 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 or an individual that holds
Preferred Shares or Preferred ADRs in a hedging transaction or as a position in
a "straddle" or "conversion transaction" for tax purposes. Similarly, it does
not address the tax treatment of 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 a company. Each prospective purchaser of a Preferred Share or Preferred ADR
should consult his/her own tax advisers as to the personal tax consequences of
the investment, which may vary for investors in different tax situations.
The summary is based upon the 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 present, 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
come 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 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
73
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 arising from Provisional Measure 135, of
October 30, 2003, converted into Law 10,833 of December 29, 2003.
Pursuant to Law 10,833/03, gains realized on the disposal of any assets
located 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 above-mentioned provision would appear 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 above-mentioned provision,
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. Based on this referred provision, the Brazilian tax authorities may
claim that transactions between non-residents involving sales of Preferred ADRs
are taxable in Brazil, but there are grounds to argue that Preferred ADRs are
not subject to such taxation because they do not fall within the concept of
assets located in Brazil. Considering the general and unclear scope of the
provision and the absence of legal precedent, it is not possible to predict the
understanding that will ultimately prevail in the courts of Brazil.
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. When Preferred Shares are registered under Regulation 2,689, a
non-Brazilian holder cannot transfer or assign them abroad. 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%.
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 15% 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 15%. 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.
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 rate of 15%,
unless such transaction involves non-Brazilian holders, residents of a tax
haven, in which case the gains referred hereto will be subject to Brazilian
income taxation at the rate of 25%.
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INTEREST ON CAPITAL STOCK
Distribution of interest on capital stock with regard to the Preferred
Shares as an alternative form of payment to shareholders that 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.
Financial Information - Interest on Capital Stock).
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 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 Foreign Exchange 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 law 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
75
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 a 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 (iii) an estate or trust
that is not a U.S. Holder. If a partnership (including for this purpose any
entity treated as a partnership for U.S. federal tax purposes) is a beneficial
owner of a Preferred Share or Preferred ADR, the U.S. federal tax treatment of a
partner in the partnership generally will depend on the status of the partner
and the activities of the partnership. A holder of a Preferred Share or
Preferred ADR that is a partnership and partners in that partnership should
consult their own tax advisers regarding the U.S. federal income tax
consequences of holding and disposing of Preferred Shares or Preferred ADRs.
NATURE OF PREFERRED ADRS FOR U.S. FEDERAL INCOME TAX PURPOSES
In general, for U.S. federal income tax purposes, a holder of a
Preferred ADR will be treated as the owner of the underlying Preferred Shares.
Accordingly, except as specifically noted below, the tax consequences discussed
below with respect to Preferred ADRs will be the same for Preferred Shares in
the Company, and exchanges of Preferred Shares for Preferred ADRs, and Preferred
ADRs for Preferred Shares, generally will not be subject to U.S. federal income
tax.
TAXATION OF DIVIDENDS
U.S. holders: In general, subject to the passive foreign investment
company rules discussed below, a distribution on a Preferred ADR (including for
this purpose a distribution of interest on capital stock) 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 ADR on which it is paid. 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 ADR (which will include
the amount of any Brazilian taxes withheld) will be subject to U.S. federal
income tax as foreign source dividend 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
disposition of the Brazilian currency generally will 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
under current law for specific categories of income, a dividend generally will
constitute foreign source "passive income" or, in the case of certain holders,
"financial services income" for purposes of the current foreign tax credit
limitation rules. For taxable years beginning after December 31, 2006,
"financial services income" generally will be treated as "general category
income," and "passive income" generally will be treated as "passive category
income." A U.S. Holder will be denied a foreign tax credit with respect to
Brazilian income tax withheld from dividends received with respect to the
underlying Preferred Shares represented by the Preferred ADRs to the extent the
U.S. Holder has not held the Preferred ADRs for at least 16 days of the 30-day
period beginning on the date which is 15 days before the ex-dividend date or to
the extent the U.S. Holder is under an obligation to make related payments with
respect to substantially similar or related property. Any days during which a
U.S. Holder has substantially diminished its risk of loss on the Preferred ADRs
are not counted toward meeting the 16-day holding period required by the
statute. The rules relating to the determination of the foreign tax credit are
complex, and you should consult with your own tax advisers to determine whether
and to what extent you would be entitled to this credit. You should consult your
tax adviser with respect to the determination of the foreign tax credit
limitation, as the relevant rules are complex and are scheduled to change in
future years. Alternatively, any Brazilian withholding tax may be taken as a
deduction against taxable income. A dividend will not be eligible for the
corporate dividends received deduction.
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
76
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 or 2004 taxable year. Effective for taxable years of foreign
corporations beginning after December 31, 2004, the rules relating to FPHCs and
FICs are repealed. 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 2005 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 through whom the 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 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
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 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 disposition of a Preferred ADR, a
U.S. holder will recognize capital gain or loss in an amount equal to the
difference between the U.S. holder's adjusted basis in the Preferred ADR and the
amount realized on the sale or other disposition, each determined in U.S.
dollars. Any gain a U.S. holder recognizes generally will 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 disposition of a Preferred Share, the amount realized will include
the gross amount of the proceeds of that sale or disposition 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 disposition of a 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 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 disposition 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.
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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 or 2004 taxable year. However, because the
determination of whether the Company is a PFIC is based upon the composition of
its income and assets from time to time, it is possible that the Company will
become a PFIC for any future 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 2005 taxable year.
The PFIC rules are designed generally to eliminate any benefits of
deferral of U.S. federal income tax that a U.S. holder could derive from
investing in a corporation that is organized outside the United States (a
"foreign corporation"). 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 dispositions 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 pursuant to
certain elections that generally require the payment of tax, 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 an election described in the next two
paragraphs would be subject to special rules with respect to (i) any gain
realized on a sale or other disposition of a 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
ADR exceed 125% of the average annual taxable distributions that the U.S. holder
received on the Preferred ADR during the preceding three taxable years or, if
shorter, the U.S. holder's holding period for the Preferred ADR). Under those
rules, (i) the gain or excess distribution would be allocated ratably over the
U.S. holder's holding period for the 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 of those
years, 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 of
those years. A U.S. holder who owns a Preferred ADR during any year that the
Company is a PFIC must file Internal Revenue Service Form 8621.
The special PFIC rules described above will not apply to a U.S. holder
if the U.S. holder makes a timely election to treat the Company as a "qualified
electing fund" ("QEF") in the first taxable year in which the U.S. holder owns a
Preferred ADR and the Company is a PFIC and if the Company complies with certain
reporting requirements. Instead, a shareholder of a QEF generally 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 that 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
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 does not satisfy the tests to be 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
78
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 Preferred 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 second preceding paragraph 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 Preferred ADRs will be considered to be marketable stock if the Preferred
ADRs trade, other than in de minimis quantities, on at least 15 days during each
calendar quarter. There is no certainty, however, that the Preferred Shares will
be considered to be "marketable stock" for these purposes unless and until the
Internal Revenue Service designates the BOVESPA as having rules adequate to
carry out the purposes of the PFIC rules. There can be no assurance that the
Internal Revenue Service will make that designation.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Dividends paid on, and proceeds from the sale or other disposition of a
Preferred ADR to a U.S. holder, generally may 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 generally will 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
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. The Company's filings are also
available to the public through 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 - Brazil or calling xx 55-51-3323 2703 or by e-mail at
inform@gerdau.com.br. In compliance with New York Stock Exchange Corporate
Governance Rule 303A.11, the Company provides on its website a summary of the
differences between its corporate governance practices and those of 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 RISK
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.
79
Gerdau has established policies and procedures for risk assessment and the
approval, reporting and monitoring of its derivative financial activities.
FOREIGN EXCHANGE RISK
Gerdau is exposed to fluctuations in exchange rate movements since
substantially all of its revenues generated outside its subsidiaries in the
United States are in the local currency of the respective subsidiaries, mainly
the 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. On December 31, 2004, its derivative
portfolio consisted essentially of cross-currency interest rate swaps. The table
below provides information about Gerdau's significant exchange rate risk
sensitive instruments on December 31, 2004 as well as the related financial
instruments acquired to mitigate such potential risk.
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 AMERICAN SUBSIDIARIES
-------------------------------------------------------------------------------------------------------------------------------
US$ THOUSAND 2005 2006 2007 2008 2009 MATURITY TOTAL
AFTER 2009
-------------------------------------------------------------------------------------------------------------------------------
FINANCING FOR MACHINERY AND OTHERS
Outstanding amount 73,524 40,372 84,725 12,276 10,100 12,534 233,531
Average interest rate FX+3.1% FX+3.1% FX+3.1% FX+3.1% FX+3.1% FX+3.1%
-------------------------------------------------------------------------------------------------------------------------------
PRE-EXPORT ADVANCES
Outstanding amount 74,180 37,935 27,000 117,500 33,500 - 290,115
Average interest rate FX+3.0% FX+3.0% FX+3.0% FX+3.0% FX+3.0% FX+3.0%
-------------------------------------------------------------------------------------------------------------------------------
EXPORT RECEIVABLES NOTES
Outstanding amount 8,012 27,052 38,086 40,962 44,055 78,386 236,553
Average interest rate FX+7.3% FX+7.3% FX+7.3% FX+7.3% FX+7.3% FX+7.3%
-------------------------------------------------------------------------------------------------------------------------------
FINANCING FOR INVESTMENTS
-------------------------------------------------------------------------------------------------------------------------------
Outstanding amount 11,835 11,417 11,417 11,417 11,417 11,417 68,920
-------------------------------------------------------------------------------------------------------------------------------
Average interest rate FX+Libor + FX+Libor + FX+Libor + FX+Libor + FX+Libor + FX+Libor + FX+Libor +
1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4%
-------------------------------------------------------------------------------------------------------------------------------
WORKING CAPITAL
Outstanding amount 411,186 - 3,973 - - - 415,159
Average interest rate FX+7.1% - FX+5.7% - - -
-------------------------------------------------------------------------------------------------------------------------------
CROSS-CURRENCY INTEREST RATE SWAP CONTRACTS
-------------------------------------------------------------------------------------------------------------------------------
Notional amount 45,169 13,035 - - - - 58,204
Average interest received in US$ FX+7.7% FX+7.4% - - - -
Average interest paid in R$ (% of
CDI) 91.3% 87.4% - - - -
-------------------------------------------------------------------------------------------------------------------------------
TOTAL DEBT OF SUBSIDIARIES OUTSIDE
NORTH AMERICAN INDEXED TO U.S.
DOLLARS, NET OF CROSS-CURRENCY SWAPS 533,568 103,741 165,201 182,155 99,072 102,337 1,186,074
-------------------------------------------------------------------------------------------------------------------------------
FX: Indicates that since the debt is denominated in a currency
different to the functional currency of the subsidiary a foreign exchange gain
or loss will be recognized in income resulting from the fluctuation of the
exchange rate between the U.S. dollar (the currency on which the debt is
denominated) and the respective local currency.
On December 31, 2004, of U.S. dollar-denominated debt in subsidiaries
outside North America that totaled $1,244.3 million, Gerdau entered into
cross-currency interest swaps in reais to swap the currency and interest rate of
the original liability to a real denominated liability carrying interest based
on Brazilian Interbank deposit rates (CDI), amounting to approximately $58.2
million.
80
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.
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 to be paid if the agreements were terminated at
December 31, 2004, was approximately $4 million.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
Not applicable.
81
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 Chief
Financial Officer and Investor Relations Executive Officer, 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 Board of Directors has determined that Egon Handel, a member of its
Board of Auditors, is a "financial expert" within the meaning of the SEC rules
applicable to disclosure of such expertise.
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). The provisions of the document are thus binding on Gerdau's Chief
Executive Officer, Chief Financial Officer, Chief Accounting Officer, and other
persons performing similar functions.
"Gerdau Ethical Guidelines" are not yet extensive to employees of
Gerdau Acominas' Ouro Branco mill and its administrative office, in Belo
Horizonte. The Company does not, therefore, considerer these employees to be
bound by the document.
The Company's subsidiary, Gerdau Ameristeel has its own Code of Ethics,
which is compatible with Gerdau's guidelines. Both documents meet the definition
of code of ethics contemplated by applicable SEC and New York Stock
82
Exchange rules, covering wrongdoing related to business conduct, conflicts of
interest, disclosure in reports and other documents, as well as compliance with
legislation. Each document establishes a manner of reporting violations, as well
as accountability for adherence.
Gerdau Ethical Guidelines states and defines the values that have
formed the foundation of the Gerdau Group for more than 100 years, which are:
Integrity, Correctness and Consistency; Satisfied Customers; Accomplished
People; Safe Work Environment; Quality in Everything We Do; Solidity and
Security; Commitment to All Stakeholders and Profit as a Measure of Performance.
The document also covers the Company's and employees' commitments regarding
relationships between Company and employees, customers, shareholders, suppliers,
competitors, community and environment.
Gerdau Ethical Guidelines were not amended in the last fiscal year, and
the Company did not grant any waiver from the document's provisions.
Gerdau Ameristeel's Code of Ethics and Business Conduct comprises the
following issues: Business Conduct and Compliance with Laws (Safety and Health;
Equal Employment; Discriminatory Harassment; Sexual Harassment; Environmental;
Antitrust; Campaign and Election Law Matters; Improper Payments and Foreign
Governmental Contracts; Delegation of Authorities and Insider Trading; Conflicts
of Interest; Corporate Opportunities; Accuracy of Records and Information
Reporting; Confidentiality; Fair Dealing; Protection and Proper Use of Company
Assets; Guidance Available; Compliance, Administration and Reporting and
Disclosures.
Gerdau Ameristeel has also adopted a Code of Ethics applicable to its
Senior Executives, which is a supplement to the Code of Ethics and Business
Conduct. This document binds all of Gerdau Ameristeel's employees who have
significant responsibility for preparing or overseeing the preparation of the
Company's financial statements and other financial data included in the
Company's periodic reports to the Canadian securities regulatory authorities and
the U.S. Securities and Exchange Commission and in other public communications
made by the Company.
Gerdau is in the process of reviewing its Ethical Guidelines, and will
evaluate the application of the document to employees not currently covered, as
well as its consolidation with Gerdau Ameristeel's Code.
The Gerdau Ethical Guidelines document may be accessed through its
Internet website (www.gerdau.com.br). Gerdau Ameristeel's Code of Ethics and
Business Conduct as well as the Code of Ethics Applicable to Senior Executives
can be found on its web site at www.gerdauameristeel.com.
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 ACCOUNTANT FEES AND SERVICES
The following table provides information on fees billed to Gerdau for
professional services rendered by the external auditors responsible for auditing
the financial statements included in this Annual Report (in U.S. dollars):
2004 2003
Audit fees 1,513,664 1,471,197
Audit-related fees 240,332 100,000
Tax fees 14,680 277,000
All other fees -- --
TOTAL 1,768,676 1,848,197
83
Audit fees are related to professional services rendered in the
auditing of Gerdau's consolidated financial statements, quarterly reviews of
Gerdau's consolidated financial statements AND statutory audits and interim
reviews of certain of the Company's subsidiaries and affiliates as required by
the appropriate legislation,.
Audit-related fees are for assurance and related services, such as
due diligence services traditionally performed by an external auditor and due
diligence related to acquisitions, as well as consulting on accounting standards
and transactions.
Tax fees are related to services provided to subsidiaries in South
America (relating to tax compliance, assistance with tax audits and inquiries,
and other tax services) and to subsidiaries in North America (tax services).
D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
On April 28, 2005, the Company elected its Board of Auditors duly
adapted to ensure compliance with the Sarbanes-Oxley Act requirements and
exemptions from the listing standards. The Board of Auditors ("Conselho Fiscal")
has been operating in accordance with Brazilian Corporate Law 6,404/76, since
April 2000. The customary 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. In establishing a permanent Board
of Auditors, the Company has availed itself of paragraph (c)(3) of Rule 10A-3 of
the U.S. Securities Exchange Act of 1934, as amended, which provides a general
exemption from the audit committee requirements for a foreign private issuer
(such as the Company) with a board of auditors, subject to certain requirements
which continue to be applicable under Rule 10A-3.
NYSE rules require that listed companies have an audit committee that
(i) is composed of a minimum of three independent directors who are all
financially literate, (ii) meets the SEC rules regarding audit committees for
listed companies, (iii) has at least one member who has accounting or financial
management expertise and (iv) is governed by a written charter addressing the
committee's required purpose and detailing its required responsibilities.
However, as a foreign private issuer, the Company needs only to comply with the
requirement that the audit committee, or Board of Auditors in our case, meet the
SEC rules regarding audit committees for listed companies. The Brazilian
Corporate Law requires companies to have a non-permanent Board of Auditors
composed of three to five members who are elected at the Ordinary General
Meeting of Shareholders. The Board of Auditors operates independently from
management and from a company's external auditors. Its main function is to
monitor the activities of management, examine the financial statements of each
fiscal year and provide a formal report to our shareholders.
The Company has a permanent "Conselho Fiscal" that consists of three
members (up to five) and three alternates (up to five) and which has ordinary
meetings every two months. The members of our "Conselho Fiscal" are all
financially literate and one member has accounting expertise that qualifies him
as an audit committee financial expert. The Company believes that its Board of
Auditors, as modified, meets the requirements for the exemption available to
foreign private issuers under the SEC rules regarding audit committees of listed
companies. In addition, the Board of Auditors operates under a written charter
that is in the process of being amended and which the Company believes meets the
NYSE's requirements for audit committee charters. The Board of Auditors is not
the equivalent of, or wholly comparable to, a U.S. audit committee. Among other
differences, it is not required to meet the standards of "independence"
established in Rule 10A-3 and is not fully empowered to act on matters that are
required by Rule 10A-3 to be within the scope of an audit committee's authority.
Nonetheless, with the duties that have been provided to the Board of Auditors to
the extent permitted by Brazilian law, the Company believes that its current
corporate governance system, taken as a whole, including the ability of the
Board of Auditors to consult internal and external experts, is fully equivalent
to a system having an audit committee functioning as a committee of its Board of
Directors. For a further discussion of our Board of Auditors, see "Item 6C.
Board Practices -- Board of Auditors".
The Board of Auditors members are elected at the Ordinary Shareholders'
Meeting for one-year terms. They are eligible for reelection. Additionally,
minority-preferred shareholders elected one of the current members. As required
by Brazilian law, members of the Board of Auditors must have held office for at
least three years as business administrators or as members of boards of
auditors. The Board of Auditors, at the request of any of its members, may ask
the external auditors to provide explanations or information and to investigate
specific facts.
84
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 CVM Instruction 10/80
and resolved to authorize the acquisition of shares issued by Gerdau S.A. for
holding as treasury stock and later disposal or cancellation.
These shares were acquired using cash funds backed by existing profit
reserves up to the adjusted limit of 4,140,000 Preferred Shares, representing 2%
of outstanding stock, which amounted to 207,933,042 adjusted shares on October
31, 2003.
The Board of Director's authorization remained in force for 90 days
from the above date of its approval. The transaction was concluded through 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
(Shares and prices have been retroactively adjusted for all periods below to
reflect: (i) a bonus issue of one share for each share held, approved in April
2004 and (ii) a one bonus share for each two shares held, approved in April
2005.)
MAXIMUM NUMBER OF
TOTAL NUMBER OF SHARES THAT MAY
AVERAGE PRICE PAID SHARES PURCHASED STILL BE
TOTAL NUMBER OF PER SHARE(1) AS PART OF PURCHASED UNDER
SHARES PURCHASED PUBLICLY ANNOUNCED THE PLANS OR
(IN R$) PLANS OR PROGRAMS PROGRAMS
NOVEMBER 170,100 14.94 4.1% 3,969,900
(11/17/2003 - 11/30/2003)
DECEMBER 864,900 16.77 25.0% 3,105,000
(12/01/2003 - 12/31/2003)
JANUARY 810,900 20.85 44.6% 2,294,100
(01/01/2004 - 01/31/2004)
FEBRUARY 513,900 19.54 57.0% 1,780,200
(02/01/2004 - 02/14/2004)
TOTAL 2,359,800 18.65 57.0% 1,780,200
(1) Price paid divided by number of shares excluding brokers' fees.
85
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-2
Consolidated balance sheets on December 31, 2004 and 2003 F-3
Consolidated statements of income for the years ended December 31, 2004, 2003 and 2002 F-5
Consolidated statements of comprehensive income (loss) for the years ended December 31, 2004, 2003 and 2002 F-6
Consolidated statement of changes in shareholders' equity for the years ended December 31, 2004, 2003 and 2002 F-7
Consolidated statement of cash flow for the years ended December 31, 2004, 2003 and 2002 F-8
Notes to consolidated financial statements for the years ended December 31, 2004, 2003 and 2002 F-10
(B) LIST OF EXHIBITS
1.01 Bylaws of Gerdau S.A.
1.02 Corporate Governance Level 1 - BOVESPA *
4.01 Deposit Agreement dated September 18, 1997, as amended and restated on
March 8, 1999, and as further amended and restated on May 7, 2003,
among the Company, The Bank of New York as Depositary and all Owners
and Beneficial Owners from time to time of American Depositary Receipts
issued thereunder. **
The Company and its subsidiaries do not have a single financial long
term debt instrument in excess 10% of the consolidated total assets of
the Company. The Company undertakes to furnish to the SEC all such
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
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
15.01 Report of independent registered public accounting firm regarding
Gallatin Steel Company
86
* Incorporated by reference to the Company's Annual Report on Form 20-F for the
year ended December 31, 2003 (File N(0) 001-14878), filed with the Securities
and Exchange Commission on June 30, 2004.
** Incorporated by reference to the Company's Registration Statement on Form F-6
(File No. 333-9896), filed with the Securities and Exchange Commission on May 6,
2003.
87
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, 2005 Title: Chief Financial
Officer
88
GERDAU S.A.
Consolidated financial statements as of December 31, 2004 and 2003 and for each
of the three years in the period ended December 31, 2004
and report of independent registered public accounting firm
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Gerdau S.A.
In our opinion, based on our audits and the report of other auditors, 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, 2004 and 2003, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2004 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 did not
audit the financial statements of Gallatin Steel Company, a 50% owned joint
venture, which represented equity investment amounting to 2.4% of total
consolidated assets as of December 31, 2004 and equity in income amounting to
8.0% of income before taxes on income and minority interests for the year ended
December 31, 2004. Those statements were audited by other auditors whose report
thereon has been furnished to us, and our opinion expressed herein, insofar as
it relates to the amounts included for this equity investee as of and for the
year ended December 31, 2004, is based solely on the report of the other
auditors. 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
audits and the report of other auditors provide a reasonable basis for our
opinion.
PricewaterhouseCoopers Auditores Independentes
Porto Alegre, Brazil
April 28, 2005
F-2
GERDAU S.A.
CONSOLIDATED BALANCE SHEETS
as of December 31, 2004 and 2003
(in thousands of U.S. Dollars, except number of shares)
--------------------------------------------------------------------------------
ASSETS
NOTE 2004 2003
------- ------------- -------------
Current assets
Cash and cash equivalents 248,954 92,504
Restricted cash 6,063 1,935
Short-term investments 5 404,512 236,137
Trade accounts receivable, net 6 835,484 465,857
Inventories 7 1,594,118 797,961
Unrealized gains on derivatives 21 - 9,599
Deferred income taxes 18.4 82,829 49,451
Tax credits 8 75,908 37,953
Prepaid expenses 22,218 21,859
Other 52,941 46,576
------------- -------------
Total current assets 3,323,027 1,759,832
------------- -------------
Non-current assets
Property, plant and equipment, net 10 2,790,201 2,304,158
Deferred income taxes 18.4 153,430 245,589
Judicial deposits 16.1 42,554 66,121
Unrealized gains on derivatives 21 - 86
Equity investments 11 207,767 139,272
Investments at cost 6,640 23,854
Goodwill 12 141,463 119,531
Prepaid pension cost 13 53,276 35,253
Advance payment for acquisition of investment in Colombia 4.1 68,500 -
Other 65,391 77,138
------------- -------------
Total assets 6,852,249 4,770,834
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
GERDAU S.A.
CONSOLIDATED BALANCE SHEETS
as of December 31, 2004 and 2003
(in thousands of U.S. Dollars, except number of shares)
------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
NOTE 2004 2003
---------- -------------- --------------
Current liabilities
Short-term debt 14 412,910 479,586
Current portion of long-term debt 15 260,294 318,910
Trade accounts payable 627,897 372,518
Income taxes payable 80,445 27,790
Unrealized losses on derivatives 21 12,470 29,582
Deferred income taxes 18.4 14,496 7,286
Payroll and related liabilities 88,969 54,478
Dividends and interest on equity payable 3,609 53,202
Taxes payable, other than income taxes 56,699 26,482
Accrued acquisition costs 4.3 51,790 -
Other 102,726 89,328
-------------- --------------
Total current liabilities 1,712,305 1,459,162
Non-current liabilities
Long-term debt, less current portion 15 1,280,516 1,132,429
Debentures 15 344,743 155,420
Deferred income taxes 18.4 58,654 72,125
Accrued pension and other post-retirement benefits obligation 13 119,925 108,679
Provision for contingencies 16.1 87,718 102,060
Taxes payable in installments 25,594 3,642
Unrealized losses on derivatives 21 6,323 11,445
Other 51,915 57,812
-------------- --------------
Total non-current liabilities 1,975,388 1,643,612
-------------- --------------
Total liabilities 3,687,693 3,102,774
COMMITMENTS AND CONTINGENCIES 16
Minority interest 641,971 264,997
SHAREHOLDERS' EQUITY 17
Preferred shares - no par value - 480,000,000 authorized shares
and 290,657,361 shares issued at December 31, 2003 and 2004,
after giving
retroactive effect to the stock bonus approved on April 29,
2004 (Note 17.1) and on March 31, 2005 (Note 27)
1,016,846 653,344
Common shares - no par value - 240,000,000 authorized shares and
154,404,672 shares issued at December 31, 2003 and 2004,
after giving retroactive effect to the stock bonus approved
on April 29, 2004 (Note 17.1) and on March 31, 2005 (Note 27)
522,358 329,257
Additional paid-in capital 3,743 3,271
Treasury stock - 2,359,800 and 1,035,000 preferred shares at December 31, (15,256) (5,920)
2004 and 2003, respectively, after giving retroactive effect
to the stock bonus approved on April 29, 2004 (Note 17.1) and
on March 31, 2005 (Note 27)
Legal reserve 122,813 63,834
Retained earnings 1,509,847 1,161,527
Cumulative other comprehensive loss
- Foreign currency translation adjustment (622,425) (790,731)
- Additional minimum pension liability (15,341) (11,519)
-------------- --------------
Total shareholders' equity 2,522,585 1,403,063
-------------- --------------
Total liabilities and shareholders' equity 6,852,249 4,770,834
============== ==============
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, 2004, 2003 and 2002
(in thousands of U.S. Dollars, except number of shares and per share amounts)
--------------------------------------------------------------------------------
NOTE 2004 2003 2002
------ -------------- -------------- --------------
Sales 7,785,998 5,033,472 3,664,920
Less: Federal and state excise taxes (724,351) (414,198) (344,654)
Less: Discounts (109,498) (88,305) (55,340)
-------------- -------------- --------------
Net sales 6,952,149 4,530,969 3,264,926
Cost of sales (4,838,949) (3,445,564) (2,349,636)
-------------- -------------- --------------
Gross profit 2,113,200 1,085,405 915,290
Sales and marketing expenses (154,558) (146,388) (112,645)
General and administrative expenses (359,102) (241,854) (221,895)
Other operating income (expenses), net 16 28,710 (824) (18,178)
-------------- -------------- --------------
Operating income 1,628,250 696,339 562,572
Financial expenses (164,370) (219,353) (216,325)
Financial income 81,592 62,036 100,350
Foreign exchange gains and losses, net 30,806 162,190 (266,594)
Gains and losses on derivatives, net 1,155 (197,600) 58,772
Equity in earnings (losses) of unconsolidated companies, net 141,890 22,062 (10,057)
Gain on change of interest 4.5 2,742 - -
-------------- -------------- --------------
Income before taxes on income and minority interest 1,722,065 525,674 228,718
Provision for taxes on income 18
Current (329,229) (87,812) (27,065)
Deferred (77,451) 121,925 20,507
-------------- -------------- --------------
(406,680) 34,113 (6,558)
-------------- -------------- --------------
Income before minority interest 1,315,385 559,787 222,160
Minority interest (157,027) (49,623) 9,667
-------------- -------------- --------------
Net income 1,158,358 510,164 231,827
============== ============== ==============
PER SHARE DATA (IN US$) 19
Basic earnings per share
Preferred 2.62 1.15 0.52
Common 2.62 1.15 0.52
Diluted earnings per share
Preferred 2.61 1.15 0.52
Common 2.61 1.15 0.52
Number of weighted-average common shares outstanding after giving
retroactive effect to stock bonus (Note. 17.1 and Note 27) - Basic and
diluted 154,404,672 154,404,672 154,029,249
============== ============== ==============
Number of weighted-average preferred shares outstanding after giving
retroactive effect to stock bonus (Note 17.1 and Note 27) - Basic 288,376,623 290,614,236 289,960,881
============== ============== ==============
Number of weighted-average preferred shares outstanding after giving
retroactive effect to stock bonus (Note 17.1 and Note 27) - Diluted 289,842,298 291,071,433 289,960,881
============== ============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
GERDAU S.A.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
for the years ended December 31,
2004, 2003 and 2002
(in thousands of U.S. Dollars)
--------------------------------------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
NET INCOME AS REPORTED IN THE CONSOLIDATED STATEMENT OF INCOME 1,158,358 510,164 231,827
Foreign currency translation adjustments 168,306 144,402 (311,071)
Pension fund additional minimum liability, net of tax (3,822) 4,790 (16,309)
Unrealized loss on cash flow hedge, net of tax - 2,310 (2,310)
-------------- -------------- --------------
COMPREHENSIVE INCOME (LOSS) FOR THE PERIOD 1,322,842 661,666 (97,863)
============== ============== ==============
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, 2004, 2003 and 2002
(in thousands of U.S. Dollars, except share data)
--------------------------------------------------------------------------------
CUMULATIVE
ADDITIONAL OTHER
PREFERRED COMMON PAID-IN TREASURY LEGAL RETAINED COMPREHENSIVE
NOTE SHARES SHARES CAPITAL STOCK RESERVE EARNINGS LOSS TOTAL
---------------------------------------------------------------------------------------------
BALANCES AS OF JANUARY 1, 2002 558,971 279,243 - - 56,074 762,494 (624,062) 1,032,720
Capital increase by conversion of
debentures 17.1 3,830 1,195 - - - - - 5,745
Net income - - - - - 231,827 - 231,827
Foreign currency translation
adjustment - - - - - - (311,071) (311,071)
Pension fund additional minimum
liability, net of tax - - - - - - (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 - - - - 2,086
Dividends (interest on equity)
$0.18 per Common share and
Preferred share (*) 17.4 - - - - - (77,678) - (77,678)
Transfer from legal reserve 17.2 - - - - (19,969) 19,969 - -
--------- ------- ----- ------ ------ --------- ------- ---------
BALANCES AS OF DECEMBER 31, 2002 562,801 281,158 2,086 - 36,105 936,612 (953,752) 865,010
Capitalization of retained earnings 17.3 90,543 48,099 - - - (138,642) - -
Net income - - - - - 510,164 - 510,164
Appropriation of reserves 17.2 1,061 - 27,729 (28,790) -
Purchase of treasury preferred shares 17.1 - - - (5,920) - - - (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 tax - - - - - - 2,310 2,310
Dividends (interest on equity) -
$0.27 per Common share and per
Preferred share (*) 17.4 - - - - - (117,817) - (117,817)
Stock option plan expense recognized
during the period 3.13 - 124 - - - - 124
--------- ------- ----- ------ ------ --------- ------- ---------
BALANCES AS OF DECEMBER 31, 2003 653,344 329,257 3,271 (5,920) 63,834 1,161,527 (802,250) 1,403,063
Capitalization of retained earnings 17.3 363,502 193,101 - - - (556,603) - -
Net income - - - - - 1,158,358 - 1,158,358
Appropriation of reserves 17.2 278 - 58,979 (59,257) -
Purchase of treasury preferred shares 17.1 - - - (9,336) - - (9,336)
Foreign currency translation adjustment - - - - - - 168,306 168,306
Pension fund additional minimum
liability, net of tax - - - - - - (3,822) (3,822)
Dividends (interest on equity) -
$0.44 per Common share 17.4 - - - - - (194,178) - (194,178)
and per Preferred share (*)
Stock option plan expense recognized
during the period 3.13 - - 194 - - - - 194
--------- ------- ----- ------ ------- --------- ------- ---------
BALANCES AS OF DECEMBER 31, 2004 1,016,846 522,358 3,743 (15,256) 122,813 1,509,847 (637,766) 2,522,585
========== ======= ===== ======= ======= ========== ======== =========
(*) After giving retroactive effect to the stock bonus and reverse stock split
described in Note 17.1 and in Note 27. Preferred treasury stock shares for the
years ended December 31, 2004 and 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 STATEMENT OF CASH FLOW
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, except share data)
--------------------------------------------------------------------------------
2004 2003 2002
----------- ----------- -----------
Cash flows from operating activities
Net income 1,158,358 510,164 231,827
Adjustments to reconcile net income to cash flows
from operating activities:
Depreciation and amortization 269,222 182,403 178,805
Equity in earnings (losses) on unconsolidated companies, net (141,890) (22,062) 10,057
Foreign exchange (gain) loss, net (30,806) (162,190) 266,594
Losses (gains) on derivative instruments (1,155) 197,600 (58,772)
Minority interest 157,027 49,623 (9,667)
Deferred income taxes 77,451 (121,925) (20,507)
Loss (gain) on disposal of property, plant and equipment 1,143 (1,913) 997
Provision for doubtful accounts 5,370 6,714 1,310
Provision for contingencies 93,162 43,106 20,773
Distributions from joint ventures 82,803 3,620 -
Gain on change of interest (Note 4.5) (2,742) - -
CHANGES IN ASSETS AND LIABILITIES:
Increase in accounts receivable (221,178) (80,017) (28,657)
Increase in inventories (532,769) (74,248) (94,477)
Increase (decrease) in accounts payable and accrued liabilities 51,267 100,298 (9,632)
Increase (decrease) in other assets and liabilities, net 181,763 (162,696) (138,196)
----------- ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,147,026 468,477 350,455
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant and equipment (440,967) (297,755) (185,892)
Proceeds from sales of property, plant and equipment 9 2,284 6,029
Payment for acquisition of:
Margusa (13,472) (2,234) -
Companies in North America (298,422) - -
Gerdau Ameristeel - (7,050) -
Acominas, mainly - - (412,150)
Other aquisitions (3,846) (5,446) -
Cash balance of acquired company (Margusa and Acominas, respectively) 270 - 19,954
Purchases of short-term investments (499,956) (959,522) (847,806)
Proceeds from maturities and sales of short-term investments 423,523 1,102,314 847,108
Advance payment for acquisition of investment in Colombia (68,500) - -
Other - 1,692 -
----------- ----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (901,361) (165,717) (572,757)
----------- ----------- -----------
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
GERDAU S.A.
CONSOLIDATED STATEMENT OF CASH FLOW
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, except share data)
--------------------------------------------------------------------------------
2004 2003 2002
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends and interest on equity paid (275,589) (122,262) (74,265)
Sale (purchase) of treasury shares (9,336) (5,920) 2,318
Decrease (increase) in restricted cash (3,958) 13,593 (6,091)
Debt issuance 1,290,035 1,997,978 1,186,109
Repayment of debt (1,273,208) (2,126,520) (824,880)
Proceeds from issuance of common stock by Gerdau Ameristeel (Note 4.5(d)) 181,323 - -
Net related party debt loans and repayments 13,291 (5,956) -
----------- ----------- -----------
NET CASH PROVIDED (USED) IN FINANCING ACTIVITIES (77,442) (249,087) 283,191
----------- ----------- -----------
Effect of exchange rate changes on cash (11,773) (1,626) (48,264)
Increase in cash and cash equivalents 156,450 52,047 12,625
Cash and cash equivalents at beginning of period 92,504 40,457 27,832
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD 248,954 92,504 40,457
=========== =========== ===========
SUPPLEMENTAL CASH FLOW DATA Cash paid during the year for:
Interest (net of amounts capitalized) 115,825 127,413 123,680
Income taxes 253,890 100,305 28,003
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
NON-CASH TRANSACTIONS
Release of judicial deposits to settle tax contingencies (Note 16) 118,587 - -
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, 2004, 2003 and 2002
(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 Canada, Chile, the United States and Uruguay and its
affiliates in Argentina (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 construction,
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 operate.
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. Their 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, 2004, the Company's parent, Metalurgica Gerdau S.A.
("MG", collectively with its subsidiaries and affiliates, the
"Conglomerate") owned 44.76% (2003 - 48.22%) of the total capital of the
Company. MG's share ownership consisted of 75.75% (2003 - 85.71%) of the
Company's voting common shares and 28.30% (2003 - 28.31%) of its
non-voting preferred shares.
F-10
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(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 (%)
------------------------------
2004 2003
------------- --------------
Aceros Cox S.A. (Chile) 100 100
Armafer Servicos de Construcao Ltda. (Brazil) (a) - 100
Gerdau Ameristeel Corporation (Canada) and its subsidiaries: 67 69
Ameristeel Bright Bar Inc. (USA) 67 69
Gerdau Ameristeel MRM Special Sections Inc. (Canada) 67 69
Gerdau Ameristeel Perth Amboy Inc. (USA) 67 69
Gerdau Ameristeel Sayreville Inc. (USA) 67 69
Gerdau Ameristeel US Inc. (USA) 67 69
Gerdau Acominas S.A. (Brazil) 92 92
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
Maranhao Gusa S.A. - Margusa (Brazil) (Note 4.6) 100 -
Seiva S.A. - Florestas e Industrias (Brazil) and subsidiaries 97 97
(a) During 2004, Armafer Servicos de Construcao Ltda. merged into Gerdau
Acominas S.A.
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. The consolidated financial
statements include, in addition to the operational companies presented
in the table above, all the other companies that meet the criteria for
consolidation under US GAAP, which consist of holding companies which
invest in the operating companies and carry out financing transactions.
The consolidated financial statements include the results of operations
of Gerdau Ameristeel Corporation ("Gerdau Ameristeel", formerly known as
Co-Steel Inc.) and its subsidiaries (Note 4.9) for the period from
October 23, 2002 (the date of acquisition). The results of Gerdau
Acominas S.A. 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 (Note 4.7).
During the year ended December 31, 2004 the Company acquired Margusa,
which is consolidated as from January 5, 2004 (Note 4.6) and Gerdau
Ameristeel acquired certain operating assets and liabilities of Gate
City and RJ Rebar, Inc. (Note 4.2), of North Star Steel (Note 4.3) and
of Potter Form & Tie Co. (Note 4.4). The results of those business
acquired are consolidated as from the respective dates of acquisition.
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, 2004, 2003 and 2002
(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, 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 20 years for machinery and
equipment, 10 to 20 years for furniture and fixtures, and 3 to 5 years
for vehicles and computer equipment. Assets under construction are not
depreciated until they are 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.
F-12
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
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 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,
2004 and 2003, the Company's equity investments are comprised of: (a)
38.18% interest in the capital of Sipar Aceros S.A. - Sipar, (b) a 50.00%
interest in each of Gallatin Steel Company, Bradley Steel Processors and
MRM Guide Rail, 50% owned joint-ventures in the United States (c) a
50.00% interest in Armacero Industrial y Comercial Limitada and (d)
51.82% interest in Dona Francisca Energetica S.A.
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.
As from January 1, 2002 the Company adopts 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 years ended December 31, 2004, 2003 and 2002 goodwill was
tested for impairment and no impairment charges were recorded.
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 13).
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). Past service costs from plan amendments are amortized on a
straight-line basis over the average remaining service period of the
active employees.
An additional minimum liability is recognized in "Cumulative other
comprehensive loss" in shareholders' equity if the accumulated benefit
obligation ("ABO") exceeds the fair value of plan assets, and this amount
is not covered by the
F-13
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
pension liability recognized in the balance sheet. An additional minimum
liability has been recognized as of December 31, 2004, 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 and subsidiaries and Gerdau (as from April 30, 2003)
maintain stock based compensation plans (Note 25). 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 fair value method prescribed by 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.
2004 2003 2002
-------------- -------------- --------------
Net income as reported 1,158,358 510,164 231,827
Reversal of stock-based compensation cost included in the
determination of net income as reported
194 124 102
Stock-based compensation cost following the fair value method (998) (556) (247)
-------------- -------------- --------------
Pro-forma net income 1,157,554 509,732 231,682
============== ============== ==============
Earnings per share - basic
Common - As reported and pro-forma 2.62 1.15 0.52
Preferred - As reported and pro-forma 2.62 1.15 0.52
Earnings per share - diluted
Common
As reported 2.61 1.15 0.52
Pro-forma 2.61 1.14 0.52
Preferred
As reported 2.61 1.15 0.52
Pro-forma 2.61 1.14 0.52
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, 2004, 2003 and 2002
(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".
Basic EPS excludes dilution, while diluted EPS for the years ended
December 31, 2004 and 2003 reflects the potential dilution resulting from
options granted during those years 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 effect to the stock bonus
and the reverse stock split approved on April 30, 2003, the stock bonus
approved on April 29, 2004 (Note 17.1) and the stock bonus approved on
March 31, 2005 (Note 27). EPS is presented on a per share basis (Note
19).
3.17 DIVIDENDS AND INTEREST ON EQUITY
The Company's By-Laws 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 the 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%.
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.
F-15
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
3.19 ADVERTISING COSTS
Advertising costs included in selling and marketing expenses were
$13,656, $12,884 and $9,386 for the years ended December 31, 2004, 2003,
and 2002 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 in the years ended December 31,
2003 and 2002. Swaps are recognized on the balance sheet at fair value
with unrealized gains and losses on the mark-to 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. Derivatives that did not qualify as cash flow hedge are
recognized at fair value on the balance sheet with unrealized gains and
losses recognized in the consolidated statement of income.
3.22 RECLASSIFICATIONS
Certain reclassifications have been made to the financial statements for
year ended December 31, 2003 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 PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51". In December 2003, the FASB
issued a revised version of FIN 46, FIN 46-R. The primary objectives of
FIN 46-R 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 46-R requires that 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 Company adopted FIN 46-R as of January 1, 2004 and has concluded that
it does not have any interest on VIEs.
F-16
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
3.24 RECENT ACCOUNTING STANDARDS NOT YET ADOPTED
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion no. 29, which eliminates the
exception from fair value measurements for nonmonetary exchanges of
similar productive assets and replaces it with an exception for exchanges
that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected
to change significantly as a result of the exchange. SFAS no. 153 is
effective for nonmonetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005, with earlier adoption permitted. The
company does not believe that the adoption of SFAS no. 153 will have a
material impact on the company's consolidated financial position or
results of operations.
On December 16, 2004, the FASB issued its Statement of Financial
Accounting Standards No. 123 (revised 2004), Share-Based Payment
(Statement 123R), which addresses the accounting for employee stock
options and eliminates the alternative to use Option 25's intrinsic value
method of accounting that was provided in Statement 123 as originally
issued. This statement requires a public entity to measure the cost of
employee services received in exchange for an award of equity instruments
based on the grant-date fair value of the award. That cost will be
recognized over the period during which an employee is required to
provide service in exchange for the award (vested period). The grant-date
fair value of employee share options and similar instruments will be
estimated using option-pricing models adjusted to the unique
characteristics of those instruments. The implementation date of
Statement 123R was originally determined to be the beginning of the first
interim or annual reporting period that begins after June 15, 2005 and
applies to all awards granted after the required effective date. For
periods before the required effective date, the companies may elect to
apply a modified version of retrospective application under which
financial statements for prior periods are adjusted on a basis consistent
under which pro forma disclosures required for those periods by Statement
123. On April 14, 2005 the United States Securities and Exchange
Commission ("SEC") amended the effective date to the first interim or
annual reporting period of the first fiscal year beginning on or after
June 15, 2005.
Had the provisions of Statement 123R been applied for the year ended
December 31, 2004 stock based compensation would have been modified as
presented in the pro-forma disclosures in Note 3.13.
In November 2004, the FASB issued SFAS no. 151, Inventory Costs, an
amendment of ARB no. 43, Chapter 4, which requires idle facility
expenses, excessive spoilage, and double freight and rehandling costs to
be treated as current period charges and also requires that the
allocation of fixed production overheads to the costs of conversion be
based on the normal capacity of the production facilities. Accounting
Research Bulletin no. 43, Inventory Pricing, previously required such
expenses to be treated as current period expenses only if they meet the
criterion of "so abnormal", which was not a defined term. SFAS no. 151 is
effective for inventory costs incurred during fiscal years beginning
after June 15, 2005, with earlier adoption permitted. The company does
not believe that the adoption of SFAS no. 151 will have a material impact
on the company's consolidated financial position or results of
operations.
F-17
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
4 ACQUISITIONS
4.1 DIACO S.A. AND SIDERURGICA DEL PACIFICO S.A. - SIDELPA
On December 23, 2004, the company reached an agreement with the Mayaguez
group and with Latin American Enterprise Steel Holding, majority
shareholders of Diaco S.A.("Diaco") and of Siderurgica del Pacifico S.A.
- Sidelpa ("Sidelpa") to buy the shares currently owned by those parties
in Diaco and Sidelpa. Diaco is the largest producer of steel and rebar in
Colombia, and Sidelpa is the only producer of specialty steel in that
country.
The transaction involves two steel mills and a profile and rebar mill of
Diaco located in the city of Tuta, and a specialty steel mill of Sidelpa
located in the city of Cali. The units operate in the long steel segment,
which is also the market focus of Gerdau. The Tuta mill services the
civil construction and industry sectors, while the Sidelpa mill is
focused on the automotive sector. The productive process of the steel
mills is fundamentally the same as that of Gerdau's long steel mills,
using electric furnaces and steel scrap as the primary raw material.
Diaco also owns three rolling mills. The transaction also includes a
fabricated reinforcing steel facility in the city of Bogota.
Closing of the transaction is subject to several conditions precedent
which were not met at December 31, 2004. The agreement establishes a
period for the conditions precedent to be met. Under the terms of the
agreement, once the conditions precedent are met, Gerdau will acquire a
controlling interest in Diaco and Sidelpa. Gerdau also has committed to
acquire additional shares of Diaco in a period no longer than eight
years.
In December 2004 the Company made a deposit of $68,500 in favor of
certain trusts created for this transaction. The amount of $ 68,500 is
recorded in the financial statements as "Advance payment for acquisition
of investment in Colombia" and presented as non current assets. Until the
conditions precedent are met, Gerdau will not have right to appoint any
director or officer of Diaco and/or Sidelpa but has the right to appoint
one member to a transition committee of an advisory nature which has no
decision making powers.
4.2 GATE CITY AND RJ REBAR, INC
On December 10, 2004, Gerdau Ameristeel completed the acquisition of the
fixed assets and working capital of Gate City's and RJ Rebar, Inc.'s
rebar fabrication facilities in the Midwest of the United States with
annual production capacity of approximately 150,000 tons for
approximately $16,400. As a result of this transaction, $4,748 of
goodwill was recorded.
4.3 NORTH STAR ASSETS
On November 1, 2004, Gerdau Ameristeel completed the acquisition of four
long steel product mini-mills and four downstream facilities, which are
referred to as North Star Steel, from Cargill Incorporated. This
acquisition increased mill manufacturing capacity by approximately 2.0
million tons for finished long steel products. The facilities consist of
four long steel product mini-mills all of which are located in the United
States in St. Paul, Minnesota; Wilton, Iowa; Calvert City, Kentucky; and
Beaumont, Texas; and four downstream facilities also in the United States
- one that processes grinding balls located in Duluth, Minnesota and
three wire rod processing facilities located in Beaumont, Texas; Memphis,
Tennessee; and Carrollton, Texas. The St. Paul and Wilton mini-mills have
scrap shredder facilities which process raw scrap into shredded scrap to
supply a large part of the mini-mills' raw material needs. North Star's
products are generally sold to steel service centers, steel fabricators
or directly to original equipment manufacturers, for use in a variety of
industries. The purchase price for the acquired assets was $266,000 in
cash plus the assumption of certain liabilities of the businesses being
acquired and changes in working capital from April 30, 2004 to the date
of closing. $181,000 of the purchase price was for working capital
computed as of April 30, 2004. On November 1,
F-18
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
2004, working capital of the acquired business had increased $51,790.
This amount was accrued as of December 31, 2004 and paid subsequent to
year end.
The following table summarizes the fair value of assets acquired and
liabilities assumed for the North Star acquisition at the date of the
acquisition, November 1, 2004:
Net assets (liabilities) acquired
Current assets 325,751
Current liabilities (67,674)
Property, plant and equipment 86,244
Other long-term liabilities (23,789)
--------------
320,532
==============
Purchase price 266,000
Plus transaction costs 2,742
Accrued working capital adjustment 51,790
--------------
320,532
==============
No goodwill was recognized for this acquisition.
4.4 ASSETS AND LIABILITIES OF POTTER FORM & TIE CO.
On March 19, 2004, Gerdau Ameristeel concluded the acquisition of certain
assets and assumed certain liabilities of Potter Form & Tie Co., a rebar
fabricator with six locations throughout the Midwest of United States,
for approximately $11,100. As a result of this transaction, $1,351 of
goodwill was recorded.
4.5 GERDAU AMERISTEEL
(a) On March 31, 2003, under the terms of the Transaction Agreement relating
to the acquisition of Co-Steel Inc. (Note 4.9), Gerdau Ameristeel
completed an exchange of minority shares of its subsidiary Ameristeel
Corporation ("Ameristeel", currently named Gerdau Ameristeel US Inc.) for
shares of Gerdau Ameristeel. Minority shareholders of Ameristeel, mostly
executives and employees, exchanged 1,398,501 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 exchange was accounted for as a step acquisition under the purchase
method of accounting, whereby the purchase price was allocated to the net
assets acquired and liabilities assumed based upon their relative fair
values. Goodwill of $2,190 was created as a result of the exchange.
(b) On September 24, 2003, the Company purchased an additional 2,566,600
shares of Gerdau Ameristeel on the open market at a cost of $7,050. After
this transaction, the Company held 69% of the outstanding shares. No
goodwill resulted from the acquisition of these additional shares.
(c) On April 14, 2004, Gerdau Ameristeel issued 26,800,000 common shares. The
price was set at Cnd$4.90 per share ($3.64 at the exchange rate on the
date of the transaction), the closing price of the common shares of
Gerdau Ameristeel on the Toronto Stock Exchange on March 31, 2004.
All the shares were acquired by the Company for a total purchase price of
$97,771, and, as a result of the transaction, the Company increased its
interest in Gerdau Ameristeel from 69% to 72%. The transaction was
accounted as a step
F-19
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
acquisition and the purchase price has been allocated to assets acquired
and liabilities assumed. No goodwill resulted from the purchase price
allocation.
(d) On October 15, 2004, Gerdau Ameristeel issued 70,000,000 common shares at
a value of Cdn $5.90 per share ($4.70 per share at the exchange rate on
the date of the transaction) totaling net proceeds of approximately
$322,700 after deducting underwriters' fees and estimated expenses.
Gerdau purchased 35,000,000 of the common shares, representing 50% of the
total common shares offered, for total net proceeds of $161,350 also
after deducting underwriters' fees and expenses. As a result of acquiring
a percentage below its previous holding of shares in Gerdau Ameristeel,
Gerdau's interest in Gerdau Ameristeel was diluted to approximately 67%.
Subsequently, on November 18, 2004, the underwriters of the public
offering of common shares above exercised their over-allotment option to
purchase an additional 4,381,000 common shares of Gerdau Ameristeel at
the initial public offering price of Cdn $5.90 per share. As agreed to in
a subscription agreement with Gerdau Ameristeel, Gerdau S.A. purchased
the same number of additional common shares as the underwriters pursuant
to the exercise of their over-allotment option at $4.70 per share, the
U.S. dollar equivalent of the public offering price. The net proceeds to
Gerdau Ameristeel after deducting underwriters' fees and estimated
expenses amounted to $39,946 of which $ 19,973 were paid by Gerdau. As a
result of acquiring a percentage below to its previous holding of shares
in Gerdau Ameristeel, Gerdau's interest in Gerdau Ameristeel was diluted
to approximately 66.5%.
As the new shares were issued at a price higher than the average carrying
amount of the shares held by the Company, Gerdau recorded a gain in the
amount of $2,742 presented as "Gain on change of interest" in the
consolidated statement of income.
4.6 MARGUSA
On November 18, 2003, the Company exchanged certain forestry holdings in
exchange for 1,776,638 newly issued shares of Margusa, a producer of pig
iron obtaining a 17% interest in total and voting interest in Margusa. On
December 2, 2003, the Company signed a purchase agreement to buy the
remaining shares of Margusa for $18,000. The cash portion is payable in 8
installments with the first paid on December 2003 and the remaining 7
installments payable during 2004. At December 31, 2003, the Company
recorded the investment in Margusa at cost ($16,300) represented by a
cash payment of $2,234 (corresponding to the first of eight installments
due) and the value of the forestry holdings transferred to Margusa of
$14,066.
Control was transferred to the Company on January 5, 2004, which is
considered the acquisition date for accounting purposes. As from that
date, the financial statements of Margusa have been consolidated. The
purchase price was finally reduced to $16,337 as a result of
contractually agreed adjustments. The following table summarizes the fair
value of assets acquired and liabilities assumed for Margusa at the date
of the acquisition:
Net assets (liabilities) acquired
Current assets 2,365
Current liabilities (2,683)
Property, plant and equipment 7,567
Goodwill 11,158
Other long-term liabilities (2,070)
-------------
Net assets acquired and purchase price 16,337
=============
F-20
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
4.7 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 Aco Minas Gerais S.A. -
Acominas ("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 79% to 92%. 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 79% to 92% 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% participation. The resulting net credit amounted to
$130,034 and was allocated, considering deferred income tax effects, to
reduce the carrying value of property, plant 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% and 25%, respectively, of voting and total shares of Acominas. The
acquisition in February 2002 increased the voting interest of Gerdau in
Acominas to 54% 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-21
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
4.8 DONA FRANCISCA ENERGETICA S.A.
On December 24, 2002, Gerdau signed a contract to purchase 199,800,000
common shares of Dona Francisca, which represented 30% of the total
number of shares. The payment for the purchase and the transfer of shares
was made on January 10, 2003. With this purchase, Gerdau's ownership
percentage of voting shares in Dona Francisca increased from 22% to 52%.
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 equity investment 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 Camara de Comercializacao de Energia Eletrica
("CCEE", formerly denominated "MAE" , the wholasele energy market). When
a final determination is made in respect to the contingency involving the
CCEE, 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. As of December 31,
2004 the contingency was not yet resolved.
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
=================
F-22
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
4.9 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 was 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 their subsidiaries 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).
The name of Co-Steel was changed to Gerdau Ameristeel Corporation 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
--------------
4.10 PRO-FORMA FINANCIAL DATA (UNAUDITED)
The following unaudited pro forma data summarizes the results of
operations for the periods indicated as if the acquisition of North Star
Steel and of Margusa had been completed as of January 1, 2003.
FOR THE YEAR ENDED
DECEMBER 31,
------------------------
2004 2003
----------- ---------
Net Sales 7,702,434 5,126,779
Net Income 1,281,143 518,874
Earnings per share
Common and preferred shares - Basic 2.89 1.17
Common and preferred shares - Diluted 2.88 1.16
F-23
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
5 SHORT-TERM INVESTMENTS
2004 2003
-------------- --------------
Investment funds 115,838 132
Investment funds administered by Banco Gerdau S.A. (related party) 80,479 45,020
Debt securities 85,352 121,947
Equity securities 122,843 69,038
-------------- --------------
404,512 236,137
============== ==============
6 TRADE ACCOUNTS RECEIVABLE, NET
2004 2003
-------------- --------------
Trade accounts receivable 869,020 493,333
Less: allowance for doubtful accounts (33,536) (27,476)
-------------- --------------
835,484 465,857
============== ==============
7 INVENTORIES
2004 2003
-------------- --------------
Finished products 648,069 302,701
Work in process 255,862 111,718
Raw materials 488,326 171,038
Packaging and maintenance supplies 176,501 198,657
Advances to suppliers of materials 25,360 13,847
-------------- --------------
1,594,118 797,961
============== ==============
8 TAX CREDITS
2004 2003
-------------- --------------
Brazilian value-added tax on sales and services - ICMS 36,747 30,677
Brazilian excise tax - IPI 1,246 2,201
Brazilian withholding taxes 3,080 40
Brazilian tax for financing of social integration program - PIS 13,599 1,592
Brasilian tax for social security financing - COFINS 21,210 -
Others 26 3,443
-------------- --------------
75,908 37,953
============== ==============
F-24
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
9 BALANCES AND TRANSACTIONS WITH RELATED PARTIES
2004 2003
------- ------
Short-term investments
Funds administered by Banco Gerdau (i) (Note 5) 80,479 45,020
Other non-current assets
Loans and advances to directors 947 1,099
Receivable from Sipar Aceros S.A. - 8,673
Intercompany debt - MG 100 -
Receivable from Fundacao Gerdau 491 5,802
Other current liabilities
Intercompany debt - MG (ii) - 1,173
Payable to Sipar Aceros S.A. 74 -
(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 exclusively of time deposits in major Brazilian banks
and treasury bills issued by the Brazilian government. Income earned on
the Company's investment in the fund aggregated $18,941 in 2004, $13,265
in 2003 and $9,469 in 2002, representing average yields of 15.8%, 25.8%
and 19.0%, respectively.
(ii) Loans from MG as of December 31, 2003 were denominated in Brazilian reais
and bear interest at the average composite borrowing rate of the
Conglomerate, determined on a monthly basis. Interest expense related to
such loans aggregated $95 in 2003 and $39 in 2002, representing average
effective rates of 20.3% and 23.0 %, respectively.
In addition , INDAC - Industria, Administracao e Comercio S.A., 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. The average amount of debt
guaranteed during the year ended December 31, 2004 amounted to $435,734
(2003 - $255,206).
The Company also paid a fee to Grupo Gerdau Empreendimentos Ltd., an
affiliate holding company controlled by the Gerdau family, amounting to
$226 (2003 - $195) for the use of the Gerdau name.
F-25
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
10 PROPERTY, PLANT AND EQUIPMENT, NET
2004 2003
------------- --------------
Buildings and improvements 899,419 913,625
Machinery and equipment 2,797,614 2,166,415
Vehicles 14,174 11,567
Furniture and fixtures 35,803 23,602
Other 96,386 148,921
-------------- --------------
3,843,396 3,264,130
Less: Accumulated depreciation (1,649,743) (1,385,604)
-------------- --------------
2,193,653 1,878,526
Land 222,534 219,887
Construction in progress 374,014 205,745
-------------- --------------
Total 2,790,201 2,304,158
============== ==============
Construction in progress as of December 31, 2004 represents principally
renewals and improvements in the manufacturing facilities of Gerdau and
Gerdau Acominas in Brazil. The Company capitalized interest on
construction in progress in the amount of $12,157 in 2004, $7,112 in 2003
and $10,370 in 2002.
As of December 31, 2004, machinery and equipment with a net book value of
$259,205 (2003 - $ 186,807) was pledged as collateral for certain
long-term debt.
11 EQUITY INVESTMENTS
2004 2003
------------- --------------
Joint-ventures in the United States 177,795 118,630
Sipar Aceros S.A. 9,368 6,265
Armacero Industrial y Comercial Ltda. 3,206 1,739
Dona Francisca Energetica S.A. 17,398 12,638
--------- ------------
207,767 139,272
========= ============
The Company's main equity investment are in Gallatin Steel Company,
Bradley Steel Processors and MRM Guide Rail, which are 50% joint ventures
in the United States. The Company's interests in the joint ventures have
been accounted for using the equity method under which the Company's
proportionate share of earnings have been included in these consolidated
financial statements.
F-26
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
The following table sets forth selected data for the Company's joint
ventures in the United States:
2004 2003
--------- -------
BALANCE SHEET
Current assets 128,004 53,137
Property, plant and equipment , net 132,472 124,144
Current liabilities 27,517 23,224
Long-term debt 1,709 4,259
STATEMENT OF INCOME
Sales 465,493 224,179
Operating income 142,429 9,685
Income before income taxes 142,538 9,440
Net Income 141,474 7,667
12 GOODWILL
2004 2003 2002
------------------------------------ --------------------------- ---------------------------
LONG NORTH SOUTH NORTH SOUTH NORTH SOUTH
BRAZIL AMERICA AMERICA TOTAL AMERICA AMERICA TOTAL AMERICA AMERICA TOTAL
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Balance at the beginning of the
year -- 116,564 2,967 119,531 114,374 2,452 116,826 114,374 -- 114,374
Goodwill arising on acquisition
of Armacero Industrial y
Comercial Ltda -- -- -- -- -- -- -- 2,452 2,452
Gate City and RJ Rebar, Inc.
(Note 4.2) -- 4,748 -- 4,748 -- -- -- -- -- --
Potter Form & Tie Co
(Note 4.4) -- 1,351 -- 1,351 -- -- -- -- -- --
Minority interest of Ameristeel -- -- -- -- 2,190 -- 2,190 -- -- --
Corporation (Note 4.5)
Maranhao Gusa S.A. Margusa
(Note 4.6) 11,158 -- 11,158 -- -- -- -- -- --
Other aquisitions -- -- 3,075 3,075 -- -- -- -- -- --
Effect of exchange rate on
goodwill of operations in
South America -- -- 1,600 1,600 -- 515 515 -- -- --
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Balance at the end of the year 11,158 122,663 7,642 141,463 116,564 2,967 119,531 114,374 2,452 116,826
====== ======= ======= ======= ======= ======= ======= ======= ======= =======
Goodwill as of the beginning of the year ended December 31, 2002 in North
America corresponds to goodwill on the acquisition of Ameristeel
Corporation in 1998.
F-27
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
13 ACCRUED PENSION AND OTHER POST-RETIREMENT BENEFITS OBLIGATION
13.1 SUMMARY OF AMOUNTS RECOGNIZED IN THE BALANCE SHEET
The amounts recognized in the balance sheets are as follows:
2004 2003
------- -------
NON-CURRENT LIABILITIES
Brazilian pension obligation (Gerdau plan) 12,751 15,681
North American pension obligation 58,092 56,322
North American obligation other than pension 49,082 36,676
------- -------
Accrued liability related to pension and other benefit obligation 119,925 108,679
======= =======
NON-CURRENT ASSETS
Prepaid pension cost for the Brazilian plans (Gerdau Acominas plan) 53,276 35,253
======= =======
13.2 PENSION PLANS
The Company and other related companies in the Conglomerate co-sponsor
pension plans (the "Brazilian Plans") covering substantially all
employees based in Brazil, including Gerdau Acominas as from its
consolidation. The Brazilian Plans consist of a plan for the former
employees of Acominas and its subsidiaries ("Gerdau Acominas Plan") and
another plan for the employees of its other operations in Brazil ("Gerdau
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 $960 in 2004, $697 in 2003 and $634 in 2002.
Contributions to and expenses for defined contribution retirement plans
of employees of the subsidiaries in the United States and Canada amounted
to $3,400, $2,600 and $10,100 in 2004, 2003 and 2002, respectively.
BRAZILIAN PLANS
Net periodic pension cost relating to the defined benefit component of
the Brazilian Plans was as follows:
2004 2003 2002
--------- ------- --------
Service cost 6,938 5,374 4,867
Interest cost 22,341 16,057 14,181
Expected return on plan assets (35,542) (21,712) (17,825)
Plan participants' contributions (1,778) (1,375) (1,001)
Amortization of unrecognized gains and losses, net (2,434) (1,569) (1,142)
Amortization of prior service cost 293 941 294
Amortization of unrecognized transition benefit (299) (284) 398
--------- ------- --------
Net pension benefit (10,581) (2,568) (228)
========= ======= ========
F-28
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
The funded status of the defined benefit components of the Brazilian
Plans was as follows:
2004 2003
----------- ---------
Plan assets at fair value 372,043 291,120
Projected benefit obligation 253,593 198,789
----------- ---------
Funded status 118,450 92,331
Unrecognized net transition benefit (2,307) (2,422)
Unrecognized prior service cost 7,515 3,566
Unrecognized net gains (83,133) (73,903)
----------- ---------
Amounts recognized in the balance sheet, net 40,525 19,572
=========== =========
Additional information for the Brazilian plans is as follows:
2004 2003
----------- ---------
Change in benefit obligation
Benefit obligation at the beginning of the year 198,789 135,455
Service cost 6,838 5,374
Interest cost 22,341 16,057
Actuarial loss 7,235 14,678
Benefits paid (6,144) (4,997)
Plan amendments (a) 3,957 -
Effect of exchange rate changes 20,577 32,222
----------- ---------
Benefit obligation at the end of the year 253,593 198,789
----------- ---------
2004 2003
----------- ---------
Change in plan assets
Fair value of plan assets at the beginning of the year 291,120 184,850
Actual return on plan assets 51,280 61,345
Employer contributions 4,447 3,360
Plan participants' contributions 1,778 1,375
Benefits paid (6,144) (4,997)
Effect of exchange rate changes 29,562 45,187
----------- ---------
Fair value of plan assets at the end of the year 372,043 291,120
----------- ---------
Expected benefit payments
2005 7,836
2006 9,756
2007 11,107
2008 12,498
2009 13,925
2010 - 2014 100,807
(a) During 2004 amendments were introduced to the terms of the Gerdau
Plan which include deferred benefits proportional to time of service,
modification of withdrawal provisions, pension benefits in case of death
as result of labor accidents, and changes in minimum benefits. The effect
of the amendments was deferred and is being recognized
F-29
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
as part of the pension benefit costs during the expected average future
service time of the participants (approximately 16 years).
The assumptions used for the defined benefit component of the Brazilian
Plans are presented below. The rates presented below are nominal rates
and consider annual inflation of 5% (6% for the year ended December 31,
2002).
Assumptions used to determine benefit obligations (in % per year):
2004 2003
--------------- ---------------
Discount rate 11.30% 11.30%
Rate of increase in compensation 8.68% - 9.20% 8.68% - 9.20%
Assumptions used to determine net periodic benefit cost for the year (in
% per year):
2004 2003 2002
--------------- --------------- ---------------
Weighted-average discount rate 11.30% 10.25% 10.30%
Rate of increase in compensation 8.68% - 9.20% 9.20% 8.68%
Long-term rate of return on plan assets 12.35% 10.25% 9.73%
The plan asset return is the expected average return of each asset
category weighted by target allocations. Asset categories' returns are
based on long term macroeconomic scenarios.
Brazilian Plan assets as of December 31, 2004 include shares of Gerdau
Acominas and of Gerdau in the amounts of $15,983 and $18,596,
respectively (2003 - $14,684 and $13,197, respectively) and shares of
Metalurgica Gerdau S.A of $15,433 (2003 - $7,041).
The Brazilian Plans are managed by Gerdau - Sociedade de Previdencia
Privada ("Gerdau Plan") and Fundacao Acominas de Seguridade Social - Acos
("Gerdau Acominas Plan"). The pension plan accumulated benefit
obligation, the weighted-average asset allocations, and the asset target
allocation for 2005, by asset category, are as follows:
GERDAU PLAN GERDAU ACOMINAS PLAN
--------------------------------- ---------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Accumulated benefit obligation 36,491 26,793 164,028 129,749
ALLOCATION OF ASSETS BY CATEGORY
AS OF DECEMBER 31
Equity Securities 45.00% 40.96% 13.26% 12.84%
Fixed income 55.00% 59.04% 81.94% 82.07%
Real estate - - 3.29% 3.84%
Loans - - 1.51% 1.25%
--------------- --------------- --------------- ---------------
Total 100.00% 100.00% 100.00% 100.00%
=============== =============== =============== ===============
F-30
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
GERDAU
GERDAU ACOMINAS
PLAN PLAN
-------------- ---------------
TARGET ALLOCATION OF ASSETS FOR 2005
Equity securities - 15.00%
Fixed Income 55.00% 80.50%
Real estate 45.00% 2.90%
Loans - 1.60%
-------------- ---------------
Total 100.00% 100.00%
============== ===============
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 planned asset mix is
composed of fixed income investments and equities. The fixed income
target allocation ranges from 55% to 100%, and equities target allocation
ranges from 0% to 45%. The 2005 expected return for this asset mix is
12.35%. The expected employer contributions for 2005 are $689.
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 are: fixed income 57% to 100%, equities 0% to 35%,
real estate allocation 0% to 5% and loans 0% to 5%. The expected employer
contributions for 2005 are $4,679.
The measurement date for the Gerdau Plan is December 31 and for the
Gerdau Acominas Plan is November 30.
NORTH AMERICAN PLANS
The components of net periodic pension cost for the North American Plans
are as follows:
2004 2003 2002
-------------- -------------- --------------
Service cost 10,980 8,027 5,606
Interest cost 22,274 20,831 12,830
Expected return on plan assets (20,975) (18,683) (13,536)
Amortization of transition liability 174 162 -
Amortization of prior service cost 293 461 388
Amortization of unrecognized gains and losses, net 2,214 957 4
Settlement loss - 140 -
-------------- -------------- --------------
Net pension expense 14,960 11,895 5,292
============== ============== ==============
The funded status
Settlement losses were recognized in the prior year due to payments to
former employees under the former Co-Steel plans.
F-31
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
The funded status of the North American Plans is as follows:
2004 2003
-------------- --------------
Plan assets at fair value 322,719 278,243
Projected benefit obligation 416,634 359,568
-------------- --------------
Funded status (93,915) (81,325)
Unrecognized prior service cost 5,962 2,673
Unrecognized transition liability 1,857 1,905
Unrecognized net gains and losses 52,610 39,067
Additional minimum liability (24,606) (18,642)
-------------- --------------
Accrued pension liability recognized in the balance sheet (58,092) (56,322)
============== ==============
Additional information required by SFAS No 132
2004 2003
-------------- --------------
Change in benefit obligation for North American Plans
is as follows:
Benefit obligation at the beginning of the year 359,568 301,352
Service cost 10,980 8,027
Interest cost 22,274 20,831
Amendments 3,149 -
Actuarial loss 25,193 11,248
Benefits paid (19,381) (14,918)
Settlement loss - 275
Foreign exchange loss 14,851 32,753
-------------- --------------
Benefit obligation at the end of the year 416,634 359,568
-------------- --------------
2004 2003
-------------- --------------
Change in plan assets
Plan assets at the beginning of the year 278,243 206,070
Employer contributions 20,815 18,470
Benefits paid (19,381) (14,918)
Actual return on assets 30,509 42,448
Foreign exchange gain 12,533 26,173
-------------- --------------
Plan assets at the end of the year 322,719 278,243
-------------- --------------
The North American Plans were impacted by amendments that enhanced
benefits paid. This cost was deferred and will be recognized during the
average future service time of the participants
Expected benefit payments
2005 17,374
2006 17,867
2007 18,539
2008 19,539
2009 20,673
2010 - 2014 125,884
F-32
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
Assumptions used in accounting for the North American Plans were:
Assumptions used to determine benefit obligations:
2004 2003
----------------- -----------------
Discount rate 5.75% - 6.00% 6.25% - 6.50%
Rate of increase in compensation 2.50% - 4.25% 4.30% - 4.50%
Weighted-average assumptions used to determine net periodic benefit costs
for the year:
2004 2003 2002
----------------- ----------------- -----------------
Weighted-average discount rate 6.25% - 6.50% 6.50% - 6.75% 7.00% - 7.30%
Rate of increase in compensation 2.50% - 4.50% 2.50% - 4.50% 2.50% - 4.50%
Long-term rate of return on plan assets 7.25% - 8.40% 7.25% - 8.40% 7.50% - 9.30%
The pension plan weighted-average asset allocations at December 31, 2004
and 2003, by asset category are as follows.
ASSET CATEGORY
2004 2003
----------------- -----------------
Equity securities 67.30% 70.40%
Debt securities 26.50% 23.90%
Real estate 2.70% 0.50%
Other 3.50% 5.20%
----------------- -----------------
Total 100.00% 100.00%
================= =================
Gerdau Ameristeel has 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 asset mix policy will consider the principles of diversification and
long-term investment goals, as well as liquidity requirements. In order
to accomplish that, the target allocations range between 55% to 85% in
equity securities, 20% to 35% in debt securities and 0% to 10% in real
estate and other.
The Company expects to contribute $20,700 to its pension plans in 2005.
The measurement date for the North America Plans is December 31.
F-33
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
13.3 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:
2004 2003 2002
-------------- -------------- ------------
Service cost 1,133 880 341
Interest cost 2,153 2,247 876
Amoritzation of prior service cost (212) - -
Recognized actuarial loss 30 - -
-------------- -------------- ------------
Net post-retirement health expense 3,104 3,127 1,217
============== ============== ============
The following sets forth the funded status of the post-retirement health
benefits:
2004 2003
-------------- ------------
Plan assets at fair value - -
Projected benefit obligation 49,186 38,554
-------------- ------------
Funded status (49,186) (38,554)
Unrecognized prior service cost (2,948) -
Unrecognized net gains and losses 3,052 1,878
-------------- ------------
Accrued post-retirement health benefits recognized in the balance sheet (49,082) (36,676)
============== ============
Additional information required for post-retirement health benefits is as
follows:
2004 2003
-------------- ------------
Change in the projected benefit obligation
Projected benefit obligation at the beginning of the year 38,554 31,978
Aquisition of North Star 8,716 -
Service cost 1,133 880
Benefits paid (2,501) (2,260)
Interest cost 2,153 2,247
Plan participants' contributions 732 648
Foreign exchange loss 1,766 3,874
Amendments (3,161) -
Actuarial loss 1,794 1,187
-------------- ------------
Projected benefit obligation at the end of the year 49,186 38,554
============== ============
F-34
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
Change in plan assets 2004 2003
-------------- ------------
Plan assets at the beginning of the year - -
Employer contribution 1,769 1,612
Plan participants' contributions 732 648
Benefits and administrative expenses paid (2,501) (2,260)
-------------- ------------
Plan assets at the end of the year - -
============== ============
Expected benefit payments
2005 1,882
2006 2,039
2007 2,179
2008 2,338
2009 2,482
2010 - 2014 15,233
Assumptions used in the accounting for the post-retirement
health benefits were:
2004 2003
------------------- -----------------
Health care - trend rate assumed for following year 9.50% - 13.00% 9.00% - 10.00%
Health care - Rate to which the cost is assumed to decline
(ultimate trend rate) 4.50% - 5.50% 5.50%
Year that the rate reaches the ultimate trend rate 2010 - 2013 2008
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 1 PERCENTAGE
POINT IN POINT DECREASE
---------------------------------------
Effect on total of service and interest cost 383 (308)
Effect on postretirement benefit obligation 6,052 (4,900)
14 SHORT-TERM DEBT
Short-term debt consists of working capital loans and export advances,
mainly denominated in U.S. dollars, with interest rates ranging from
3.77% p.a. to 10.50% p.a. (2003- 1.36% to 11.13% p.a.). Advances received
against export commitments are obtained from commercial banks with a
commitment that the products be exported.
F-35
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
15 LONG-TERM DEBT AND DEBENTURES
Long-term debt consisted of the following as of December 31:
ANNUAL INTEREST RATE
AT DECEMBER 31,
2004 2004 2003
----------------------- --------- ---------
LONG-TERM DEBT, EXCLUDING DEBENTURES, DENOMINATED
IN BRAZILIAN REAIS
Working capital 3.40% 10,629 1,319
Financing for machinery TJLP + 3.0% to 3.5% 239,349 208,651
LONG-TERM DEBT, EXCLUDING DEBENTURES, DENOMINATED IN FOREIGN
CURRENCIES
Working capital (US$) Libor + 3.8% 3,973 270,034
Financing for machinery and others (US$) 3.09% to 5.71% 233,531 205,107
Export Receivables Notes by Gerdau Acominas (US$) 7.321% and 7.37% 236,553 104,971
Advances on exports (US$) 2.95% 290,115 63,842
Working capital (Chilean pesos) Chilean banking rate - 6,124 10,367
TAB + 1.15%
Financing for machinery (Chilean pesos) Chilean banking rate - 12,370 20,212
TAB + 1.15%
Financing for investments (US$) Libor + 1.40% 68,920 -
(b) Long-term debt of Gerdau Ameristeel
Senior notes, net of original issue discount (US$) 10.375% 397,986 397,271
Senior Secured Credit Facility (Canadian dollar -Cdn$ and US$) 5.75% 27 135,027
Industrial Revenue Bonds (US$) 1.74% to 6.38% 31,600 27,400
Other 3.75% to 5.25% 9,633 7,138
--------- ---------
1,540,810 1,451,339
Less: Current portion (260,294) (318,910)
--------- ---------
Long-term debt, excluding debentures, less current portion 1,280,516 1,132,429
========= =========
Long-term debt matures in the following years:
2006 195,030
2007 208,606
2008 209,036
2009 117,894
2010 75,300
After 2010 474,650
---------
1,280,516
=========
F-36
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
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, as defined in the
respective debt agreements), debt service coverage and interest coverage,
amongst others. At December 31, 2004, the Company was in compliance with
all of its debt covenants.
On September 5, 2003, Gerdau Acominas concluded a private placement of
the first tranche of Export Notes in the amount of US$ 105,000. The
Export Notes bear interest of 7.37% p.a., with final due date in July
2010, and have quarterly payments starting October 2005. On June 3, 2004
Gerdau Acominas S.A. also placed privately the second tranche for a
notional amount of $128,000 of its Export Receivables Notes. This second
tranche was placed with a final maturity of 8 years (April 2012) and
interest of 7.321% p.a. The notes have a quarterly amortization schedule
starting in July 2006.
(B) GERDAU AMERISTEEL DEBT
On June 27, 2003, Gerdau Ameristeel refinanced its debt by issuing
$405,000 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 $350,000. The borrowings
under the Senior Secured Credit Facility are secured by the subsidiary's
inventory and accounts receivable. The proceeds were used to repay
existing indebtedness. At December 31, 2004, there was $27 thousand drawn
against this facility, and, based upon available collateral under the
terms of the agreement, approximately $295,000 was available under the
Senior Secured Credit Facility.
The debt agreements contain covenants that require Gerdau Ameristeel to,
among other things, maintain a minimum fixed charge coverage ratio, a
specified minimum level of tangible shareholders equity, a minimum
working capital ratio and limit the debt to equity ratio. In addition, if
its business suffers a material adverse change or if other events of
default under the loan agreements are triggered, then pursuant to cross
default acceleration clauses, substantially all of the outstanding debt
could become due and the underlying facilities could be terminated. At
December 31, 2004, Gerdau Ameristeel was in compliance with all of its
debt covenants.
F-37
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
DEBENTURES
Debentures include five outstanding issuances of Gerdau and a convertible
debentures of Gerdau Ameristeel as follows:
ISSUANCE MATURITY 2004 2003
-------- -------- ------- -------
DEBENTURES, DENOMINATED IN BRAZILIAN REAIS
Third series 1982 2011 58,916 25,442
Seventh series 1982 2012 45,610 7,486
Eighth series 1982 2013 54,957 28,924
Ninth series 1983 2014 64,404 10,358
Eleventh series 1990 2020 36,991 6,662
DEBENTURES, DENOMINATED IN CANADIAN DOLLARS
Gerdau Ameristeel's convertible debentures 1997 2007 87,635 78,230
------- -------
348,513 157,102
Less: Debentures held by consolidated companies
eliminated on consolidation (2,645) (634)
------- -------
Total 345,868 156,468
Less: current portion (presented under Other current
liabilities in the consolidated balance sheet) (1,125) (1,048)
------- -------
Total debentures - long-term 344,743 155,420
======= =======
(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
16.17% and 23.25% during the years ended December 31, 2004 and 2003,
respectively.
(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 through the
issuance of Common Shares based on their market value at the time of
redemption.
F-38
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
16 COMMITMENTS AND CONTINGENCIES
16.1 TAX AND LEGAL CONTINGENCIES
The Company is party to claims with respect to certain taxes, civil and
labor matters. Management believes, based in part on advice from legal
counsel, that the provision for contingencies is sufficient to meet
probable and reasonably estimable losses from unfavorable rulings, and
that the ultimate resolution will not have a significant effect on the
consolidated financial position as of December 31, 2004, although it may
have a significant effect on future results of operations or cash flows.
The following table summarizes the contingent claims and related judicial
deposits:
CONTINGENCIES JUDICIAL DEPOSITS
--------------------------- --------------------------
Claims 2004 2003 2004 2003
----------------------- ------------ ------------ ------------ ------------
Tax 66,237 89,424 34,326 62,140
Labor 18,676 10,248 7,773 3,546
Other 2,805 2,388 455 435
------------ ------------ ------------ ------------
87,718 102,060 42,554 66,121
============ ============ ============ ============
PROBABLE LOSSES ON TAX MATTERS, FOR WHICH A PROVISION WAS RECORDED
All contingencies described in the section below correspond to instances
where the Company is challenging the legality of taxes and contributions.
The description of the contingent losses includes a description of the
tax or contribution being challenged, the current status of the
litigation as well as the amount of the probable loss which has been
provided.
o Of the total provision, $19,008 relates to a contingency for
compulsory loans to Eletrobras, the government-owned energy company,
the constitutionality of which is being questioned by the Company. In
March 1995, the Federal Supreme Court judged the proceedings against
the tax payers. In relation to the Company's proceedings, some are
pending decision, but the outcomes are already foreseeable, taking
into consideration prior decisions. The Company established a
provision relating to "compulsory loans" taking into consideration
that, although the payment to Eletrobras was made as a loan: (i) the
reimbursement to the Company would be in the form of shares of
Eletrobras, (ii) the conversion will be made based on the equity
value of the shares, and (ii) based on the current available
information, the shares of Eletrobras are valued at substantially
less than its equity value.
o $2,599 related to the unconstitutionality of the Social Investment
Fund ("Fundo de Investimento Social" --FINSOCIAL). Although the
Federal Supreme Court has confirmed the constitutionality of the
collection of tax at the 0.5% rate, some proceedings are still
pending judgment, most of them in the Superior Courts.
o $6,517 related to amounts for State Value Added Tax ("Imposto Sobre
Circulacao de Mercadorias e Servicos" - ICMS), the majority of which
is related to credit rights involving the Finance Secretary and the
State Courts of First Instance in the state of Minas Gerais.
o $2,763 related to Social Contribution on Net Income ("Contribuicao
Social Sobre o Lucro") (CSSL). The amounts refer to challenges of the
constitutionality of the contribution in 1989, 1990 and 1992. Some
proceedings are pending decision, most of them in the Superior
Courts. Considering the negative outcome of similar cases of other
companies seeking the right to pay CSSL after full offset of tax loss
carryforwards rather than having that offset limited to 30% of
taxable income, the subsidiary Gerdau Acominas S.A. decided to
F-39
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
transfer amounts previously deposited in court for $32,908 (of which
$20,983 were deposited during the 2004) to the tax authorities as
payment of CSSL that would be payable limiting the offset of tax loss
carryforwards to 30%. As result of such transfer, the Company settled
the tax contingency previously recorded with the amounts previously
deposited in court and transferred the amounts deposited during the
quarter ended September 2004 to the tax authorities as a tax payment.
Gerdau Acominas has not withdrawn the lawsuit and, if successful, it
would have the right to be reimbursed or receive a tax credit for the
amounts currently paid. Management believes that the probability of
success is remote.
o $7,532 related to Corporate Income Tax ("Imposto Renda de Pessoa
Juridica - IRPJ), for which administrative appeals have been filed.
Considering the negative outcome of similar cases of other companies
seeking the right to pay IRPJ after full offset of tax loss
carryforwards rather than having that offset limited to 30% of
taxable income, the subsidiary Gerdau Acominas S.A. decided to
transfer amounts previously deposited in court for $85,679 (of which
$54,869 were deposited during 2004) to the tax authorities as payment
of the income tax that would be payable limiting the offset of tax
loss carryforwards to 30%. As result of such transfer the Company
settled the tax contingency previously recorded with the amounts
previously deposited in court and transferred the amounts deposited
during the quarter ended September 2004 to the tax authorities as a
tax payment. Gerdau Acominas has not withdrawn the lawsuit and, if
successful, it would have the right to be reimbursed or receive a tax
credit for the amounts currently paid. Management believes that
probability of success is remote.
o $9,381 on contributions due to the social security authorities
which correspond to suits for annulment by the Company in progress in
the Federal Court of First Instance in the state of Rio de Janeiro.
The amount provided also refers to lawsuits questioning the position
of the National Institute of Social Security ("Institutio Nacional da
Seguridade Social" - INSS) in terms of charging INSS contributions on
profit sharing payments made by the subsidiary Gerdau Acominas and
several INSS assessments due to services contracted from third
parties, in which the INSS accrued debts related to the last ten
years and assessed Gerdau Acominas as jointly responsible. The
assessments were reaffirmed by the INSS when challenged by the
Company and are currently being challenged by Gerdau Acominas in
annulment proceedings with deposit in court of the amount being
discussed, since the Company understands that the right to set up
part of the credits had expired, and that, in any event, the Company
is not responsible.
o $717 related to contributions for the Social Integration Program
("Programa de Integracao Social" - PIS) and $2,613 related to Social
Contribution on Revenues ("Contribuicao para o Financiamento da
Seguridade Social" - COFINS), in connection with lawsuits questioning
the constitutionality of Law 9,718 which changed the calculation
basis of these contributions. These suits are in progress in the
Federal Regional Court of the 2nd Region and the Federal Supreme
Court.
o $443 related to a lawsuit brought by the subsidiary Gerdau Acominas
regarding the Government Severance Indemnity Fund surcharges ("Fundo
de Garantia por Tempo de Servico" - FGTS), which arose from the
changes introduced by Complementary Law 110/01. Currently, the
corresponding court injunction is awaiting the judgment of the
extraordinary appeal filed by the Company. The provided amount is
fully deposited in court.
o $9,630 related to the Emergency Capacity Charge ("Encargo de
Capacidade Emergencial" - ECE), as well as $4,911 related to the
Extraordinary Tariff Recomposition ("Recomposicao Tarifaria
Extraordinaria - RTE), which are charges included in the electric
energy bills of the Company's plants. According to the Company, these
charges are of a tax nature and, as such, are incompatible with the
National Tax System provided in the Federal Constitution. For this
reason, the constitutionality of this charge is being challenged in
court. The lawsuits are in progress in the Federal Justice of the
First Instance of the states of Pernambuco, Ceara, Minas Gerais, Rio
de Janeiro, Sao Paulo, Parana and Rio Grande do Sul, as well as in
the Federal Regional Courts of the 1st and 2nd Regions. The Company
has fully deposited in court the amount of the disputed charges.
F-40
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
o $123 related to other processes of a tax nature, most of which is
deposited in court.
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 or remote and, therefore, are not recognized in the
provision for contingencies. These claims are comprised by:
o The Company is defendant in debt foreclosures filed by the State of
Minas Gerais to demand ICMS credits arising mainly from the sales of
products to commercial exporters. The total amount of the processes
is $12,375. The Company did not set up a provision for contingency in
relation to these processes, since it considers this tax is not
payable , because products for export are exempted from ICMS.
o The Company and its subsidiary Gerdau Acominas are defendants in
tax foreclosures filed by the state of Minas Gerais, which demand
ICMS credits on the export of semi-finished manufactured products.
The total amount demanded is $94,086 The Company did not set up a
provision for contingency in relation to these processes since it
considers the tax as not payable, because the products do not fit in
the definition of semi-finished manufactured products defined by the
federal complementary law and, therefore, are not subject to ICMS.
o The Federal Revenue Secretariat claims an amount of $25,780 related
to transactions carried out by the subsidiary Gerdau Acominas under
the drawback concession granted by DECEX (Foreign Trade Department)
which would not be in conformity with the legislation. Gerdau
Acominas filed a preliminary administrative defense of the legality
of the arrangement, which is pending judgment. Since the tax
assessment has not been finally confirmed, and considering that the
arrangement that generated the mentioned demand conforms with the
assumptions required for the drawback concession, and also that the
concession was granted after analysis by the legal administrative
authority, Gerdau Acominas considers an unfavorable outcome to be
remote and, for this reason, did not set up a provision for the
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 them is a court-ordered debt security issued in 1999 in favor
of the Company by the state of Rio de Janeiro in the amount of
$10,013 arising from an ordinary lawsuit regarding non-compliance
with the Loan Agreement for Periodic Execution in Cash under the
Special Industrial Development Program- PRODI. Due to the default by
the State of Rio de Janeiro and the non-regulation of the
Constitutional Amendment 30/00, which granted the government a
ten-year moratorium for the payment of securities issued to cover
court-order debt not related to food, there is no expectation of
realization of this credit in 2005 or in the next following years.
o The Company has filed several ordinary proceedings related to the
correction of the PIS calculation basis under Complementary Law
07/70, due to the declarations of unconstitutionality of Decree Laws
2445/88 and 2449/88. The Company expects to recover the taxes unduly
paid. The Company believes that the amount under discussion totals
$31,738.
The Company and its subsidiary Gerdau Acominas S.A. received a final
non appealable favorable decision by the court and recognized a tax
credit for $43,528 and a gain which is presented as a tax recovery
under "Other operating income (expenses), net" in the statement of
income. The tax credits recognized were used to pay income taxes, and
PIS and COFINS taxes.
o The Company and its subsidiary Gerdau Acominas S.A. and Margusa -
Maranhao Gusa S.A. are claming recovery of IPI premium credits.
Gerdau S.A. and its subsidiary Margusa - Maranhao Gusa S.A. have
filed
F-41
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
administrative appeals, which are pending judgment. With regard to
the subsidiary Gerdau Acominas S.A., the claims were filed directly
to the courts and a decision unfavorable to Gerdau Acominas S.A. was
issued and has been appealed by Gerdau Acominas S.A.. The Company
estimates a credit in the amount of $148,433.
LABOR CONTINGENCIES
The Company is also defending labor proceedings, for which there is a
provision as of December 31, 2004 of $18,676. None of these lawsuits
refers to individually significant amounts, and the lawsuits mainly
involve claims due to overtime, health and risk premiums, among others.
The balances of deposits in court related to labor contingencies, at
December 31, 2004, totaled $7,773.
OTHER CONTINGENCIES
The Company is also defending in court civil proceedings arising from the
normal course of its operations and has accrued $2,805 for these claims.
Escrow deposits related to these contingencies, at December 31, 2004,
amount to $455. Other contingent liabilities with remote or possible
chances of loss, involving uncertainties as to their occurrence, and
therefore, not included in the provision for contingencies, are comprised
by:
o An antitrust process involving Gerdau S.A. related to the
representation of two civil construction syndicates in the state of
Sao Paulo that alleged that Gerdau S.A. and other long steel
producers in Brazil divide customers among them, violating the
antitrust legislation. After investigations carried out by the
National Secretariat of Economic Law - ("Secretaria de Direito
Economico"- SDE) and based on public hearings, the SDE is of the
opinion that a cartel exists. This conclusion was also supported by
an earlier opinion of the Secretariat for Economic Monitoring
("Secretaria de Acompanhamento Economico" - SEAE). The process is
pending evaluation by the Administrative Council for Economic Defense
- ("Conselho Administrativo de Defesa Economica" - CADE), which will
decide the matter.
Gerdau S.A. denies having engaged in any type of anti-competitive
behavior and understands, based on information available, including
the opinion of its legal advisors, that the administrative process
until now includes many irregularities, some of which are impossible
to resolve.
The investigations of SDE did not comply with the legal due process
and representatives of this agency oriented some of the witnesses
that testified in the process. In addition, the SDE report opinion
was issued before Gerdau S.A. had a chance to reply to the closing
arguments, which indicates that there was a bias in the judgment made
by the SDE. The same applies to the SEAE report, which does not
analyze the economic issues and is based exclusively on the
witnesses' testimony.
The mentioned irregularities also include non-compliance with the
related constitutional provisions and will affect the decision in the
administrative system, based on the conclusions presented by
antitrust authorities until now. Gerdau S.A. has pointed out and
tried to defeat all these irregularities in the administrative
process. Gerdau S.A. believes in a favorable outcome to this process,
if not in the administrative system, possibly in the judicial system.
Due to the facts exposed above, no provision was set up for this
case. According to Brazilian legislation, fines up to 30% of gross
sales revenue in the prior fiscal years may be applied against the
Company and, if the personal responsibility of an executive is
proven, such executive may be penalized by 10% to 50% of the fine
applied to the Company. There are no precedents in the country for
fines exceeding 4%. In a similar case involving flat steel companies,
the fine was 1% of gross sales revenue.
F-42
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
o There is a civil lawsuit filed against Gerdau Acominas S.A.,
regarding the termination of a contract for the supply of slag and
indemnities for losses and damages. The amount of the claim, at
December 31, 2004, was approximately $13,944. Gerdau Acominas S.A.
contested all bases for the lawsuit and filed a counterclaim for the
termination of the contract and indemnity for breach of contract. The
judge declared the contract to be terminated, since such demand was
common to both parties. With regards to the remaining discussion, the
judge understood that both parties were at fault and judged unfounded
the requests for indemnity. This decision was maintained by the Court
of Civil Appeals of the state of Minas Gerais (CCPMG) and is based on
expert evidence and interpretation of the contract. The process went
to the High Court of Justice and returned to CCPMG for the judgment
of the appeal. Gerdau Acominas S.A. believes that a loss from the
case is remote, since it understands that a change in the judgment is
unlikely.
INSURANCE CLAIM
A civil lawsuit was filed by Sul America Cia Nacional de Seguros on
August 4, 2003 against Gerdau Acominas S.A. and Banco Westdeustsche
Landesbank Girozentrale, New York Branch (WestLB), for the payment of
$12,953 which was deposited in court to settle an insurance claim made by
Gerdau Acominas. The insurer pleads uncertainty in relation to whom
payment should be made and alleges that the Company is resisting in
receiving and settling it. The lawsuit was contested by both the bank
(which claimed having no right over the amount deposited, solving the
question raised by Sul America) and the Company (which claimed
inexistence of uncertainty and justification to refuse the payment, since
the amount owed by Sul America is higher than stated). After this
pleading, Sul America claimed fault in the bank's representation, and
this matter is therefore already settled, which resulted collection by
Gerdau Acominas in December 2004 of the amount deposited bu the insurer.
The process is expected to enter in the expert evidence phase, mainly for
determine of the amount finally due.
The civil lawsuits arise from the accident on March 23, 2002 with the
blast furnace regenerators of the Presidente Arthur Bernardes mill, which
resulted in stoppage of several activities, material damages to the steel
mill equipment and loss of profits. The equipment, as well as loss of
profits arising from the accident, was covered by an insurance policy.
The report on the event, as well as the loss claim was filed with IRB -
Brasil Resseguros S.A., and the Company received an advance of $23,357
during 2002.
In 2002, a preliminary estimate of indemnities related to the coverage of
loss of profits and material damages, in the total amount of
approximately $41,441, was recorded, based on the amount of fixed costs
incurred during the period of partial stoppage of the steel mill and on
the expenses incurred to recover the equipment temporarily. This estimate
is close to the amount of the advance received, plus the amount proposed
by the insurance company as a complement for settling the indemnity.
Subsequently, new amounts were added to the discussion, as demonstrated
in the Company's appeal, although they were not accounted for.
Considering the litigation initiated in August 2003 by the insurers, the
Company reduced the amount of the receivable to the amount proposed by
the insurers to settle the indemnification (deposited by the insurer in
court).
Based on the opinion of its legal advisors, management considers that
losses from other contingencies are remote, and that eventual losses
would not have a material adverse effect on the consolidated results of
operations, consolidated financial position of the Company or its future
cash flows.
F-43
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
16.2 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 residue 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 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 present
value of total remaining costs to be approximately $16,000 (including
$3,600 assumed in the North Star acquisition) and $13,600 as of December
31, 2004 and 2003, respectively. Of the costs recorded as a liability at
December 31, 2004, the Company expects to pay approximately $3,300 within
the year ended December 31, 2005. Included in the amounts outstanding is
$8,600 on recorded in 2002 with respect to certain environmental
obligations which were triggered by the change in control of Co-Steel
Inc. in certain jurisdictions in which Co-Steel Inc. operated.
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 Environmental Protection
Agency (EPA) of an investigation that identified the Company as a
potential responsible party (PRP) at a Superfund Site in Pelham, Georgia.
The Pelham site was a fertilizer manufacturer in operation from 1910
through 1992, operated last by Stoller Chemical Company, a now bankrupt
corporation. The EPA has filed suit with the Company named as a
defendant. The Company is in this action because of EAF dust allegedly
shipped by the Company to this property in 1978. In 2003, the EPA offered
a settlement to the named PRP's totaling $15,500, under which the
Company's allocation was approximately $1,800. The Company did not accept
the settlement and objected to its inclusion as a PRP, has asserted
defenses and is pursuing legal alternatives, including adding a larger
third party which the Company believes was incorrectly excluded from the
original lawsuit. In 2004, the court denied a motion asserting some, but
not all, of the Company's defenses. Also in 2004, the EPA and the Company
had further discussions on a settlement with the EPA indicating a
settlement range of $8,000 to $10,000. The Company is not in agreement
with this assessment and is considering legal alternatives including
pursuing other contributing parties' insurance carriers. At this time,
the ultimate exposure is not estimable.
The Company is not aware of any environmental remediation cost or
liability in relation to its operations outside United States and Canada.
F-44
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
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 costs and improved service from
these contracts. The Company believes these raw materials would be
readily available in the market without such contracts.
16.3 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
---------------
2005 14,530
2006 10,276
2007 8,610
2008 7,300
2009 5,883
Thereafter 30,042
---------------
76,641
===============
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.
Rent expense related to operating leases was $19,800 and $19,200 for the
years ended December 31, 2004 and 2003, respectively.
16.4 VENDOR FINANCING
Gerdau Acominas S.A. provides guarantees to Banco Gerdau S.A. for
financing 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, 2004, customer
guarantees provided by the company totaled $25,670. Since Banco Gerdau
S.A. and Gerdau Acominas S.A. are under the common control of MG, this
guarantee is not covered by the recognition requirements of FASB
Interpretation No 45 ("FIN 45").
F-45
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
17 SHAREHOLDERS' EQUITY
17.1 SHARE CAPITAL
As of December 31, 2004, 102,936,448 shares of Common stock and
193,771,574 shares of Preferred stock had been issued. The share capital
of the Company is comprised of Common shares and Preferred shares, all
without par value. The authorized capital of the Company 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.
The shareholders meeting held on April 29, 2004 approved a bonus to both
common and preferred shareholders of 1 share per share held, which
resulted in the issuance of 148,354,011 new shares (51,468,224 Common
shares and 96,885,787 Preferred shares).
At a meeting held on November 17, 2003, the Board of Directors of the
Company authorized the acquisition of shares of the Company. The shares
held in treasury will be sold in the capital markets or cancelled.
At December 31, 2004, the Company held in treasury 1,573,200 preferred
shares at a cost of $15,256 (December 31, 2003 - 690,000 preferred shares
at a cost of $5,920).
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 meeting, a reverse stock split of 1 share for each
1,000 shares held (after taking into consideration the above mentioned
bonus) was approved.
The following sets forth the changes in the number of the Gerdau's shares
from January 1, 2002 through December 31, 2004:
COMMON PREFERRED TREASURY STOCK -
SHARES SHARES PREFERRED
------------------ ---------------------------------------
Balances as of January 1, 2002 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
Shares issued in regards to share bonus 51,468,224 96,885,787 345,000
Acquisition of treasury stock - - 883,200
------------------ ------------------ ------------------
Balances as of December 31, 2004 102,936,448 193,771,574 1,573,200
================== ================== ==================
F-46
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
17.2 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.
17.3 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 29, 2004 an amount of R$1,735,656 thousand (equivalent to
$556,603 at the exchange rate of April 29, 2004) recorded as of December
31, 2003 as part of the statutory reserve was capitalized by resolution
adopted in the shareholders meeting held that day.
On April 30, 2003 an amount of R$ 400,536 thousand (equivalent to
$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.
17.4 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, 2004, retained earnings in the statutory accounting records
correspond to the balance of the statutory reserve described in Note 17.3
above which amounts in the statutory records of the Gerdau to $715,746
(translated at the year-end exchange rate).
Aggregate dividends (which consisted mainly of interest on equity)
declared by Gerdau are as follows:
2004 2003 2002
-------------- -------------- --------------
Common shares 67,725 40,917 26,948
Preferred shares 126,453 76,900 50,730
-------------- -------------- --------------
Total 194,178 117,817 77,678
============== ============== ==============
18 ACCOUNTING FOR INCOME TAXES
18.1 ANALYSIS OF INCOME TAX EXPENSE
Income tax payable is calculated as required by the tax laws of the
countries in which Gerdau and its subsidiaries operate.
F-47
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Current tax (benefit) expense:
Brazil 214,050 95,815 37,245
United States 101,381 700 (8,255)
Canada 1,216 713 (2,890)
Other countries 12,582 (9,416) 965
-------------- -------------- --------------
329,229 87,812 27,065
-------------- -------------- --------------
DEFERRED TAX (BENEFIT) EXPENSE:
Brazil 61,050 (99,569) (32,971)
United States (4,870) (28,067) 9,598
Canada 12,333 (13,014) 830
Other Countries 8,938 18,725 2,036
-------------- -------------- --------------
77,451 (121,925) (20,507)
-------------- -------------- --------------
INCOME TAX (BENEFIT) EXPENSE 406,680 (34,113) 6,558
============== ============== ==============
F-48
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
18.2 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:
2004 2003 2002
-------------- -------------- --------------
Income before taxes and minority interest 1,722,065 525,674 228,718
Brazilian composite statutory income tax rate 34% 34% 34%
-------------- -------------- --------------
Income tax at Brazilian income tax rate 585,502 178,729 77,764
Reconciling items:
Foreign income having different statutory rates 8,266 (25,845) (5,448)
Non-deductible expenses net of non-taxable income (2,717) (6,593) (17,560)
Reversal of valuation allowance (120,317) (137,333) (12,939)
Defered tax asset valuation adjustment (48,563) - -
Benefit of deductible interest on equity paid to shareholders (37,866) (40,058) (31,001)
Other, net 22,375 (3,013) (4,258)
-------------- -------------- --------------
Income tax (benefit) / expense 406,680 (34,113) 6,558
============== ============== ==============
18.3 TAX RATES
Tax rates in the principal geographical areas in which the Company
operates were as follows:
2004 2003 2002
--------------- -------------- --------------
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) 39.00% 40.00% 40.00%
=============== ============== ==============
CANADA
Federal income tax 22.12% 22.12% 21.84%
Provincial rate (approximate) 12.00% 13.50% 15.16%
--------------- -------------- --------------
Composite income tax rate 34.12% 35.62% 37.00%
=============== ============== ==============
CHILE
Federal income tax 17.00% 16.50% 16.00%
=============== ============== ==============
F-49
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
18.4 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.
2004 2003
-------------- --------------
Deferred tax assets
Property plant and equipment 25,366 27,931
Net operating loss carryforwards 146,222 225,369
Accrued pension costs 3,057 11,390
Other 61,614 151,196
Valuation allowance on deferred tax assets - (120,846)
-------------- --------------
Gross deferred income tax assets 236,259 295,040
-------------- --------------
2004 2003
-------------- --------------
Deferred tax liabilities
Net operating loss carryforwards (39,481) (43,142)
Accounting provisions not currently deductible (11,258) (18,405)
Accrued pension costs (19,784) (15,981)
Property plant and equipment 147,454 155,638
Other (3,781) 1,301
-------------- --------------
Gross deferred income tax liabilities 73,150 79,411
-------------- --------------
2004 2003
-------------- --------------
Deferred tax balances
Deferred tax assets - current 82,829 49,451
Deferred tax assets - non-current 153,430 245,589
-------------- --------------
236,259 295,040
============== ==============
Deferred tax liabilities - current 14,496 7,286
Deferred tax liabilities - non-current 58,654 72,125
-------------- --------------
73,150 79,411
============== ==============
During 2004 and 2003 $120,317 and $137,333, respectively, of the
valuation allowance that was recognized in prior years 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 2004 and 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 4.7 which allows 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.
During 2004, the Company recorded the utilization of net operating losses
related to the former Co-Steel U.S. group resulting in a $48,563
reduction of U.S. tax expense. The NOL carryforward from the predecessor
company is subject to annual limitations as outlined in Internal Revenue
Code (IRC) S. 382 and IRC S. 1502, Separate Return Limitation
F-50
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
Year provisions. At the time of the acquisition of Co-Steel, the tax
assets were recorded at their estimated realization rate under purchase
accounting, which resulted in a portion of the existing NOLs being
reserved. Due to the high profitability of the former Co-Steel U.S. group
in 2004, the Company now believes it is more likely than not that it will
be able to realize the benefit of these losses, and as such the valuation
reserve related to these NOLs has been reversed. Substantially all of the
federal NOLs that are available to the Company under the applicable
change in ownership rules which limit a company's ability to utilize NOLs
that existed as of the date of an ownership change have been recognized.
The Company believes its total net deferred tax asset as December 31,
2004 is more likely than not to be realized based substantially on future
taxable income from operations.
19 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, (c) a stock
bonus of 1 share per each share held approved by the Shareholders Meeting
on April 29, 2004 and (d) a stock bonus of 50 share per each share held
approved on March 31, 2005 (Note 27).
YEAR ENDED DECEMBER 31, 2004
YEAR ENDED DECEMBER 31, 2004
Common Preferred Total
-------------- ---------------- ---------------
(in thousands, except share and per share data)
BASIC NUMERATOR
Dividends (interest on equity) declared 67,725 126,453 194,178
Allocated undistributed earnings 336,224 627,956 964,180
-------------- ---------------- ---------------
Allocated net income available to Common and Preferred shareholders 403,949 754,409 1,158,358
============== ================ ===============
BASIC DENOMINATOR
Weighted-average outstanding shares after deducting the average
treasury shares (Note 17.1) and considering the effect of stock
bonus aproved on March 31, 2005 (Note 27) 154,404,672 288,376,623
============== ================
Earnings per share (in US$) - Basic 2.62 2.62
============== ================
F-51
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
DILUTED NUMERATOR
Allocated net income available to Common and Preferred shareholders
Net income allocated to preferred shareholders 754,409
Add:
Adjustment to net income allocated to preferred shareholders in respect to the
potential increase in number of preferred shares outstanding, as a result 1,344
of options granted to acquire stock of Gerdau ---------------
755,753
===============
Net income allocated to common shareholders 403,949
Less:
Adjustment to net income allocated to common shareholders in respect to the potential increase in (1,344)
number of preferred shares outstanding, as a result of option granted to acquire stock of Gerdau ---------------
402,605
===============
DILUTED DENOMINATOR
WEIGHTED - AVERAGE NUMBER OF SHARES OUTSTANDING
Common Shares 154,404,672
Preferred Shares
Weighted-average number of preferred shares outstanding 288,376,623
Potential increase in number of preferred shares outstanding in respect of stock option plan 1,465,675
---------------
Total 289,842,298
===============
Earnings per share - Diluted (Common and Preferred Shares) 2.61
===============
YEAR ENDED DECEMBER 31, 2003
Common Preferred Total
------------- ----------------- ---------------
(in thousands, except share and per share data)
BASIC NUMERATOR
Dividends (interest on equity) declared 40,917 76,900 117,817
Allocated undistributed earnings 136,130 256,217 392,347
------------- ----------------- ---------------
Allocated 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 aplit described above and deducting
the average average treasury shares (Note 17.1) 154,404,672 290,614,236
============== ================
Earnings per share (in US$) - Basic 1.15 1.15
============== ================
F-52
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
DILUTED NUMERATOR
Allocated net income available to Common and Preferred shareholders
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 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
option granted to acquire stock of Gerdau (221)
---------------
176,826
===============
DILUTED DENOMINATOR
WEIGHTED - AVERAGE NUMBER OF SHARES OUTSTANDING
Common Shares 154,404,672
Preferred Shares
Weighted-average number of preferred shares outstanding 290,614,236
Potential increase in number of preferred shares outstanding in respect of stock option plan 457,197
---------------
Total 291,071,433
===============
Earnings per share - Diluted (Common and Preferred Shares) 1.15
===============
YEAR ENDED DECEMBER 31, 2002
Common Preferred Total
--------------- --------------- ---------------
(in thousands, except share and per share data)
BASIC NUMERATOR
Dividends declared 26,948 50,730 77,678
Allocated undistributed earnings 53,477 100,672 154,149
--------------- --------------- ---------------
Allocated net income available to Common and Preferred shareholders 80,425 151,402 231,827
=============== =============== ===============
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 17.1) 154,029,329 289,960,881
=============== ===============
Earnings per share (in US$) - Basic 0.52 0.52
=============== ===============
F-53
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
20 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 fair value of the Senior Notes issued by Gerdau Ameristeel, was
$474,863 and $447,525 as of December 31, 2004 and 2003 The fair value of
the Convertible Debentures issued by Gerdau Ameristeel was $105,574 and
$90,325 as of December 31, 2004 and 2003, respectively. Fair values of
debt issued by Gerdau Ameristeel were estimated based on quoted market
prices from the trading desk of a investment bank.
The Company's estimate of the fair value of the other financial
instruments, which include receivables, accounts payable and long-term
debt, approximates the carrying value.
21 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 are
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 Gerdau Acominas to foreign exchange gains and losses
which are recognized in the statement of income and also to changes in
the amount of Brazilian reais necessary to pay such U.S. dollar
denominated debt. Changes in interest rates on their fixed rate debt
expose Gerdau and Gerdau Acominas to changes in fair value on its debt.
In order to manage such risks Gerdau and Gerdau Acominas enter into
derivative instruments, primarily cross-currency interest rate swap
contracts. Under the swap contracts Gerdau and Gerdau 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
$58,204 ($459,684 as of December 31, 2003) and mature between January
2005 and March 2006 (January 2004 and March 2006 as of December 31, 2003)
with Brazilian reais interest payable which varies between 85.55% to
106.00% of CDI (between 71.60% and 105.00% of CDI of December 31, 2003).
There are no unrealized gains on swaps outstanding as of December 31,
2004 (unrealized gains of $9,685 as of December 31, 2003) and unrealized
losses amount to $14,775 as of December 31, 2004 ($40,938 as of December
31, 2003).
F-54
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
GERDAU AMERISTEEL
In order to reduce its exposure to changes in the fair value of its
Senior Notes, Gerdau Ameristeel entered into interest rate swaps
subsequent to the June 2003 refinancing. The agreements have a notional
value of $200,000 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 paid if the
agreements were terminated at December 31, 2004, was approximately $4,018
(December 31, 2003 - $89).
22 CONCENTRATION OF CREDIT RISKS
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 2004 were made to civil
construction and manufacturing customers.
Approximately 41.5% of the Company's consolidated sales are to domestic
Brazilian companies, 40% 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.
23 SEGMENT INFORMATION
The Gerdau Executive Committee, which 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, is
responsible for managing of the business.
The Company's' reportable segments under SFAS No. 131 "Disclosures About
Segments of an Enterprise and Related Information" correspond to the
business units through which the Gerdau Executive Committee manages its
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 Long 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.
There are no significant inter-segment sales transactions. The
identifiable assets are trade accounts receivable, inventories and
property, plant and equipment.
F-55
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004
-----------------------------------------------------------------------------------------------------------------------------
ADJUSTMENTS
SOUTH AMERICA AND TOTAL AS PER
ACOMINAS OURO (EXCEPT NORTH RECONCILLIA- FINANCIAL
LONG BRAZIL BRANCO BRAZIL) AMERICA TOTAL TIONS STATEMENTS
-----------------------------------------------------------------------------------------------------------------------------
Net sales 2,761,079 997,119 287,773 3,336,964 7,382,935 (430,786) 6,952,149
Financial expenses, net (33,507) 31,266 1,692 66,894 66,345 (15,528) 50,817
Net income 475,265 340,112 65,642 337,669 1,218,688 (60,330) 1,158,358
Capital expenditures 244,149 100,155 10,310 435,752 790,366 (33,659) 756,707
Depreciation and amortization 88,763 100,101 10,643 89,321 288,828 (19,606) 269,222
Identifiable assets 1,649,495 1,311,979 251,790 2,309,948 5,523,212 (303,409) 5,219,803
YEAR ENDED DECEMBER 31, 2003
-----------------------------------------------------------------------------------------------------------------------------
ADJUSTMENTS
SOUTH AMERICA AND TOTAL AS PER
ACOMINAS OURO (EXCEPT NORTH RECONCILLIA- FINANCIAL
LONG BRAZIL BRANCO BRAZIL) AMERICA TOTAL TIONS STATEMENTS
-----------------------------------------------------------------------------------------------------------------------------
Net sales 1,459,805 785,317 169,640 1,927,839 4,342,601 188,368 4,530,969
Financial expenses, net 120,878 39,100 1,326 62,485 223,789 (31,062) 192,727
Net income 202,276 220,810 32,320 (21,208) 434,198 75,966 510,164
Capital expenditures 103,243 115,643 7,702 57,041 283,629 28,856 312,485
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
YEAR ENDED DECEMBER 31, 2002
-----------------------------------------------------------------------------------------------------------------------------
ADJUSTMENTS
SOUTH AMERICA AND TOTAL AS PER
ACOMINAS OURO (EXCEPT NORTH RECONCILLIA- FINANCIAL
LONG BRAZIL BRANCO BRAZIL) AMERICA TOTAL TIONS STATEMENTS
-----------------------------------------------------------------------------------------------------------------------------
Net sales 1,571,136 459,930 113,341 994,348 3,138,755 126,171 3,264,926
Financial expenses, net 188,393 78,092 19,675 20,535 306,695 17,102 323,797
Net income 171,243 20,954 9,498 29,799 231,494 333 231,827
Capital expenditures 503,222 64,351 5,621 32,806 606,000 (7,958) 598,042
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
The segment information above has been prepared under Brazilian GAAP,
which is the basis of presentation used for internal decision making.
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 Adjustments and Reconciliations column include the effects of
differences between the criteria followed under Brazilian GAAP and the
criteria followed in the consolidated financial statements. The
differences that have the most significant effects are:
o Segment information includes data from the join ventures Gallatin
Steel Company, Bradley Steel Processors and MRM Guide Rail on a
proportional consolidation basis, companies that are not included in
the consolidated financial statements.
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 Identifiable assets and depreciation and amortization in the
segment information include property, plant and equipment which are
presented on the basis of historical costs of acquisition, while in
the consolidated
F-56
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
financial statements they include the effects of property, plant and
equipment acquired in business combinations at fair value.
o Derivative financial instruments are not fair valued in the segment
information while they are recognized at fair value in the
consolidated financial statements.
o Exchange gain and losses resulting from the translation of
financial information of subsidiaries outside Brazil are recognized
in income in the segment information while such effects are
recognized directly in equity in the consolidated financial
statements if the functional currency of the subsidiary is other than
the Brazilian reais.
Geographic information about the Company, prepared following the same
basis as the financial statements, is as follows:
YEAR ENDED DECEMBER 31, 2004
-----------------------------------------------------------------------------
SOUTH AMERICA NORTH
BRAZIL (EXCEPT BRAZIL) AMERICA TOTAL
-----------------------------------------------------------------------------
Net sales 3,623,046 319,248 3,009,855 6,952,149
Long lived assets 1,762,517 163,233 1,220,321 3,146,071
YEAR ENDED DECEMBER 31, 2003
-----------------------------------------------------------------------------
SOUTH AMERICA NORTH
BRAZIL (EXCEPT BRAZIL) AMERICA TOTAL
-----------------------------------------------------------------------------
Net sales 2,597,770 122,028 1,811,171 4,530,969
Long lived assets 1,422,121 134,437 1,030,257 2,586,815
YEAR ENDED DECEMBER 31, 2002
-----------------------------------------------------------------------------
SOUTH AMERICA NORTH
BRAZIL (EXCEPT BRAZIL) AMERICA TOTAL
-----------------------------------------------------------------------------
Net sales 2,111,684 99,482 1,053,760 3,264,926
Long lived assets 1,212,519 120,708 987,730 2,320,957
Long lived assets include property, plant and equipment, equity
investments, investments at cost and goodwill.
F-57
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
24 VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGES TO
BEGINNING OF COST AND
DESCRIPTION YEAR PAYMENTS EXPENSE REVERSALS
---------------------------------------------------- ------------- ------------ ----------- -------------
Provisions offset against assets balances:
Allowance for doubtful accounts 27,476 5,370 (1,144)
Valuation allowance on deferred income tax assets 120,846 - - (120,317)
Reserves:
Provision for contingencies 102,060 (118,991) 93,162
YEAR ENDED DECEMBER 31, 2003
BALANCE AT CHARGES TO
BEGINNING OF COST AND
DESCRIPTION YEAR PAYMENTS EXPENSE REVERSALS
---------------------------------------------------- ------------- ------------ ----------- -------------
Provisions offset against assets balances:
Allowance for doubtful accounts 15,139 - 6,714 -
Valuation allowance on deferred income tax assets 205,139 - - (137,333)
Reserves:
Provision for contingencies 45,304 (3,622) 44,361 (1,255)
YEAR ENDED DECEMBER 31, 2002
BALANCE AT CHARGES TO
BEGINNING OF COST AND
DESCRIPTION YEAR PAYMENTS EXPENSE REVERSALS
---------------------------------------------------- ------------- ------------ ----------- -------------
Provisions offset against assets balances:
Allowance for doubtful accounts 23,045 - 1,310 -
Valuation allowance on deferred income tax assets - - - (12,939)
Reserves:
Provision for contingencies 55,170 (2,243) 14,179 -
EFFECT OF
EXCHANGE RATE BALANCES AT
DESCRIPTION CHANGES (a) END OF YEAR
---------------------------------------------------- --------------- -------------
Provisions offset against assets balances:
Allowance for doubtful accounts 1,834 33,536
Valuation allowance on deferred income tax assets (529) -
Reserves:
Provision for contingencies 11,487 87,718
YEAR ENDED DECEMBER 31, 2003
EFFECT OF
EXCHANGE RATE BALANCES AT
DESCRIPTION CHANGES (a) END OF YEAR
---------------------------------------------------- --------------- -------------
Provisions offset against assets balances:
Allowance for doubtful accounts 5,623 27,476
Valuation allowance on deferred income tax assets 53,040 120,846
Reserves:
Provision for contingencies 17,272 102,060
YEAR ENDED DECEMBER 31, 2002
EFFECT OF
EXCHANGE RATE BUSINESS BALANCES AT
DESCRIPTION CHANGES (a) COMBINATION END OF YEAR
---------------------------------------------------- --------------- -------------- -------------
Provisions offset against assets balances:
Allowance for doubtful accounts (9,216) - 15,139
Valuation allowance on deferred income tax assets (85,292) 303,370 205,139
Reserves:
Provision for contingencies (21,802) 45,304
(a) Includes the effect of exchange rates on balances in currencies
other than the United States dollar.
F-58
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
25 STOCK BASED COMPENSATION
25.1 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 individuals who render
services to the Company or to entities under its control, and approved
the creation of the "Long Term Incentive Program". The options must be
exercised up to 5 years after vested.
A summary of the Brazil Plan is as follows (giving retroactive effect to
the stock bonus approved on March 31, 2005 (Note 27):
YEAR ENDED DECEMBER 31, 2004 YEAR ENDED DECEMBER 31, 2003
------------------------------------------- --------------------------------------------
NUMBER OF SHARES WEIGHTED AVERAGE NUMBER OF SHARES WEIGHTED AVERAGE
EXERCISE PRICE EXERCISE PRICE
--------------------- ------------------- --------------------- --------------------
Outstanding, beginning of year 2,052,207 2.76 - -
Granted during the year 260,331 7.66 1,026,104 2.76
Shares issued in regards to share bonus 260,331 7.66 1,026,104 2.76
--------------------- ---------------------
Outstantind, end of year 2,572,869 3.75 2,052,207 2.76
===================== =====================
All options granted through December 31, 2004 were granted to management
or employees of the Company. There are no options exercisable at December
31, 2004 and the weighted average remaining contractual life is 1.82
years to options granted in 2003 and 3.98 years to options granted in
2004.
The assumptions used for estimating the fair value of the options on the
grant date during the year ended December 31, 2004 following the Black &
Scholes method, included in the pro-forma disclosures in Note 3.13 were
as follows:
GRANTED DURING THE YEAR
---------------------------
2004 2003
-------------- ----------
Expected dividend yield 7% 7%
Expected stock price volatility 43% 43%
Riskfree rate of return 8% 8%
Expected period until exercise 4.9 year 3.5 year
F-59
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
25.2 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 subsidiary
AmeriSteel.
(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 4.9). All amounts presented in the discussion below have been
restated to reflect the historical shares at the exchanged value.
(B.1) STAKEHOLDER PLAN
Ameristeel had 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 were
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 could elect cash payout or investments in phantom
stock of Ameristeel or Gerdau S.A., for which a 25% premium was earned if
elected. Following the minority exchange, investments in phantom stock of
Ameristeel became investments in phantom common shares of Gerdau
Ameristeel based on the exchange ratio. Benefits charged to expense under
this plan for the years ended December 31, 2004 and 2003, were $1,300 and
$150, respectively.
An award of approximately $14,000 was earned by participants in the
Stakeholder Plan for the year ended December 31, 2004 and was granted on
March 1, 2005. The award will be accrued over the vesting period. No
awards are expected to be granted under the Stakeholder Plan in the
future.
(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. The
SARs are recorded as a liability and benefits charged to expense under
this plan for the years ended December 31, 2004 and 2003, were $6,400 and
$3,500, respectively.
In July 2002, Ameristeel's Board of Directors approved the issuance of
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, 2004 and 2003, were $14,300 and $5,900,
F-60
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
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.
(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 $1.12 per share.
The options were granted with the exercise price equal to fair value at
the date of the grant, determined based on an independent appraisal as of
the end of the previous year-end. A total of 2,139,612 options were
granted under the Purchase Plan. No options remain available for future
grant. All options outstanding are currently vested. Options may be
exercised for 10 years from the grant date.
A summary Gerdau Ameristeel stock option plans is as follows:
YEAR ENDED DECEMBER 31, 2004 YEAR ENDED DECEMBER 31, 2003
----------------------------------------- ---------------------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
AMERISTEEL PLANS NUMBER OF SHARES EXERCISE PRICE NUMBER OF SHARES EXERCISE PRICE
-------------------------------- --------------------- ------------------ --------------------- --------------------
(US$) (US$)
Outstanding, beginning of year - - 281,197 20.37
Exchange for options of Gerdau
Ameristeel - - (281,197) 20.37
--------------------- ---------------------
Outstanding, end of year - - - -
===================== =====================
GERDAU AMERISTEEL PLANS
--------------------------------
Outstanding, beginning of year 3,606,570 6.41 1,367,400 9.30
Ameristeel Plans Options exchanged-
for Gerdau Ameristeel Options - - 2,660,601 2.15
Exercised (374,609) 1.90 - -
Forfeit (76,973) 1.92 - --
Expired (321,700) 19.46 (421,431) 19.72-
Outstanding, end of year 2,833,288 5.94 3,606,570 6.41
--------------------- ---------------------
Options exercisable 2,350,378 2,585,767
===================== =====================
The following table summarizes information about options outstanding at
December 31, 2004:
F-61
GERDAU S.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2004, 2003 and 2002
(in thousands of U.S. Dollars, unless otherwise stated)
--------------------------------------------------------------------------------
WEIGHTED-AVERAGE
NUMBER REMAINING CONTRACTUAL WEIGHTED-AVERAGE NUMBER EXERCISABLE
EXERCISE PRICE RANGE (US$) OUTSTANDING LIFE EXERCISE PRICE AT DEZEMBER 31, 2004
--------------------------------- --------------------- --------------------- ------------------- ---------------------
(US$)
$1.32 to $1.43 752,829 4.4 1.38 597,086
$1.80 to $1.90 824,536 5.9 1.84 497,369
$2.11 to $2.96 563,923 4.5 4.48 563,923
$15.45 to $18.69 (1) 342,500 2.1 16.80 342,500
$20.06 to $20.15 (1) 349,500 1.7 20.15 349,500
--------------------- ---------------------
2,833,288 2,350,378
===================== =====================
Note: (1) these options are denominated in Cdn dollars and have been
translated to US$ using the exchange rate as at December 31, 2004.
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 for options
granted during all years presented:
Expected dividend yield: 0%
Expected stock price volatility: 55%
Risk-free rate of return: 4%
Expected period until exercise: 5 years
26 GUARANTEE OF INDEBTEDNESS
(a) Gerdau has provided a surety to its subsidiary Dona Francisca Energetica
S.A. in financing contracts which amount to R$ 97,275 thousand
(equivalent of $36,647 at period-end exchange rate). Under the surety
Gerdau guarantees 51.82% of the debt ($18,990) of such debt. 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 Dona Francisca.
(b) Gerdau is the guarantor on Euro Commercial Papers of its subsidiary GTL
Trade Finance Inc., in the amount of $110,000, on loans of its subsidiary
GTL Financial Corp in the amount of $5,000 and on Export Receivables
Notes of its subsidiary Gerdau Acominas S.A. amounting to approximately
$233,000.
As the guarantees above are between a parent company (the Company) and
its subsidiaries (GTL Trade Finance Inc., GTL Financial Corp and Gerdau
Acominas S.A.), they are not subject to the recognition provisions under
FIN 45. These guarantees may be executed upon failure by the subsidiaries
of satisfying their financial obligation.
27 SUBSEQUENT EVENT
The Board of Directors approved on its meeting held on March 31 2005 a
bonus to both common and preferred shareholders of 50 bonus shares per
100 shares held.
* * *
F-62