Company Quick10K Filing
Gerdau
20-F 2019-12-31 Filed 2020-03-31
20-F 2018-12-31 Filed 2019-03-29
20-F 2017-12-31 Filed 2018-04-03
20-F 2016-12-31 Filed 2017-03-15
20-F 2015-12-31 Filed 2016-03-31
20-F 2014-12-31 Filed 2015-03-31
20-F 2013-12-31 Filed 2014-03-24
20-F 2012-12-31 Filed 2013-03-28
20-F 2011-12-31 Filed 2012-04-23
20-F 2010-12-31 Filed 2011-06-02
20-F 2009-12-31 Filed 2010-06-07

GGB 20F Annual Report

Part Il
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 4. Company Information
Item 4A. Unresolved Sec Staff Comments
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related-Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures Regarding Market Risk
Item 12. Description of Securities Other Than Equity Securities
Part II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Item 16. [Reserved]
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions From The Listing Standards for Audit Committees
Item 16E. Purchases of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F. Change in Registrant's Certifying Accountant.
Item 16G. Corporate Governance
Part III
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Financial Statements and Exhibits
Note 1 - General Information
Note 2 - Summary of Significant Accounting Practices
Note 3 - Consolidated Financial Statements
Note 4 - Cash and Cash Equivalents
Note 5 - Short and Long-Term Investments
Note 6 - Trade Accounts Receivable
Note 7 - Inventories
Note 8 - Tax Credits
Note 9 - Income and Social Contribution Taxes
Note 10 - Property, Plant and Equipment
Note 11 - Investments
Note 12 - Goodwill
Note 13 - Intangible Assets
Note 14 - Loans and Financing
Note 15 - Debentures
Note 16 - Financial Instruments
Note 17 - Taxes Payable
Note 18 - Provisions and Contingent Obligations
Note 19 - Related-Party Transactions
Note 20 - Employee Benefits
Note 21 - Environmental Liabilities
Note 22 - Equity - Parent Company Gerdau S.A.
Note 23 - Earnings per Share (Eps)
Note 24 - Net Sales Revenue
Note 25 - Long-Term Incentive Plans
Note 26 - Segment Reporting
Note 27 - Insurance
Note 28 - Impairment of Assets
Note 29 - Expenses By Nature
Note 30 - Financial Income
Note 31 - Subsequent Events
EX-1.01 a10-11270_1ex1d01.htm
EX-4.02 a10-11270_1ex4d02.htm
EX-12.01 a10-11270_1ex12d01.htm
EX-12.02 a10-11270_1ex12d02.htm
EX-13.01 a10-11270_1ex13d01.htm
EX-13.02 a10-11270_1ex13d02.htm

Gerdau Earnings 2009-12-31

Balance SheetIncome StatementCash Flow

20-F 1 a10-11270_120f.htm 20-F

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

o

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, 2009

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

OR

 

 

o

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 1-14878

 

GERDAU S.A.

(Exact Name of Registrant as Specified in its Charter)

 

N/A

(Translation of Registrant’s name into English)

 

Federative Republic of Brazil

(Jurisdiction of Incorporation or Organization)

 

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:

 

Title of Each Class

 

Name of Each Exchange in 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

 



Table of Contents

 

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, 2009 was:

 

 

496,586,494 Common Shares, no par value per share

 

934,793,732 Preferred Shares, no par value per share

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

x Yes   o No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

o Yes   x No

 

Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

 

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 for 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.

x Yes   o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

o Yes   x No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP o

 

International Financial Reporting Standards as issued
by the International Accounting Standards Board
x

 

Other o

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

o Item 17   x Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes   x No

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

INTRODUCTION

 

3

 

 

 

PART I

 

5

 

 

 

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

5

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

5

ITEM 3.

KEY INFORMATION

5

ITEM 4.

COMPANY INFORMATION

17

ITEM 4A.

UNRESOLVED SEC STAFF COMMENTS

48

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

48

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

76

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED-PARTY TRANSACTIONS

83

ITEM 8.

FINANCIAL INFORMATION

84

ITEM 9.

THE OFFER AND LISTING

88

ITEM 10.

ADDITIONAL INFORMATION

93

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK

102

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

104

 

 

 

PART II

 

105

 

 

 

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

105

ITEM 14.

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

105

ITEM 15.

CONTROLS AND PROCEDURES

105

ITEM 16.

[RESERVED]

107

ITEM 16A.

AUDIT COMMITTEE FINANCIAL EXPERT

107

ITEM 16B.

CODE OF ETHICS

107

ITEM 16C.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

107

ITEM 16D.

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

108

ITEM 16E.

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

109

ITEM 16F.

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

110

ITEM 16G.

CORPORATE GOVERNANCE

110

 

 

 

PART III

 

112

 

 

 

ITEM 17.

FINANCIAL STATEMENTS

112

ITEM 18.

FINANCIAL STATEMENTS

112

ITEM 19.

FINANCIAL STATEMENTS AND EXHIBITS

112

 



Table of Contents

 

INTRODUCTION

 

Unless otherwise indicated, all references herein to:

 

(i)                                     the “Company”, “Gerdau”, “we” or “us” are references to Gerdau S.A., a corporation organized under the laws of the Federative Republic of Brazil (“Brazil”) and its consolidated subsidiaries;

 

(ii)                                  “Açominas” are references to Aço Minas Gerais S.A. — Açominas prior to November 2003 whose business was to operate the Ouro Branco steel mill. In November 2003 the company underwent a corporate reorganization, receiving all of Gerdau’s Brazilian operating assets and liabilities and being renamed Gerdau Açominas S.A.;

 

(iii)                               “Gerdau Açominas” are references to Gerdau Açominas S.A. after November 2003 and to Açominas before such date. In July 2005, certain assets and liabilities of Gerdau Açominas were spun-off to four other newly created entities: Gerdau Aços Longos, Gerdau Aços Especiais, Gerdau Comercial de Aços and Gerdau América do Sul Participações. As a result of such spin-off, as from July 2005, the activities of Gerdau Açominas only comprise the operation of the Ouro Branco steel mill;

 

(iv)                              “Chaparral Steel” or to “Chaparral” are references to Chaparral Steel Company, a corporation organized under the laws of the State of Delaware, and its consolidated subsidiaries;

 

(v)                                 “Preferred Shares” and “Common Shares” refer to the Company’s authorized and outstanding preferred stock and common stock, designated as ações preferenciais and ações ordinárias, respectively, all without par value. All references herein to the “real”, “reais” or “R$” are to the Brazilian real, the official currency of Brazil. All references to (i) “U.S. dollars”, “dollars”, “U.S.$” or “$” are to the official currency of the United States, (ii) “Canadian dollars” or “Cdn$” are to the official currency of Canada, (iii) “Euro” or “€” are to the official currency of Europe,  (iv) “billions” are to thousands of millions, (v) “km” are to kilometers, and (vi) “tonnes” are to metric tones;

 

(vi)                              “Installed capacity” means the annual projected capacity for a particular facility (excluding the portion that is not attributable to our participation in a facility owned by a joint venture), calculated based upon operations for 24 hours each day of a year and deducting scheduled downtime for regular maintenance;

 

(vii)                           “Tonne” means a metric tonne, which is equal to 1,000 kilograms or 2,204.62 pounds;

 

(viii)                        “Consolidated shipments” means the combined volumes shipped from all our operations in Brazil, Latin America, North America and Europe, excluding our jointly-controlled entities and associate companies;

 

(ix)                                “worldsteel” means World Steel Association, “IABr” means Brazilian Steel Institute (Instituto Aço Brasil) and “AISI” means American Iron and Steel Institute;

 

(x)                                   “CPI” means consumer price index, “CDI” means Interbanking Deposit Rates (Certificados de Depósito Interfinanceiro), “IGP-M” means Consumer Prices Index (Índice Geral de Preços do Mercado), measured by FGV (Fundação Getulio Vargas), “LIBOR” means London Interbank Offered Rate, “GDP” means Gross Domestic Product;

 

(xi)                                “Brazil BO” means Brazil Business Operation, “North America BO” means North America Business Operation, “Latin America BO” means Latina America Business Operation, “Specialty Steel BO” means Specialty Steel Business Operation.

 

The Company has prepared the consolidated financial statements included herein in accordance with International Financial Reporting Standards (IFRS) issued by International Accounting Standards Board (IASB). The investments 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, the investments in the holding company Multisteel Business Holdings Corp., in which the Company holds a 49% stake, which holds 99.13% of the capital stock of Industrias Nacionales, C. por A. (INCA), in Dominican Republic, the investments in the holding company Corsa Controladora, S.A. de C.V., in which the Company holds a 49% stake, which holds the capital stock of Aceros Corsa S.A. de C.V., in Mexico, the investments in the holding company Corporacion Centroamericana del Acero S.A., in which the Company holds a 30% stake, which holds the capital stock of Aceros de Guatemala S.A., in Guatemala, the investments in Estructurales Corsa S.A.P.I. de C.V., in Mexico, in which the Company holds a 50% stake, the investments in Kalyani Gerdau Steel Ltd., in India, in which the Company holds a 56.81% stake, and the investment in Dona Francisca Energética S.A, in Brazil, in which the Company holds a 51.82% stake, are accounted for using the equity method.

 

Unless otherwise indicated, all information in this Annual Report is stated for December 31, 2009.  Subsequent developments are discussed in Item 8.B - Financial Information - Significant Changes.

 

3



Table of Contents

 

CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING STATEMENTS

 

This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Act of 1995.  These statements relate to our future prospects, developments and business strategies.

 

Statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates” and similar expressions are forward-looking statements.  Although we believe that these forward-looking statements are based upon reasonable assumptions, these statements are subject to several risks and uncertainties and are made in light of information currently available to us.

 

It is possible that our future performance may differ materially from our current assessments due to a number of factors, including the following:

 

·                  general economic, political and business conditions in our markets, both in Brazil and abroad, including demand and prices for steel products;

 

·                  interest rate fluctuations, inflation and exchange rate movements of the real in relation to the U.S. dollar and other currencies in which we sell a significant portion of our products or in which our assets and liabilities are denominated;

 

·                  our ability to obtain financing on satisfactory terms;

 

·                  prices and availability of raw materials;

 

·                  changes in international trade;

 

·                  changes in laws and regulations;

 

·                  electric energy shortages and government responses to them;

 

·                  the performance of the Brazilian and the global steel industries and markets;

 

·                  global, national and regional competition in the steel market;

 

·                  protectionist measures imposed by steel-importing countries; and

 

·                  other factors identified or discussed under “Risk Factors.”

 

Our forward-looking statements are not guarantees of future performance, and actual results or developments may differ materially from the expectations expressed in the forward-looking statements.  As for the forward-looking statements that relate to future financial results and other projections, actual results will be different due to the inherent uncertainty of estimates, forecasts and projections.  Because of these uncertainties, potential investors should not rely on these forward-looking statements.

 

We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.

 

4



Table of Contents

 

PART Il

 

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

 

In 2008, the Company changed its financial basis of reporting for purposes of filing financial statements with the SEC from United States Generally Accepted Accounting Principles (U.S. GAAP) to International Financial Reporting Standards (IFRS) as issued by International Accounting Standards Board (IASB), beginning with the financial statements as of and for the year ended December 31, 2008. The first financial statements of the Company prepared following IFRS as issued by the IASB were those as of and for the year ended December 31, 2007, with first time adoption date of January 1, 2006, which were filed with the local securities regulator in Brazil and made publicly available. The selected financial information for the Company included in the following tables should be read in conjunction with, and is qualified in its entirety by, the IFRS financial statements of the Company and Operating and Financial Review and Prospects” appearing elsewhere in this Annual Report.

 

The consolidated financial data of the Company as of and for each years ended on December 31, 2009, 2008, 2007 and 2006 are derived from the financial statements prepared in accordance with IFRS and presented in Brazilian Reais. The consolidated financial data of 2005 was presented according to US GAAP, because the date of transition to IFRS as issued by IASB was January 1, 2006. As such, no financial statements were prepared in accordance with IFRS prior to 2006.

 

In conjunction with our change in basis of reporting from US GAAP to IFRS as adopted by the IASB we have also changed our reporting currency from the United States dollars previously used to Brazilian Reais.

 

In order to comply with Regulation S-X 3-20 the consolidated financial data prepared under US GAAP is presented in Brazilian reais and, as such, has not been derived from our audited financial statements presented in United States dollars. The consolidated financial data under US GAAP presented in Brazilian reais results from converting the corresponding information in our financial statements presented in United States dollars as follows: (a) balance sheet date has been converted by applying the respective year-end exchange rates as of December 31, 2005, and (b) income statement data has been converted by applying average exchange rates for the years ended December 31, 2005.

 

The summary financial data prepared in accordance with IFRS and U.S. GAAP is not comparable.

 

IFRS Summary Financial and Operating Data

 

5



Table of Contents

 

 

 

(Expressed in thousands of Brazilian Reais - R$ except quantity of shares and
amounts per share)

 

 

 

2009

 

2008

 

2007

 

2006

 

NET SALES

 

26,540,050

 

41,907,845

 

30,613,528

 

25,883,911

 

Cost of sales

 

(22,107,346

)

(31,018,946

)

(23,133,902

)

(19,039,266

)

 

 

 

 

 

 

 

 

 

 

GROSS PROFIT

 

4,432,704

 

10,888,899

 

7,479,626

 

6,844,645

 

Selling expenses

 

(627,816

)

(688,640

)

(618,938

)

(557,045

)

General and administrative expenses

 

(1,714,494

)

(2,284,857

)

(1,884,405

)

(1,784,865

)

Impairment of assets

 

(1,222,897

)

 

 

 

Other operating income

 

190,157

 

205,676

 

110,721

 

255,194

 

Other operating expenses

 

(101,810

)

(116,064

)

(282,679

)

(291,357

)

Equity in earnings of unconsolidated companies

 

(108,957

)

122,808

 

118,399

 

243,550

 

 

 

 

 

 

 

 

 

 

 

INCOME BEFORE FINANCIAL INCOME (EXPENSES) AND TAXES

 

846,887

 

8,127,822

 

4,922,724

 

4,710,122

 

Financial income

 

436,236

 

484,046

 

810,137

 

939,484

 

Financial expenses

 

(1,286,368

)

(1,620,782

)

(1,202,027

)

(903,292

)

Exchange variations, net

 

1,060,883

 

(1,035,576

)

723,289

 

329,633

 

Gain and losses on derivatives, net

 

(26,178

)

(62,396

)

1,170

 

74,467

 

 

 

 

 

 

 

 

 

 

 

INCOME BEFORE TAXES

 

1,031,460

 

5,893,114

 

5,255,293

 

5,150,414

 

Income and social contribution taxes

 

 

 

 

 

 

 

 

 

Current

 

(303,272

)

(1,423,660

)

(872,315

)

(906,297

)

Deferred

 

276,320

 

475,444

 

(80,012

)

17,361

 

NET INCOME

 

1,004,508

 

4,944,898

 

4,302,966

 

4,261,478

 

 

 

 

 

 

 

 

 

 

 

ATRIBUTABLE TO:

 

 

 

 

 

 

 

 

 

Owners of the parent

 

1,121,966

 

3,940,505

 

3,549,881

 

3,546,934

 

No-controlling interests

 

(117,458

)

1,004,393

 

753,085

 

714,544

 

 

 

1,004,508

 

4,944,898

 

4,302,966

 

4,261,478

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share (1) — in R$ 

 

 

 

 

 

 

 

 

 

Common

 

0.79

 

2.83

 

2.68

 

2.67

 

Preferred

 

0.79

 

2.83

 

2.68

 

2.67

 

Diluted earnings per share (1) — in R$ 

 

 

 

 

 

 

 

 

 

Common

 

0.79

 

2.75

 

2.66

 

2.66

 

Preferred

 

0.79

 

2.75

 

2.66

 

2.66

 

Cash dividends declared per share (1) — in R$ 

 

 

 

 

 

 

 

 

 

Common

 

0.25

 

0.79

 

0.63

 

0.67

 

Preferred

 

0.25

 

0.79

 

0.63

 

0.67

 

 

 

 

 

 

 

 

 

 

 

Weighted average Common Shares outstanding during the year

 

494,888,956

 

485,403,980

 

463,214,016

 

463,214,016

(2)

 

 

 

 

 

 

 

 

 

 

Weighetd average Preferred Shares outstanding during the year

 

925,676,955

 

905,257,476

 

861,908,769

 

864,477,790

(2)

 

 

 

 

 

 

 

 

 

 

Number of Common Shares outstanding at year end

 

496,586,494

 

496,586,494

 

463,214,016

 

463,214,016

(3)

 

 

 

 

 

 

 

 

 

 

Number of Preferred Shares outstanding at year end

 

934,793,732

 

934,793,732

 

871,972,082

 

871,972,082

(3)

 


(1) Per share information has been retroactively restated for 2007 and 2006 to reflect the effect of:  (a) the stock bonus of one share for every share held approved in April 2008. Earnings per share has been computed on weighted average share outstanding during each year.

 

(2) The information on the numbers of shares presented above relate to the weighted average, and the years of 2007 and 2006 were retroactively restated to reflect changes in numbers of shares due to the transactions described in (1) above.

 

(3) The information on the numbers of shares presented above for the years of 2007 and 2006 were retroactively restated to reflect changes in numbers of shares due to the transactions described in (1) above.

 

6



Table of Contents

 

 

 

On December 31,

 

 

 

(expressed in thousands of Brazilian Reais - R$)

 

 

 

2009

 

2008

 

2007

 

2006

 

Balance sheet selected information

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

2,091,944

 

2,026,609

 

2,026,096

 

1,070,524

 

Short-term investments (1)

 

2,677,714

 

3,386,637

 

3,113,277

 

5,308,765

 

Current assets

 

14,164,686

 

20,775,540

 

15,312,973

 

15,083,956

 

Current liabilities

 

4,818,521

 

8,475,437

 

6,587,148

 

6,191,420

 

Net working capital (2)

 

9,346,165

 

12,300,103

 

8,725,825

 

8,892,536

 

Property, plant and equipment, net

 

16,731,101

 

20,054,747

 

15,827,944

 

13,373,543

 

Net assets (3)

 

22,004,793

 

25,043,578

 

16,723,208

 

14,188,216

 

Total assets

 

44,583,316

 

59,050,514

 

41,553,912

 

31,596,256

 

Short-term debt (including “Current Portion of Long-Term Debt”)

 

1,356,781

 

3,788,085

 

2,500,985

 

2,274,523

 

Long-term debt, less current portion

 

12,563,155

 

18,595,002

 

12,461,128

 

6,671,456

 

Debentures - short term

 

 

145,034

 

38,125

 

2,932

 

Debentures - long term

 

600,979

 

705,715

 

903,151

 

929,024

 

Equity

 

22,004,793

 

25,043,578

 

16,723,208

 

14,188,216

 

Capital stock

 

14,184,805

 

14,184,805

 

7,810,453

 

7,810,453

 

 


(1) Include trading and available for sale investments for all years and held to maturity for 2006.

(2) Total current assets less total current liabilities.

(3) Total assets less total current liabilities and less total non current liabilities.

 

7



Table of Contents

 

 

U.S. GAAP Summary Financial and Operating Data

 

(Expressed in thousands of Brazilian Reais - R$ except quantity of shares and amounts per share)

 

 

 

2005

 

Net sales

 

21,644,566

 

Cost of sales

 

(15,964,460

)

 

 

 

 

Gross profit

 

5,680,106

 

Sales and marketing expenses

 

(491,345

)

General and administrative expenses

 

(1,125,216

)

Other operating income (expenses), net

 

(9,900

)

 

 

 

 

Operating income

 

4,053,645

 

Interest expense, exchange (gain) loss and gains (losses) on derivatives, net

 

(448,744

)

Financial income

 

480,797

 

Equity in earnings of unconsolidated companies, net

 

238,053

 

 

 

 

 

Income before taxes on income and minority interest

 

4,323,751

 

Provision for taxes on income

 

 

 

Current

 

(856,472

)

Deferred

 

(295,277

)

Income before minority interest

 

3,172,002

 

Minority interest

 

(437,170

)

Net income

 

2,734,832

 

 

 

 

 

Basic earnings per share (1) — in R$

 

 

 

Common

 

2.06

 

Preferred

 

2.06

 

Diluted earnings per share (1) — in R$

 

 

 

Common

 

2.06

 

Preferred

 

2.06

 

Cash dividends declared per share (1) — in R$

 

 

 

Common

 

0.79

 

Preferred

 

0.79

 

 

 

 

 

Weighted average Common Shares outstanding during the year (2)

 

463,214,016

 

 

 

 

 

Weighetd average Preferred Shares outstanding during the year (2)

 

864,331,942

 

 

 

 

 

Number of Common Shares outstanding at year end (3)

 

463,214,016

 

 

 

 

 

Number of Preferred Shares outstanding at year end (3)

 

862,834,998

 

 


(1) Per share information has been retroactively restated for all periods to reflect the effect of:  (a) the stock bonus of one share for two shares held approved in March 2005, (b) the stock bonus of one share for two shares held approved in March 2006 and (c) the stock bonus of one share for every share held approved in April 2008. Earnings per share has been computed on weighted average share outstanding during each year.

 

(2) The information on the numbers of shares presented above relate to the weighted average, and it was retroactively restated to reflect changes in numbers of shares due to the transactions described in (1) above.

 

(3) The information on the numbers of shares presented above was retroactively restated to reflect changes in numbers of shares due to the transactions described in (1) above.

 

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On December 31,

(expressed in thousands of Brazilian Reais - R$)

 

 

 

2005

 

Balance sheet selected information

 

 

 

Cash and cash equivalents

 

1,249,484

 

Restricted cash

 

22,571

 

Short-term investments (1)

 

4,134,055

 

Net working capital (2)

 

7,915,330

 

Property, plant and equipment, net

 

8,256,657

 

Total assets

 

21,831,188

 

Short-term debt (including “Current Portion of Long-Term Debt”)

 

1,329,721

 

Long-term debt, less current portion

 

5,240,924

 

Debentures - short term

 

2,727

 

Debentures - long term

 

972,149

 

Shareholders’ equity

 

8,499,731

 

Capital stock

 

5,206,969

 

 


(1)     Include trading, available for sale and held to maturity investments.

(2)     Total current assets less total current liabilities.

 

Exchange rates between the United States Dollar and Brazilian Reais

 

The following table presents the exchange rates, according to the Brazilian Central Bank, for the periods indicated between the United States dollar and the Brazilian reais which is the currency in which we prepare our financial statements included in this Annual Report on Form 20-F.

 

Exchange rates from U.S. dollars to Brazilian reais

 

Period

 

Period-end

 

Average

 

High

 

Low

 

May - 2010

 

1.8167

 

1.8132

 

1.8811

 

1.7315

 

April - 2010

 

1.7360

 

1.7566

 

1.7806

 

1.7306

 

March - 2010

 

1.7810

 

1.7858

 

1.8231

 

1.7637

 

February - 2010

 

1.8110

 

1.8416

 

1.8773

 

1.8046

 

January - 2010

 

1.8748

 

1.7798

 

1.8748

 

1.7227

 

December - 2009

 

1.7412

 

1.7503

 

1.7879

 

1.7096

 

November - 2009

 

1.7505

 

1.7262

 

1.7588

 

1.7024

 

2009

 

1.7412

 

1.9976

 

2.5004

 

1.5593

 

2008

 

2.3370

 

1.8346

 

2.5004

 

1.7325

 

2007

 

1.7713

 

1.9479

 

2.1556

 

1.7325

 

2006

 

2.1380

 

2.1761

 

2.3711

 

2.0586

 

2005

 

2.3470

 

2.4352

 

2.7621

 

2.1633

 

 

Dividends

 

The Company’s total authorized capital stock is composed of common and preferred shares. As of April 30, 2010, the Company had 496,586,494 common shares and 934,793,732 non-voting preferred shares outstanding.

 

The following table details dividends and interest on equity paid to holders of common and preferred stock since 2005. The figures are expressed in Brazilian reais and converted into U.S. dollars on the date of the resolution approving the dividend. Dividend per share figures have been retroactively adjusted for all periods to reflect: (a) the stock dividend of one for every two shares held (approved in March 2005), (b) the stock dividend of one share for every two shares held (approved in March 2006), (c) the public share offering, with the issue of 44,000,000 shares (approved in March 2008); and (d) the stock dividend of one share for every share held (approved in May 2008).

 

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Dividend per share information has been computed by dividing dividends and interest on equity by the number of shares outstanding, which excludes treasury stock. The table below presents the quarterly dividends payment, except where stated otherwise:

 

 

 

 

 

R$ per Share

 

$ per Share

 

 

 

Date of

 

Common or

 

Common or

 

Period

 

Resolution

 

Preferred Stock

 

Preferred Stock

 

1st Quarter 2005

 

05/03/2005

 

0.1500

 

0.0600

 

2nd Quarter 2005

 

08/03/2005

 

0.1600

 

0.0691

 

3rd Quarter 2005

 

11/08/2005

 

0.1500

 

0.0681

 

4th Quarter 2005

 

02/08/2006

 

0.1400

 

0.0638

 

1st Quarter 2006 (1)

 

05/03/2006

 

0.1500

 

0.0724

 

2nd Quarter 2006

 

08/02/2006

 

0.1750

 

0.0802

 

3rd Quarter 2006 (1)

 

11/07/2006

 

0.1750

 

0.0820

 

4th Quarter 2006

 

02/07/2007

 

0.1750

 

0.0839

 

1st Quarter 2007 (1)

 

05/03/2007

 

0.1700

 

0.0840

 

2nd Quarter 2007

 

08/08/2007

 

0.1450

 

0.0769

 

3rd Quarter 2007 (1)

 

11/07/2007

 

0.1700

 

0.0977

 

4th Quarter 2007

 

02/13/2008

 

0.1450

 

0.0831

 

1st Quarter 2008 (1)

 

05/12/2008

 

0.2050

 

0.1224

 

2nd Quarter 2008

 

08/06/2008

 

0.3600

 

0.2281

 

3rd Quarter 2008

 

11/05/2008

 

0.1800

 

0.0849

 

4th Quarter 2008

 

02/19/2009

 

0.0400

 

0.0172

 

3rd Quarter 2009 (1)

 

11/05/2009

 

0.0750

 

0.0435

 

4th Quarter 2009 (1)

 

12/23/2009

 

0.1800

 

0.1013

 

1st Quarter 2010 (1)

 

05/06/2010

 

0.1200

 

0.0654

 

 


(1) Payment of interest on equity.

Note: the Company did not advance dividends in the 1st and 2nd quarter of 2009.

 

Brazilian Law 9,249 of December 1995 provides that a company may, at its sole discretion, pay interest on equity in addition to or instead of dividends (See Item 8 — Financial Information - Interest on Equity). A Brazilian corporation is entitled to pay its shareholders interest on equity up to the limit based on the application of the TJLP rate (Long-Term Interest Rate) to its shareholders’ equity or 50% of the net income in the fiscal year, whichever is lower. This payment is considered part of the mandatory dividend required by Brazilian Corporation Law for each fiscal year. The payment of interest on equity described herein is subject to a 15% withholding tax. See Item 10. Additional Information - Taxation.

 

In the fourth quarter of 2008, Gerdau launched the Dividend Reinvestment Plan (DRIP), which is a program that allows the holders of Gerdau ADRs to reinvest dividends to purchase additional ADRs in the Company, with no issuance of new shares. In January 2009, Gerdau provided its shareholders a similar program in Brazil that allows the reinvestment of dividends in additional shares, with no issuance of new shares.

 

B. CAPITALIZATION AND INDEBTEDNESS

 

Not required, as the Company is filing this Form 20-F as an annual report.

 

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

 

Not required, as the Company is filing this Form 20-F as an annual report.

 

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D. RISK FACTORS

 

Global Risks

 

Global crises and subsequent economic slowdowns as what happen during 2008 and 2009 may adversely affect global steel demand. As a result the Company’s financial condition and results of operations may be adversely affected.

 

Gerdau’s business operations are substantially affected by international economic conditions. Starting in September 2008 and lasting through much of 2009, a steep downturn in the global economy, sparked by uncertainty in credit markets and deteriorating consumer confidence, sharply reduced demand for steel products worldwide. This had, and to some extent continues to have, a pronounced negative effect on Gerdau’s financial condition and results of operations.

 

The current crisis was triggered by a dramatic rise in subprime mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. Developed markets, such as North America and Europe, have experienced serious recessions as a result of the collapse of mortgage lending and lack of global credit. Demand for steel products contracted in 2009, based on the pattern observed since 2008. If the Company is unable to remain competitive in these changing markets, its profits, profit margins and revenues may be adversely affected. The unprecedented economic slowdown and turmoil in the global economy have adversely impacted consumer markets, affecting the companies’ business environment as follows:

 

·                  Decrease in international steel prices;

·                  Slump in international steel trading volumes;

·                  Crisis in automotive industry and infrastructure sectors; and

·                  Lack of liquidity, mainly in the U.S. economy.

 

After a period of continuous growth between 2004 and 2008, the sharp fall in demand resulting from the global economic crisis of 2008-2009 once again demonstrated the steel market’s vulnerability to volatility and sharp corrections. The last quarter of 2008 and the first half of 2009 were characterized by a deep slump in demand, as consumers used up existing inventories rather than buying new stock. The steel market began a gradual recovery in the second half of 2009 in line with global economic activity, but real demand for steel products remained below levels prevailing before the crisis and the extent of the recovery remains uncertain in some regions. Recently, this crisis has sharply affected credit conditions in Europe. Even though the Company has low exposure in this market, the global steel prices can be affected and impact Gerdau’s results.

 

In 2009, Gerdau’s shipments decreased 26.8% compared to 2008, mainly due to the economic slowdown. North America Business Operation (BO) was the Company’s most affected business with a 35.4% decrease in shipments in the same period, mainly affected by a sharp reduction in consumer spending in the U.S., that affected industry and infrastructure demand. Latin American BO suffered a 9.7% reduction in shipments resulting from a large exposure in the international market (steel importers countries) affecting mainly Colombia, Peru and Chile where Gerdau owns some of its mills. Specialty Steel BO fell 30.2% in the same period, due the automotive industry crisis, its main consumer market. In Brazil BO the economic turmoil affected shipments which decreased 21.3% in 2009, mainly impacted in the first half of the year.

 

In 2010 the demand for steel products is showing gradual improvements on a monthly basis. No assurance can be given that these improvements will be constant through 2010. A decline in this trend could result in a decrease in Gerdau shipments to lower levels, considering the lowest level reached in the first quarter of 2009, reducing Company’s cash generation.

 

Risks Relating to Brazil

 

Brazil’s political and economic conditions and the Brazilian government’s economic and other policies may negatively affect demand for the Company’s products as well as its net sales and overall financial performance.

 

The Brazilian economy has been characterized by frequent and occasionally extensive intervention by the Brazilian government. The Brazilian government has often changed monetary, taxation, credit, tariff and other policies to influence the course of the country’s economy. The Brazilian government’s actions to control inflation and implement other policies have involved hikes in interest rates, wage and price controls, devaluation of the currency, freezing of bank accounts, capital controls and restrictions on imports.

 

The Company’s operating results and financial condition may be adversely affected by the following factors and the government responses to them:

 

·                  exchange rate controls and fluctuations;

 

·                  interest rates;

 

·                  inflation;

 

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·                  tax policies;

 

·                  energy shortages;

 

·                  liquidity of domestic and foreign capital and lending markets; and

 

·                  other political, diplomatic, social and economic developments in or affecting Brazil.

 

Uncertainty over whether the Brazilian government will change policies or regulations affecting these or other factors may contribute to economic uncertainty in Brazil and to heightened volatility in Brazilian securities markets and securities issued abroad by Brazilian issuers. These and other developments in Brazil’s economy and government policies may adversely affect the Company and its business.

 

Inflation and government actions to combat inflation may contribute significantly to economic uncertainty in Brazil and could adversely affect the Company’s business.

 

Brazil has experienced high inflation in the past. Since the implementation of the Real Plan in 1994, the annual rate of inflation has decreased significantly, as measured by the National Broad Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo, or IPCA). Inflation measured by the IPCA index was 5.7% in 2005, 3.1% in 2006, 4.5% in 2007, 5.9% in 2008 and 4.3% in 2009. If Brazil were to experience high levels of inflation once again, the country’s rate of economic growth could slow, which would lead to lower demand for the Company’s products in Brazil. Inflation is also likely to increase some costs and expenses which the Company may not be able to pass on to its customers and, as a result, may reduce its profit margins and net income. In addition, high inflation generally leads to higher domestic interest rates, which could lead the cost of servicing the Company’s debt denominated in Brazilian reais to increase. Inflation may also hinder its access to capital markets, which could adversely affect its ability to refinance debt. Inflationary pressures may also lead to the imposition of additional government policies to combat inflation that could adversely affect its business.

 

Variations in the foreign exchange rates between the U.S. dollar and the currencies of countries in which the Company operates may increase the cost of servicing its debt denominated in foreign currency and adversely affect its overall financial performance.

 

The Company’s operating results are affected by fluctuations in the foreign exchange rates between the Brazilian real, the currency in which the Company prepares its financial statements, and the currencies of the countries in which it operates.

 

For example, Gerdau Ameristeel reports its results in U.S. dollars. Therefore, fluctuations in the exchange rate between the U.S. dollar and the Brazilian real could affect its operating results. The same occurs with all other businesses located outside Brazil with respect to the exchange rate between the local currency of the respective subsidiary and the Brazilian real.

 

The Brazilian real appreciated against the U.S. dollar by 17.2% in 2007, depreciated against the U.S. dollar by 31.9% in 2008. On December 31, 2009, the U.S. dollar/Brazilian real exchange rate was $1.00 per R$ 1.74, resulting in appreciation of 25.5% when compared to December 31, 2008. On April 30, 2010 the Brazilian real depreciated 0.6% against the U.S. dollar to R$ 1.73.

 

Depreciation in the Brazilian real in relation to the U.S. dollar could also result in additional inflationary pressures in Brazil, by generally increasing the price of imported products and services and requiring recessionary government policies to curb demand. In addition, depreciation in the Brazilian real could weaken investor confidence in Brazil.

 

The Company held debt denominated in foreign currency, mainly U.S. dollars, in an aggregate amount of R$ 11,676.5 million at December 31, 2009, representing 80.4% of its indebtedness on a consolidated basis. On December 31, 2009, the Company held R$ 1,847.6 million in cash equivalents and short-term investments denominated in currencies different from Brazilian real. Significant depreciation in the Brazilian real in relation to the U.S. dollar or other currencies could reduce the Company’s ability to service its obligations denominated in foreign currencies, particularly since a significant part of its net sales revenue is denominated in Brazilian reais.

 

Export revenue and margins are also affected by fluctuations in the exchange rate of the U.S. dollar and other local currencies of the countries where the Company produces in relation to the Brazilian real. The Company’s production costs are denominated in local currency but its export sales are generally denominated in U.S. dollars. Revenues generated by exports denominated in U.S. dollars are reduced when they are translated into Brazilian real in periods during which the Brazilian currency appreciates in relation to the U.S. dollar.

 

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Table of Contents

 

Developments in other emerging markets or in the United States may adversely affect Brazil’s capital markets.

 

Political, economic, social and other developments in other countries, particularly those in Latin America, other emerging-market countries or the United States, may have an adverse effect on the market value of the Company. Although conditions in these countries may be quite different from those in Brazil, investors’ reactions to developments in these countries may affect Brazil’s securities markets and reduce investor interest in the securities of Brazilian issuers. Brazil has experienced periods with significant outflows of U.S. dollars, and Brazilian companies have faced higher costs for raising funds, both domestically and abroad, and have been prevented from accessing international capital markets.

 

Risks Relating to Gerdau and the Steel Industry

 

A change in China’s steelmaking capacity or a slowdown in China’s steel consumption could have a material adverse effect on domestic and global steel pricing and could result in increased steel imports into the markets in which we operate.

 

A significant factor in the worldwide strengthening of steel pricing over the past several years has been the significant growth in steel consumption in China, which at times has outpaced that country’s manufacturing capacity to produce enough steel to satisfy its own needs. At times this has resulted in China being a net importer of steel products, as well as a net importer of raw materials and supplies required in the steel manufacturing process. A reduction in China’s economic growth rate with a resulting reduction of steel consumption, coupled with China’s expansion of steel-making capacity, could have the effect of a substantial weakening of both domestic and global steel demand and steel pricing. Moreover, many Asian and European steel producers that had previously shipped their output to China may ship their steel products to other markets in the world, which could cause a material erosion of margins through a reduction in pricing.

 

Demand for steel is cyclical and a reduction in prevailing world prices for steel could adversely affect the Company’s operating results.

 

The steel industry is highly cyclical. Consequently, the Company is exposed to substantial swings in the demand for steel products, which in turn causes volatility in the prices of most of its products and eventually causing write downs on its inventories. In addition, the demand for steel products, and hence the financial condition and operating results of companies in the steel industry, including the Company itself, are generally affected by macroeconomic changes in the world economy and in the domestic economies of steel-producing countries, including general trends in the steel, construction and automotive industries. Since 2003, demand for steel products from developing countries (particularly China), the strong euro compared to U.S. dollar and world economic growth have contributed to a historically high level of prices for the Company’s steel products. However, these relatively high prices may not last, especially due to expansion in world installed capacity or a new level of demand. In the second half of 2008, and especially in the beginning of 2009, the U.S. and European economies showed strong signs of slow down, in turn affecting many other countries. Since the end of 2009 the world steel demand and prices have been improving if compared to the situation mentioned above and the Company believes that this trend will continue. A material decrease in demand for steel or exports by countries not able to consume their production, as happened in 2008, could have a significant adverse effect on the Company’s operations and prospects.

 

Higher steel scrap prices or a reduction in supply could adversely affect production costs and operating margins.

 

The main metal input for the Company’s mini-mills, which corresponded to 74.3% of total crude steel output in 2009 (in volume), is steel scrap. Although international steel scrap prices are determined essentially by scrap prices in the U.S. local market, because the United States is the main scrap exporter, scrap prices in the Brazilian market are set by domestic supply and demand. The price of steel scrap in Brazil varies from region to region and reflects demand and transportation costs. Should scrap prices increase significantly without a commensurate increase in finished steel sale prices, the Company’s profits and margins could be adversely affected. An increase in steel scrap prices or a shortage in the supply of scrap to its units would affect production costs and potentially reduce operating margins and revenues.

 

Increases in iron ore and coal prices or reductions in market supply could adversely affect the Company’s operations.

 

When the prices of the raw materials increase, the Company needs to produce steel in its integrated facilities, particularly iron ore and coking coal, the production costs in its integrated facilities also increase. The Company uses iron ore to produce liquid pig iron at its Ouro Branco unit, and at its Gerdau Barão de Cocais and Gerdau Divinópolis 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.

 

The Ouro Branco unit is the Company’s biggest mill in Brazil, and its main metal input for the production of steel is iron ore. In 2009, this unit represented 48.5% of the total crude steel output (in volume) of Gerdau’s Brazilian

 

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Table of Contents

 

operations. A shortage of iron ore in the domestic market may adversely affect the steel producing capacity of its Brazilian units, and an increase in iron ore prices could reduce profit margins.

 

All of the Company’s coking coal requirements for its Brazilian units are imported due to the low quality of Brazilian coal. Coking coal is the main energy input at the Ouro Branco unit and is used at the coking facility. Although this mill is not dependent on coke supplies, a contraction in the supply of coking coal could adversely affect the integrated operations at this site, since the Ouro Branco unit requires coking coal to produce coke in its coking facility. The coking coal used in Ouro Branco is imported from Canada, the United States, Australia and in a less extent from Colombia. A shortage of coking coal in the international market would adversely affect the steel producing capacity of the Ouro Branco unit, and an increase in prices could reduce profit margins. The Company does not have long-term supply contracts for certain raw materials it uses.

 

The Company may not successfully integrate its businesses, management, operations or products, or achieve any of the benefits anticipated from future acquisitions.

 

Over the years, the Company has expanded its presence mainly through acquisitions in the North American and Latin American markets. The integration of the business and opportunities stemming from entities recently acquired and those that may be acquired by the Company in the future may involve risks. The Company may not successfully integrate acquired businesses, managements, operations, products and services with its current operations. The diversion of management’s attention from its existing businesses, as well as problems that can arise in connection with the integration of the new operations may have an impact on revenue and operating results. The integration of acquisitions may result in additional expenses that could reduce profitability. The Company may not succeed in addressing these risks or any other problems encountered in connection with past and future acquisitions.

 

All these acquisitions generated a large amount of goodwill, which is stated in the Company’s balance sheet. The Company evaluates the recoverability of this goodwill on investments annually and uses accepted market practices, including discounted cash flow for business segments which have goodwill. A downturn in the steel market could negatively impact expectations for futures earnings, leading to the need to recognize a loss in its statement of income regarding the impairment in goodwill.

 

The Company’s operations are energy-intensive, and energy shortages or higher energy prices could have an adverse affect.

 

Steel production is an energy-intensive process, especially in melt shops with electric arc furnaces. Electricity represents a significant cost component at these units, as also does natural gas, although to a lesser extent. Electricity cannot be replaced at the Company’s mills and power rationing or shortages could adversely affect production at those units.

 

Natural gas is used in the reheating furnaces at the Company’s rolling mills. In the case of shortages in the supply of natural gas, the Company could in some instances change to fuel oil or LPG as an energy sources. However, these measures could increase its production costs and consequently reduce its operating margins

 

Restrictive measures on trade in steel products may affect the Company’s business by increasing the price of its products or reducing its ability to export.

 

The Company is a steel producer that supplies both the domestic market in Brazil and a number of international markets. The Company’s exports face competition from other steel producers, as well as restrictions imposed by importing countries in the form of quotas, ad valorem taxes, tariffs or increases in import duties, any of which could increase the costs of products and make them less competitive or prevent the Company from selling in these markets. There are no assurances that importing countries will not impose quotas, ad valorem taxes, tariffs or increase import duties.

 

Less expensive imports from other countries to North and Latin America may adversely affect the Company’s business.

 

Steel imports to North and Latin America have caused downward pressure on steel prices in recent years, adversely affecting sales and profit margins. Competition from foreign steel producers is strong and may grow due to an increase in foreign installed steel capacity, depreciation in the U.S. dollar and a reduction in domestic steel demand in other markets, with these factors leading to higher levels of steel imports to North America and Latin America at lower prices. In the past, the U.S. government has taken temporary protective measures to regulate steel imports by means of quotas and tariffs. Protective measures may not be taken and, despite trade regulation efforts, unfairly priced imports could enter North and Latin American markets in the future, resulting in price pressure that could adversely affect the Company’s business.

 

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Costs related to complying with environmental regulations may increase if requirements become more stringent, which may adversely affect the Company’s operating results.

 

The Company’s industrial plants are required to comply with a number of federal, state and municipal environmental laws and regulations with respect to the environment and the operation of mills in every country in which the Company operates. These regulations include environmental licensing procedures, the control of air emissions, waste water discharges and solid and hazardous waste handling and disposal. Failure to comply with these laws and regulations may result in civil and administrative penalties, criminal sanctions or closure orders, and in various circumstances requires the cleanup of the contamination. If existing laws or future legislation become more stringent, expenditure on fixed assets and the costs of compliance may rise, adversely affecting the Company’s financial condition. Furthermore, the Company may be subject to additional expenditures and costs associated with environmental compliance as a result of future acquisitions.

 

Laws and regulations intended to reduce greenhouse gases and other air emissions may be enacted in the future and could have a material adverse effect on the Company’s results of operations, cash flows and financial condition.

 

One of the feasible effects of the growing requirements regarding reduction of CO2 emissions is likely to be an increase in costs, mainly due to demand of renewable energy and implementation of new technologies in the productive chain. On the other hand, there is an expectation of an increase in demand for goods that result in lower emissions and the upward trend in the steel industry is for products that are produced by processes with reduced greenhouse and air emissions. In this scenario, Brazil BO has been granted the Falcão Bauer Ecological Seal for its civil construction products. This certification ensures that the Company follows sustainable environmental practices in the fabrication of its products. Moreover, Gerdau has also invested in increasing the consumption of solid biofuels as a source of energy for pig iron production. At the same time, the Company has increased its efforts to improve CO2 inventory control and management, including the use of differing technologies.

 

The Company anticipates that in some countries where it operates it will, in the future, be affected by federal, provincial, and state level climate change initiatives intended to address greenhouse gases and other air emissions. Canadian provincial governments, for example, are implementing a number of legislative measures, some that have recently taken effect and others planned for the relatively near term. One of the effects of this growing body of legal requirements is likely to be an increase in the cost of energy. Another example is that certain state governments in the United States, including California, and growing coalitions of Western and Northeastern/mid-Atlantic states, are taking active steps to achieve greenhouse gas emission reductions, and the federal government is moving in a similar direction. In particular, various pieces of federal legislation that would limit greenhouse gas emissions have been introduced in the U.S. Congress, some form of which could be enacted in the future. In addition, the U.S. Environmental Protection Agency (EPA) issued its finding that current and projected atmospheric concentrations of certain greenhouse gases thereafter the public health and welfare, which could form the basis for further EPA action. The Canadian federal government is monitoring these U.S. developments closely, and has indicated that it will consider partnering with the U.S. in future greenhouse gas reduction and renewable energy initiatives. While the details of this emerging legislative regime are still in a state of flux, the outcome could have a material adverse effect on the Company’s results of operations, cash flows and financial condition.

 

Layoffs in our labor force have generated severance costs, and such layoffs could reoccur.

 

A substantial number of our employees are represented by labor unions and are covered by collective bargaining or other labor agreements, which are subject to periodic negotiation. Strikes or work stoppages have occurred in the past and could reoccur in connection with negotiations of new labor agreements or during other periods for other reasons, including the risk of layoffs during a downcycle that could generate severance costs. Moreover, we could be adversely affected by labor disruptions involving unrelated parties that may provide us with goods or services. Strikes and other labor disruptions at any of our operations could adversely affect the operation of facilities and the timing of completion and the cost of our capital projects.

 

Unexpected equipment failures may lead to production curtailments or shutdowns.

 

The Company operates several steel plants in different sites. Nevertheless, interruptions in the production capabilities at the Company’s principal sites would increase production costs and reduce sales and earnings for the affected period. In addition to periodic equipment failures, the Company’s facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. The Company’s manufacturing processes are dependent upon critical pieces of steelmaking equipment, such as its electric arc furnaces, continuous casters, gas-fired reheat furnaces, rolling mills and electrical equipment, including high-output transformers, and this equipment may, on occasion, incur downtime as a result of unanticipated failures. The Company has experienced and may in the future experience material plant shutdowns or periods of reduced production as a result of such equipment failures. Unexpected interruptions in production capabilities would adversely affect the Company’s productivity and results of operations. Moreover, any interruption in production capability may require the Company to

 

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make additional capital expenditures to remedy the problem, which would reduce the amount of cash available for operations. The Company’s insurance may not cover the losses. In addition, long-term business disruption could harm the Company’s reputation and result in a loss of customers, which could materially adversely affect the business, results of operations, cash flows and financial condition.

 

The Company may be unable to reduce its financial leverage, which could increase its cost of capital, in turn adversely affecting its financial condition or operating results.

 

In 2007, the international rating agencies Fitch Ratings and Standard & Poor’s classified the Company’s credit risk as “investment grade”, which gave the Company access to financing at lower borrowing rates. Due to its acquisitions in recent years, its total debt/EBITDA ratio reached the maximum normally accepted by the agencies for an “investment grade” rating. In the first half of 2009, Standard & Poor’s put Gerdau on a CreditWatch Negative listing reflecting its views of the Company’s weakening cash flow and credit metrics in the currently challenging market environment. Considering that the market conditions have been improving since the low point of December 2008 and January 2009, Standard & Poor’s believed that the Company would have the ability to strengthen its credit metrics in the second half of 2009 reiterating its “investment grade”. The gradual recovery in the Company’s operational cash generation and the efforts to reduce its levels of indebtedness in 2010, might help the Company to maintain its credit rating. If the Company is unable to improve its operating and financial results, it may loses its “investment grade” rating, which could increase its cost of capital and consequently adversely affect its financial condition and operating results.

 

The Company’s level of indebtedness could adversely affect its ability to raise additional capital to fund operations, limit the ability to react to changes in the economy or the industry and prevent it from meeting its obligations under its debt agreements.

 

The Company’s degree of leverage could have important consequences, including the following:

 

·                  it may limit the ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes;

 

·                  it may limit the ability to declare dividends on the common shares;

 

·                  a portion of the cash flows from operations must be dedicated to the payment of interest on existing indebtedness and is not available for other purposes, including operations, capital expenditures and future business opportunities;

 

·                  certain of the Company’s borrowings, including borrowings under its term loan facility and senior secured credit facility, are at variable rates of interest and are subject to increases in interest rates;

 

·                  it may limit the ability to adjust to changing market conditions and place the Company at a competitive disadvantage compared to its competitors that have less debt;

 

·                  the Company may be vulnerable in a downturn in general economic conditions; and

 

·                  the Company may be required to adjust the level of funds available for capital expenditures.

 

Under the terms of its existing indebtedness, the Company is permitted to incur additional debt in certain circumstances; doing so could increase the risks described above.

 

In the second quarter of 2009 the Company’s management, based on projections which took into account the economic crisis and its impacts on the steel market worldwide, concluded that there was a possibility that the Company would temporarily be in default of certain covenants in some of its debt agreements by the end of the third or fourth quarters of 2009.

 

Therefore, as a proactive measure, the Company began working on a proposal for the temporary resetting of its financial covenants and, during the second quarter of 2009, submitted a proposal to the creditors involved in financing agreements subject to financial covenants. On June 22, 2009, the Company obtained approval from 100% of the creditors involved, which represented a universe of 43 financial institutions and involved US$3.7 billion of the Company’s debt. See “Item 5. Operating and Financial Review and Prospects — B. Liquidity and Capital Resources”.

 

The covenant reset would come into effect if any of the original financial covenants were breached, which in fact occurred on September 30, 2009. Due to non-compliance with the original financial covenants, the temporary covenant reset became effective starting September 30, 2009 through September 30, 2010. On March 31, 2010 the original financial covenants levels were recovered, even though the temporary covenant reset is still valid until September 30, 2010. The Company expects not to have the original covenants breached after September 30, 2010 and for the year ending December 31, 2010.

 

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Pursuant to the financial agreements, the penalty for non-compliance with such financial covenants is the possibility of declaration of default by the creditors and loans having its maturity accelerated.

 

Furthermore, there were US$ 6.5 billion of the Company’s total indebtedness as of December 31, 2009 (US$ 6.4 billion as of 31 March, 2010) that is subject to cross-default provisions, with threshold amounts varying from US$ 10 million to US$ 100 million, depending on the agreement. It means that there is a risk that an event of default in one single debt agreement can potentially trigger events of default in other debt agreements.

 

ITEM 4.                  COMPANY INFORMATION

 

A.            HISTORY AND DEVELOPMENT OF THE COMPANY

 

Gerdau S.A. is a Brazilian corporation (Sociedade Anônima) that was incorporated on November 20, 1961 under the laws of Brazil. Its main registered office is located at Av. Farrapos, 1811, Porto Alegre, Rio Grande do Sul, Brazil, and the telephone number is +55 (51) 3323 2000.

 

History

 

The current Company is the product of a number of corporate acquisitions, mergers and other transactions dating back to 1901. The Company began operating in 1901 as the Pontas de Paris nail factory controlled by the Gerdau family based in Porto Alegre, who is still the Company’s indirect controlling shareholder. In 1969, Pontas de Paris was renamed Metalúrgica Gerdau S.A., which today is the holding company controlled by the Gerdau family through intermediate holding companies that in turn controls what is today Gerdau S.A.

 

From 1901 to 1969, the Pontas de Paris nail factory grew and expanded its business into a variety of other steel and steel-related products and services. At the end of World War II, the Company acquired Siderúrgica Riograndense S.A., a steel producer also located in Porto Alegre, in an effort to broaden its activities and provide it with greater access to raw materials. In February 1948, the Company initiated its steel operations, which foreshadowed the successful mini-mill model of producing steel in electric arc furnaces using steel scrap as the main raw material. At that time the Company adopted a regional sales strategy to ensure more competitive operating costs. In 1957, the Company installed a second unit in the state of Rio Grande do Sul in the city of Sapucaia do Sul, and in 1962, steady growth in the production of nails led to the construction of a larger and more advanced factory in Passo Fundo, also in Rio Grande do Sul.

 

In 1967, the Company expanded into the Brazilian state of São Paulo, purchasing Fábrica de Arames São Judas Tadeu, a producer of nails and wires, which was later renamed Comercial Gerdau and ultimately became the Company’s Brazilian distribution channel for steel products. In June 1969, the Company expanded into the Northeast of Brazil, producing long steel at Siderúrgica Açonorte in the state of Pernambuco. In December 1971, the Company acquired control of Siderúrgica Guaíra, a long steel producer in the state of Paraná in Brazil’s South Region. The Company also established a new company, Seiva S.A. Florestas e Indústrias, to produce lumber on a sustainable basis for the furniture, pulp and steel industries. In 1979, the Company acquired control of the Cosigua mill in Rio de Janeiro, which currently operates the largest mini-mill in Latin America. Since then, the Company has expanded throughout Brazil with a series of acquisitions and new operations, and today owns 15 steel units in Brazil.

 

In 1980, the Company began to expand internationally with the acquisition of Gerdau Laisa S.A., the only long steel producer in Uruguay, followed in 1989 by the purchase of the Canadian company Gerdau Ameristeel Cambridge, a producer of common long rolled steel products located in Cambridge, Ontario. In 1992, the Company acquired control of Gerdau AZA S.A., a producer of crude steel and long rolled products in Chile. Over time, the Company increased its international presence by acquiring a minority interest in a rolling mill in Argentina, a controlling interest in Diaco S.A. in Colombia, and, most notably, additional interests in North America through the acquisition of Gerdau Ameristeel MRM Special Sections, a producer of special sections such as elevator guide rails and super light beams, and the former Ameristeel Corp., a producer of common long rolled products. In October 2002, through a series of transactions, the Company merged its North American steel production assets with those of the Canadian company Co-Steel, a producer of long steel, to create Gerdau Ameristeel, which is currently the second largest long steel producer in North America based on steel production volume. The Company currently holds 66.4% of the outstanding shares of Gerdau Ameristeel, whose remaining shares are publicly traded in Canada and in the United States. Gerdau Ameristeel itself has a number of operations throughout Canada and the United States, including its 50% joint venture interest in Gallatin Steel, a manufacturer of flat steel, and also operates 18 steel units, 49 fabrication shops and 12 downstream operations.

 

In September 2005, Gerdau acquired 35.98% of the stock issued by Sipar Aceros S.A., a long steel rolling mill with a total installed capacity of 260,000 tonnes of rolled steel, located in the Province of Santa Fé, Argentina. This interest, added to the 38.46% already owned by Gerdau represents 74.44% of the capital stock of Sipar Aceros S.A. At

 

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the end of the third quarter of 2005, Gerdau concluded the acquisition of a 57.1% interest in Diaco S.A., the largest rebar manufacturer in Colombia with a total installed capacity of 580,000 tonnes of crude steel and 640,000 tonnes of rolled steel. In January 2008, the Company purchased an additional interest of 40.2%, for $107.2 million (R$ 188.7 million on the acquisition date).

 

In January 2006, through its subsidiary Gerdau Hungria Holdings Limited Liability Company, Gerdau acquired 40% of the capital stock of Corporación Sidenor S.A. for $219.2 million  (R$ 493.2 million), the largest long specialty steel producer, forged parts manufacturer and foundry in Spain, and one of the major producers of forged parts using the stamping process in that country. In December 2008, Gerdau Hungria Holding Limited Liability Company acquired for $288.0 million (R$ 674.0 million) from LuxFin Participation S.L., its 20% interest in Corporación Sidenor. With this acquisition, Gerdau became the majority shareholder (60%) in Corporación Sidenor. In December 2006, Gerdau announced that its Spanish subsidiary Corporación Sidenor, S.A., had completed the acquisition of all outstanding shares issued by GSB Acero, S.A., a subsidiary of CIE Automotive for $143.0 million (R$ 313.8 million). GSB Acero produces specialty steel and is located in Guipúzcoa, Spain. Corporación Sidenor S.A. has a total installed capacity of 1.2 million tonnes of crude steel and 1.2 million tonnes of rolled steel.

 

In March 2006, the assets of two industrial units were acquired in the United States. The first was Callaway Building Products in Knoxville, Tennessee, a supplier of fabricated rebars to the construction industry. The second was Fargo Iron and Metal Company located in Fargo, North Dakota, a storage and scrap processing facility and service provider to manufacturers and construction companies.

 

In June 2006, Gerdau acquired for $103.0 million (R$ 224.5 million) Sheffield Steel Corporation in Sand Springs, Oklahoma in the USA. Sheffield is a mini-mill producer of common long steel, namely concrete reinforcement bars and merchant bars. It has one melt shop and one rolling mill in Sand Springs, Oklahoma one rolling mill in Joliet, Illinois and three downstream units in Kansas City and Sand Springs.

 

In the same month, Gerdau S.A. won the bid for 50% plus one share of the capital stock of Empresa Siderúrgica Del Perú S.A.A. (Siderperú) located in the city of Chimbote in Peru for $60.6 million (R$ 134.9 million). In November 2006, Gerdau also won the bid for 324,327,847 shares issued by Siderperú, which represented 32.84% of the total capital stock for $40.5 million, totaling $101.1 million (R$ 219.8 million). This acquisition added to the interest already acquired earlier in the year, for an interest of 83.27% of the capital stock of Siderperú. Siderperú operates a blast furnace, a direct reduction unit, with a total installed capacity of 400,000 tonnes of pig iron, a melt shop with two electric arc furnaces and two LD converters with a total installed capacity of 600,000 tonnes of crude steel and three rolling mills with a total installed capacity of 960,000 tonnes of rolled steel.

 

In November 2006, the Company completed the acquisition of a 55% controlling interest in Pacific Coast Steel (“PCS”), for $104.0 million (R$ 227.4 million). The company operates rebar fabrication plants in San Diego, San Bernardino, Fairfield, and Napa, California. Additionally, in April, 2008 Gerdau increased its stake in PCS to 84% paying $82.0 million (R$ 138.4 million). The acquisition of PCS expanded the Company’s operations to the West Coast of the United States and also added rebar placing capability.

 

In March 2007, Gerdau acquired Siderúrgica Tultitlán, a mini mill located in the Mexico City metropolitan area that produces rebar and profiles with installed capacity of 500,000 tonnes of crude steel and 340,000 tonnes of rolled steel. The price paid for the acquisition was $259.0 million (R$ 536.0 million).

 

In May 2007, Gerdau acquired an interest of 30.45% in Multisteel Business Holdings Corp., a holding of Indústrias Nacionales, C. por A. (“INCA”), a company located in Santo Domingo, Dominican Republic. INCA is a producer of rolled products, with annual capacity of approximately 300,000 tonnes of rolled steel. This partnership allowed the Company to access the Caribbean market. The total cost of the acquisition was $42.9 million (R$ 82.0 million). In July 2007, the Company acquired an additional interest of 18.55% in Multisteel Business Holdings Corp., bringing its total interest in the Company to 49%. The total cost of this second acquisition was $72.0 million (R$ 135.2 million).

 

In June 2007, Gerdau acquired 100% of the capital stock of Siderúrgica Zuliana C.A., a Venezuelan company operating a steel mill in the city of Ojeda, Venezuela, with annual production capacity of 300,000 tonnes of crude steel and 200,000 tonnes of rolled steel. The total cost of the acquisition was $92.5 million (R$ 176.2 million).

 

In the same month, Gerdau and the Kalyani Group from India initiated an agreement to establish a joint venture for an investment in Tadipatri, India. The joint venture included an interest of 45% in Kalyani Gerdau Steel Ltd., a producer of steel with two LD converters, one continuous casting unit and facilities for the production of pig iron. The agreement provides for shared control of the joint venture, and the purchase price was $73.0 million (R$ 127.3 million). In May 2008, Gerdau concluded this acquisition and during 2009 it increased its stake to 56.8%.

 

In September 2007, Gerdau Ameristeel concluded the acquisition of Chaparral Steel Company, increasing the

 

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Company’s portfolio of products and including a comprehensive line of structural steel products. Chaparral operates two mills, one located in Midlothian, Texas, with a total installed capacity of 1.5 million tonnes of crude steel and 1.4 million tonnes of rolled steel and the other located in Petersburg, Virginia, with a total installed capacity of 1.0 million tonnes of crude steel and 1.0 million tonnes of rolled steel. The total cost of the acquisition was $4.2 billion (R$ 7.8 billion), plus the assumption of certain liabilities.

 

In October 2007, Gerdau Ameristeel acquired 100% of Enco Materials Inc., a leading company in the market of commercial materials headquartered in Nashville, Tennessee. Enco Materials Inc. has eight units located in Arkansas, Tennessee and Georgia. The purchase price for this acquisition was $46 million (R$ 84.9 million) in cash, plus the assumption of certain liabilities of the acquired company.

 

In the same month, Gerdau executed a letter of intent for the acquisition of an interest of 49% in the capital stock of the holding company Corsa Controladora, S.A. de C.V., headquartered in Mexico City, Mexico. The holding company owns 100% of the capital stock of Aceros Corsa, S.A. de C.V. and its distributors. Aceros Corsa, located in the city of Tlalnepantla in the Mexico City metropolitan area, is a mini-mill responsible for the production of long steel (light commercial profiles) with installed capacity of 160,000 tonnes of crude steel and 250,000 tonnes of rolled products per year. The acquisition price was $110.7 million (R$ 186.3 million). In February, 2008, the Company announced conclusion of this acquisition.

 

In November 2007, Gerdau entered into a binding agreement for the acquisition of the steel company MacSteel from Quanex Corporation. MacSteel is the second largest producer of Special Bar Quality (SBQ) in the United States and operates three mini-mills located in Jackson, Michigan; Monroe, Michigan; and Fort Smith, Arkansas. The Company also operates six downstream operations in the states of Michigan (two), Ohio, Indiana (two) and Wisconsin. MacSteel has annual installed capacity of 1.2 million tonnes of crude steel and 1.1 million tonnes of rolled products. The agreement did not include the Building Products business of Quanex, which is an operation not related to the steel market. The purchase price for this acquisition was $1.5 billion (R$ 2.4 billion) in addition to the assumption of their debts and some liabilities. Gerdau concluded the acquisition in April, 2008.

 

In February 2008, Brazil’s National Electric Power Agency (ANEEL) transferred to Gerdau the concession to operate the São João — Cachoeirinha Hydroelectric Power Plant complex, which comprises two power plants to be built on the Chopim River, located in the cities of Honório Serpa and Clevelândia in Paraná state. The plant complex will have 105 MW of installed capacity.

 

In April 2008, Gerdau entered into a strategic partnership with Corporación Centroamericana del Acero S.A., assuming a 30.0% interest in the capital of this company, which has total installed capacity of 430,000 tonnes of crude steel and 570,000 tonnes of rolled steel. The Company owns assets in Guatemala and Honduras as well as distribution centers in El Salvador, Nicaragua and Belize. The price of the acquisition was $180 million (R$ 303.7 million).

 

In June, 2008, the parenty Company Metalúrgica Gerdau S.A. acquired a 28.88% stake of voting and total capital in Aços Villares S.A. from BNDESPAR for R$ 1.3 billion. As a payment, the Company issued debentures to be exchanged for Gerdau S.A.’s preferred shares. In December, 2009 the Company’s stake in Aços Villares S.A. owned through its subsidiary Corporación Sidenor S.A. was transferred to direct control of Gerdau S.A., which now owns a total 58.5% stake in Aços Villares S.A.

 

Also in 2008, Gerdau invested in the verticalization of its businesses. In July, it acquired a 50.9% stake in the capital of Cleary Holdings Corp, which controls a metallurgical coke producer and coking coal reserves in Colombia for $ 73.0 million (R$ 119.3 million).

 

B.            BUSINESS OVERVIEW

 

Steel Industry

 

The world steel industry is composed of hundreds of steel producing installations and is divided into two major categories based on the production method utilized: integrated steel mills and non-integrated steel mills, sometimes referred to as “mini-mills”. Integrated steel mills normally produce steel from iron oxide, which is extracted from iron ore melted in blast furnaces, and refine the iron into steel, mainly through the use of basic oxygen furnaces or, more rarely, electric arc furnaces. Non-integrated steel mills produce steel by melting in electric arc furnaces scrap steel, which occasionally is complemented by other metals such as direct-reduced iron or hot-compressed iron. According to World Steel Association, in 2009, 28.2% of the total crude steel production in the world was through mini-mill process and the remaining 71.8% was through the integrated process.

 

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Crude Steel Production by Process in 2009

 

 

 

Crude Steel
Production

 

Production by Process (%)

 

Country

 

(in million tonnes)

 

Mini-mill

 

Integrated

 

World

 

1,220

 

28.2

%

71.8

%

China

 

568

 

8.5

%

91.5

%

Japan

 

88

 

21.9

%

78.1

%

Russia

 

60

 

28.4

%

71.6

%

U.S.A.

 

58

 

61.7

%

38.3

%

India

 

57

 

60.1

%

39.9

%

S. Korea

 

49

 

43.0

%

57.0

%

Germany

 

33

 

34.7

%

65.3

%

Ukraine

 

30

 

4.2

%

95.8

%

Brazil

 

27

 

23.9

%

76.1

%

 

Source: worldsteel/monthly statistics

 

Over the past 17 years, according to World Steel Association, total annual crude steel production has grown from 728 million tonnes in 1993 to 1,220 million tonnes in 2009, for an average annual increase of 3.4%, with a large part of this growth occurring after 2000.

 

The main factor responsible for the increase in the demand for steel products has been China. Since 1993, China has become the world’s largest steel market and currently consumes as much as the United States and Europe combined.

 

Over the past year, total annual crude steel production decreased by 8.0% from 1,326.5 million tonnes in 2008 to 1,219.7 million tonnes in 2009, triggered mainly by steel production declines in nearly all the major steel producing countries and regions including the EU, North America, South America and the CIS. However, Asia, in particular China and India, and the Middle East showed positive growth in 2009.

 

Crude Steel Production (in million tonnes)

 

 

Source: worldsteel/monthly statistics

 

China is still undergoing a period of strong industrialization, launching numerous infrastructure projects and developing an important manufacturing base, which has contributed to increased Chinese output. China’s crude steel production in 2009 reached 567.8 million tonnes, an increase of 13.5% on 2008. This was a record annual crude steel production figure for a single country. China’s share of world steel production continued to grow in 2009 producing 46% of world total crude steel, an increase of 9 percentage points compared to 2008.

 

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Crude Steel Production by Country in 2009 (million tonnes)

 

 

Source: worldsteel/monthly statistics

 

Asia produced 776.3 million tonnes of crude steel in 2009, an increase of 3.8% compared to 2008. Its share of world steel production increased to 63.6% in 2009 from 56.4% in 2008. Japan produced 87.5 million tonnes in 2009, a decrease of 26.3% on 2008. India’s crude steel production was 56.6 million tonnes in 2009, a 2.8% increase compared with 2008. South Korea showed a decrease of 9.4%, producing 48.6 million tonnes in 2009.

 

The EU-27 where all major steel producing countries including Germany, Italy and France showed substantial decline of 29.7% compared to 2008, producing 139.1 million tonnes of crude steel in 2009.

 

In 2009, crude steel production in North America was 82.3 million tonnes, a decrease of 33.9% compared with 2008. The United States produced 58.1 million tonnes of crude steel, 36.4% lower than 2008.

 

The CIS showed a crude steel production decrease of 14.7% in 2009. Russia produced 59.9 million tonnes of crude steel, a reduction of 12.5%, while Ukraine recorded a decrease of 20.2% with year-end figures of 29.8 million tonnes.

 

The Brazilian Steel Industry

 

Since 1940, steel has been of vital importance to Brazil’s economy. For approximately 50 years, the Brazilian government held a monopoly in the production of flat steel products via the state-owned company Siderurgia Brasileira S.A. (SIDEBRÁS). But the Brazilian government did not hold a monopoly in the non-flat steel industry, traditionally composed mainly of small private companies. The principal integrated producers of flat steel products operated as semi-independent companies under the control of SIDEBRÁS. During the 1970s, the government invested heavily to give Brazil a steel industry capable of fueling the country’s industrialization process. After a decade of practically no investments in this industry, the government selected steel as the first industry to be sold in the privatization process that began in 1991.

 

In 2009, Brazil maintained its position as the world’s 9th largest producer of crude steel, with a production of 26.5 million tonnes, a 2.2% share of the world market and 50.0% of the total steel production in Latin America during that year. This was equivalent to approximately half of U.S. production.

 

Total sales of Brazilian steel products were 25.0 million tonnes in 2009, 31.0 million tones in 2008 and 31.0 million tonnes in 2007, exceeding domestic demand of 18.6 million tonnes in 2009, 24.0 million tonnes in 2008 and 22.1 million tonnes in 2007. In 2009, total steel sales in the domestic market decreased 25% compared to 2008, from 21.8 million tonnes to 16.3 million tonnes.

 

The breakdown of total sales of Brazilian steel products in 2009 was 62.3% or 15.6 million tonnes of flat steel products, formed by domestic sales of 9.2 million tonnes and exports of 6.4 million tonnes. The other 37.7% or 9.4 million tonnes represented sales of long steel products, which were formed by domestic sales of 7.2 million tonnes and exports of 2.2 million tones.

 

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Breakdown of Total Sales of Brazilian Steel Products (million tonnes)

 

 

Source: IABr - Instituto Aço Brasil

 

Domestic demand - Historically, the Brazilian steel industry has been affected by significant variations in domestic steel demand. Although per capita domestic consumption varies in accordance with Gross Domestic Product (GDP), variations in steel consumption tend to be more accentuated than changes in the level of economic growth. In 2009, Brazilian GDP decreased by 0.2%, grew 4.5% in 2008 and grew 6.1% in 2007. Per capita crude steel consumption in Brazil increased from 100 kilos in 2003 to 108 kilos in 2009, which is still considered low compared to the levels in developed countries.

 

Exports and imports — Over the past 20 years, the Brazilian steel industry has been characterized by a structural need for exports. The Brazilian steel market has undergone periods of excess capacity, cyclical demand and intense competition in recent years. Demand for finished steel products, based on apparent domestic consumption, has lagged total supply (total production plus imports).

 

In 2009, Brazilian steel exports totaled 8.6 million tonnes, representing 34.6% of total sales (domestic sales plus exports) or $4.7 billion in export revenue. Brazil has performed an important role in the world export market, principally as an exporter of semi-finished products (slabs, blooms and billets) for industrial use or for re-rolling into finished products. Brazilian exports of semi-finished products totaled 4.7 million tonnes in 2009, 5.7 million tonnes in 2008 and 5.1 million tonnes in 2007, representing 54.0%, 61.7% and 48.9% of Brazil’s total exports of steel products, respectively.

 

Production and Apparent Demand for Steel Products (million tonnes)

 

 

Source: IABR - Instituto Aço Brasil

 

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Production and Apparent Demand for Long Steel (million tonnes)

 

 

Source: IABr - Instituto Aço Brasil

 

Brazil’s steel export market is highly diversified. In 2009, Asia, Latin America and North America were the main markets, accounting for 48.2%, 25.3% and 9.1% of all Brazilian steel exports, respectively. Among Asia countries, South Korea was the main destination, representing 10.9%. The five biggest markets together corresponded to 42.8% of Brazilian steel exports in 2009.

 

Brazil is a small importer of steel products. Its steel imports in 2009 totaled only 2.2 million tonnes (excluding the imports made by the steel mills to avoid double counting), or 12.0% of apparent domestic consumption. In 2009, Brazil recorded a positive balance in steel transactions of US$ 1.9 billion. In 2009, Brazil imported 838,327 tonnes of long steel products or 11.7% of apparent domestic consumption of long steel products.

 

Raw materials - One of Brazil’s major competitive advantages is the low cost of its raw materials. Brazil has an abundance of high quality iron ore. Various integrated producers are located in the state of Minas Gerais, where some of the world’s biggest iron ore mines are located. The cost of iron ore in Brazil is approximately one-third the cost of iron ore in Japan, Eastern Europe, United States and South Korea.

 

In Brazil, most of the scrap metal utilized by the steel mills comes from the state of São Paulo. Its suppliers deliver scrap metal derived from obsolete products directly to the steel mills. The Brazilian steel industry’s dependence on scrap metal is minimal, due to the high percentage of total steel production coming from integrated producers.

 

Brazil is a net producer of pig iron. Most of Brazil’s pig iron is produced in the state of Minas Gerais by several small producers. In Brazil, the price of pig iron is related to the cost of charcoal, an important input and the most volatile component in pig iron’s production cost. When the price of charcoal is high, coking coal can be used as a substitute and, although more expensive, it produces more pig iron. Practically all the coking coal is imported because domestic supplies are considered low quality.

 

North American Steel Industry

 

The global steel industry is highly cyclical and competitive due to the large number of steel producers, the dependence upon cyclical end markets and the high volatility of raw material and energy prices. The North American steel industry is currently facing a variety of challenges, including volatile pricing, high fixed costs, low priced imports, the diminution of the effect of U.S. tariffs and challenges to the industry’s ability to attract new management talent. The future success of North American steel producers is dependent upon numerous factors, including general economic conditions, levels and prices of steel imports and the strength of the U.S. dollar.

 

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Crude Steel Production by North American Countries (million tonnes)

 

 

Source: worldsteel/monthly statistics

 

Beginning in mid-2000 and continuing through 2002, the North American steel industry experienced a severe downward cycle due to excess global production capacity, high import levels at low prices, including prices that were below the combined costs of production and shipping, and weak general economic conditions. These forces resulted in lower domestic steel prices and significant domestic capacity closures. Prices for many steel products reached 10-year lows in late 2001. As a result of these conditions, over 20 U.S. steel companies sought protection under Chapter 11 of the United States Bankruptcy Code since the beginning of 2000.

 

In response to these conditions, in March 2002, Former President Bush imposed a series of tariffs and quotas on certain imported steel products under Section 201 of the Trade Act of 1974. These measures were intended to give the domestic steel industry an opportunity to strengthen its competitive position through restructuring and consolidation. On November 10, 2003, the World Trade Organization (“WTO”) Appellate Body issued a ruling that upheld an initial WTO panel ruling that declared the Section 201 tariffs on steel imports to be in violation of WTO rules concerning safeguard measures. On December 4, 2003, Former President Bush signed a proclamation terminating the steel safeguard tariffs, and announced that the tariffs had achieved their purpose and changed economic circumstances indicated it was time to terminate them. International trade negotiations, such as the ongoing Organization for Economic Cooperation and Development steel subsidy agreement negotiations and the WTO Doha Round negotiations, may affect future international trade rules with respect to trade in steel products.

 

The North American steel industry has recently experienced a significant amount of consolidation. Bankrupt steel companies, once overburdened with underfunded pension, healthcare and other legacy costs, are being relieved of obligations and purchased by other steel producers. This consolidation, including the purchases of the assets of LTV Corporation, Bethlehem Steel Corporation, Trico Steel Co. LLC and National Steel Corporation, has created a lower operating cost structure for the resulting entities and a less fragmented industry. In the bar sector in 2002, the combination of Gerdau North America and Co-Steel in October 2002 and Nucor Corporation’s acquisition of Birmingham Steel Corporation in February 2002 significantly consolidated the market. The Company’s acquisition of the North Star Steel assets from Cargill in November 2004, Sheffield Steel Corporation in 2006 and Chaparral Steel Company in September 2007 have further contributed to this consolidation trend. Since the beginning of 2007, Tata Iron and Steel Co. Ltd. acquired Corus Group PLC, SSAB Svenskt Staal AB acquired Ipsco Inc., Essar Global Ltd. acquired Algoma Steel Inc., United States Steel Corporation acquired Stelco Inc., and ArcelorMittal Inc. acquired Bayou Steel Corporation. The Company believes continued consolidation in the North American steel industry will occur over the next several years, resulting in the creation of larger steel companies, the reduction of operating cost structures and further rationalization among steel producers.

 

The creation of larger and more efficient steel producers resulting from consolidation in the steel industry has strongly contributed to a maintenance of profitability in the long term. As a result, the remaining steel producers have become better positioned to tailor production capacity to market demand and have benefited from scale efficiencies. Such factors have improved steel producers’ ability to reduce costs, negotiate raw material contracts and better respond to the cyclical nature of the steel industry. In addition, the increase in domestic competition from imports observed in early 2000 has diminished, primarily in response to higher steel prices globally, higher transportation costs resulting from fuel price increases and a weaker U.S. dollar.

 

The steel industry demonstrated strong performance through the middle of 2008, resulting from the increased global demand for steel related products and a continuing consolidation trend among steel producers. Additionally, through the same time period, the domestic U.S. market experienced a rebound in non-residential construction mainly driven by industrial and infrastructure projects (including highway, energy-related construction and water treatment plants), warehouse space, schools, hospitals and a strong retail market. Beginning in the fall of 2008, the steel industry began feeling the negative effects of the severe economic downturn brought on by the credit crisis. The economic

 

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downturn continued through 2009 and has resulted in a significant reduction in the production and shipment of steel products in North America, as well as reduced exports of steel products from the United States to other parts of the world.

 

Company Profile

 

According to the Brazilian Steel Institute (IABr - Instituto Aço Brasil), Gerdau is Brazil’s largest producer of long rolled steel. Gerdau holds significant market share in the steel industries of almost all countries where it operates and has been classified by World Steel Association as the world’s 13th largest steel producer based on its consolidated crude steel production in 2008.

 

Gerdau operates steel mills that produce steel by direct iron-ore reduction (DRI) in blast furnaces and in electric arc furnaces (EAF). In Brazil it operates four integrated steel mills, including its largest mill, Ouro Branco unit, an integrated steel mill located in the state of Minas Gerais. The Company currently has a total of 59 steel producing units globally, including joint ventures and associate companies. The joint ventures include a unit located in the United States for the production of flat rolled steel and another unit in India. The associate companies are Aceros Corsa in Mexico; Corporación Centroamericana del Acero in Guatemala; and INCA in the Dominican Republic.

 

In the year ended December 31, 2009, approximately 37.0% of all physical sales were generated from Brazil BO, 35.3% from North America BO, 14.4% from Latin American BO and 13.3% from Specialty Steel BO.

 

As of December 31, 2009, total consolidated installed capacity, excluding the Company’s investments in joint ventures and associates, unconsolidated companies, was approximately 26 million tonnes of crude steel and 22 million tonnes of rolled steel products. In the same period, the Company had total consolidated assets of R$ 44.6 billion, consolidated net sales of R$ 26.5 billion, total consolidated net income (including non-controlling interests) of R$ 1.0 billion and shareholders’ equity (including non-controlling interests) of R$ 22.0 billion.

 

Gerdau offers a wide array of steel products, which are manufactured according to an extensive variety of customer specifications. Its product mix includes crude steel (slabs, blooms and billets) sold to rolling mills, finished products for the construction industry such as rods and structural bars, finished products for industry such as commercial rolled steel bars and machine wire and products for farming and agriculture such as poles, smooth wire and barbed wire. Gerdau also produces specialty steel products utilizing advanced technology and normally with a certain degree of customization for the manufacture of tools and machinery, chains, locks and springs, mainly for the automotive and mechanical industries.

 

A significant and increasing portion of Gerdau’s steel production assets is located outside Brazil, particularly in the United States and Canada, as well as in Latin America and Europe. The Company began its expansion into North America in 1989, when consolidation in the global steel market effectively began. The Company currently operates 19 steel production units in the United States and Canada through its principal entity, Gerdau Ameristeel, and believes that it is one of the market leaders in North America in terms of production of some long steel products, such as rods, commercial rolled steel bars, extruded products and girders.

 

The Company’s operating strategy is based on the acquisition or construction of steel mills located close to its customers and sources of the raw materials required for steel production, such as scrap metal, pig iron and iron ore. For this reason, most of its production has historically been geared toward supplying the local markets in which it has production operations. However, the Company also exports an important portion of its production mainly to Asia and South America.

 

Through its subsidiaries and affiliates, the Company also engages in other activities related to the production and sale of steel products, including reforestation; electric power generation projects; coking coal, iron ore and pig iron production; as well as fab shops and downstream operations.

 

Business Cyclicality and Seasonality

 

The steel industry is highly cyclical worldwide. Consequently, the Company is exposed to substantial swings in the demand for steel products which in turn causes volatility in the prices of most of its products. In addition, since the Brazilian steel industry produces substantially more steel than the domestic economy is able to consume, the sector is dependent on export markets. The demand for steel products and hence the financial condition and operating results of companies in the steel industry, including the Company itself, are generally affected by macroeconomic fluctuations in the world economy and the domestic economies of steel-producing countries, including general trends in the manufacturing, construction and automotive sectors. Since 2003, demand for steel products from developing countries (particularly China) and overall world economic growth have contributed to historically high levels in the prices of the

 

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Company’s steel products. However, these relatively high prices did not persist, especially in view of the expansion in installed capacity worldwide or the recent lower level of demand. In 2008 and more effectively in the beginning of 2009, the United States economy had shown strong signs of lower economic activity, affecting many other countries and consequently international steel prices. Since the second half of 2009 the world economy has been showing gradual recovery, positively impacting steel demand and prices.

 

In the Company’s Brazilian and Latin American operations, shipments in the second and third quarters of the year tend to be stronger than in the first and fourth quarters, given the reduction in construction activity. In the Company’s North American operations, demand is influenced by winter conditions, 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 and decreased construction activity, and in turn leading to lower sales. In the Company’s Specialty Steel Operations, particularly in Spain, the third quarter is traditionally marked by collective vacations that reduce operations in the quarter to only two months.

 

Operations

 

The Company sells its products to a diversified list of customers for use in the construction, manufacturing and agricultural industries. Sales by the Company’s Brazilian operations include both domestic and export sales. Most of the sales by the Company’s business operations in North and Latin America (except Brazil) are aimed at their respective local markets.

 

In 2009, the Company’s Board of Directors approved the proposal of the Gerdau Executive Committee (the chief operating decision maker) related to the new governance of the Company, which established a new business segmentation, as follows:

 

·                  Brazil (Brazil BO) — includes Brazil’s operations, except specialty steel;

 

·                  North America (North America BO) — includes all North American operations, except Mexico and specialty steel;

 

·                  Latin America (Latin America BO) — includes all Latin American operations, except for Brazil;

 

·                  Specialty Steel (Specialty Steel BO) — includes the specialty steel operations in Brazil, Spain and the United States.

 

Açominas and Long Steel Brazil, previously treated as separate segments, are now reported as a single operating segment since most of their operational support areas are integrated. This means in practical effect that Long Steel Brazil sells part of the Açominas products to the domestic and export markets. In the same way, Açominas’s purchasing department is responsible for buying all of Long Steel Brazil’s iron ore needs. Furthermore, numerous other services are shared by them, including Human Resources, Information Technology, Accounting, Domestic and Export Sales, Tax and Financial departments. These are examples of the extent of integration of these operations and why the Company decided to change its governance and aggregate the information the chief operating decision maker uses to manage the business. The chief operating decision maker is no longer monitoring individual information about Açominas and Long Steel Brazil, but rather information concerning a unified operating segment styled Operation Brazil. For comparison, information of December 31, 2008 and 2007 was modified with respect to the information originally reported in order to consider the same criteria established by the new business segmentation established by the Gerdau Executive Committee.

 

The following tables present the Company’s consolidated shipments in tonnage and net sales by Business Operation for the periods indicated:

 

Shipments*

 

Gerdau S.A. Consolidated Shipments
by Business Operations (**)

 

Year ended December 31,

 

(1,000 tonnes)

 

2009

 

2008

 

2007

 

 

 

 

 

 

 

 

 

TOTAL

 

13,987

 

19,118

 

17,159

 

Brazil

 

5,175

 

6,578

 

5,920

 

North America

 

4,935

 

7,641

 

6,941

 

Latin America

 

2,015

 

2,232

 

2,249

 

Specialty Steel

 

1,862

 

2,667

 

2,049

 

 


(*) The information includes intercompany eliminations inside each business operation.

(**) The information does not include data from associate companies and joint ventures.

 

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Net Sales

 

Gerdau S.A. Consolidated Net Sales by
Business Operations (*)

 

Year ended December 31,

 

(R$ million)

 

2009

 

2008

 

2007

 

TOTAL

 

26,540.1

 

41,907.8

 

30,613.5

 

Brazil

 

10,596.3

 

15,474.6

 

10,144.9

 

North America

 

8,293.4

 

15,017.5

 

11,234.7

 

Latin America

 

3,137.1

 

4,473.3

 

3,318.9

 

Specialty Steel

 

4,777.2

 

7,983.9

 

6,083.5

 

Intercompany Eliminations

 

(263.9

)

(1,041.5

)

(168.5

)

 


(*) The information does not include data from associate companies and joint ventures.

 

Brazil BO

 

Brazil BO minimizes delays by delivering its products directly to customers through outsourced companies under Gerdau’s supervision. Sales trends in both the domestic and export markets are forecast monthly based on historical data for the three preceding months. Brazil BO uses a proprietary information system to stay up-to-date on market developments so that it can respond swiftly to fluctuations in demand. Gerdau considers its flexibility in shifting between markets (Brazilian and export markets) and its ability to monitor and optimize inventory levels for most of its products in accordance with changing demand as key factors to its success.

 

In the Brazil BO, sales volume in 2009 contracted by 21.3% from 2008. Domestic sales volume recorded a sharper decline in the same period of 24.6%, influenced by the poor performance in the first half of the year. Domestic demand recovered gradually over the course of the year, as demonstrated by the increase of 51.3% in sales volume in the fourth quarter from the first quarter. The recovery basically reflects the demand from the construction sector, which was driven by the resumption of construction for projects launched before the onset of the crisis and the accelerated construction of new projects launched in 2009. The manufacturing industry also showed signs of recovery in 2009, fueled by recovery in demand for heavy vehicles and agricultural machinery, which benefitted from the government stimulus measures.

 

In 2009, approximately 19.8% of the production sold in Brazil before intercompany eliminations was distributed through Comercial Gerdau, the Company’s largest distribution channel, with 69 stores throughout Brazil, 38 fabricated reinforcing steel facilities (Prontofer) and four flat steel service centers, serving more than 110,000 customers in the year. Another important distribution channel is the network of almost 21,000 points of sales to which Gerdau sells its products, giving it comprehensive national coverage. Sales through its distribution network and to final industrial and construction consumers are made by Company employees and authorized sales representatives working on commission. This Business Operation has annual crude steel installed capacity of 9.3 million tonnes and 5.4 million tonnes of finished steel products.

 

North America BO

 

The Company operates in North America through its majority-owned subsidiary, Gerdau Ameristeel. The North America BO has annual manufacturing capacity of over 10.3 million tonnes of mill finished steel products. It has a vertically integrated network of 18 steel units and one 50.0%-owned joint venture for the operation of a mini-mill, 21 scrap recycling facilities, 12 downstream operations (including three 50.0%-owned joint ventures) and 49 fab shops. Gerdau Ameristeel primarily serves customers in the eastern regions of the United States and Canada. North America BO’s products are generally sold to steel service centers and steel fabricators or directly to original equipment manufacturers for use in a variety of industries, including construction, automotive, mining, cellular and electrical transmission, metal construction fabrication and equipment fabrication. Most of the raw material feed stock for the mini-mill operations is recycled steel scrap.

 

This BO operates mills and downstream. The mills manufactures and markets a wide range of steel products, including steel reinforcement bars (rebar), merchant bars, structural shapes, beams, special sections and coiled wire rod. The mills also produces rebar, merchant bars, rod and special bar quality products used by the downstream and transfers these products at an arm’s length market price to the downstream. The downstream comprises secondary value-added steel businesses and consists of fabrication of rebars, railroad spikes, cold drawn products, super light beam processing, elevator guide rails, grinding balls, wire mesh and collated nails.

 

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The strategy is to have production facilities located in close proximity to customers’ job sites so that quick delivery is provided to meet their reinforcing steel needs and construction schedules.

 

In general, sales of mill finished products to U.S. customers are centrally managed by the Tampa sales office while sales to Canadian customers are managed by the Whitby sales office. The Company has a sales office in Selkirk, Manitoba for managing sales of special sections. Metallurgical service representatives at the mills provide technical support to the sales group. Sales of the cold drawn and super light beam products are managed by sales representatives located at their respective facilities. Fabricated rebar and elevator guide rails are generally sold through a bidding process in which employees at the Company’s facilities work closely with customers to tailor product requirements, shipping schedules and prices.

 

At the North America BO, despite the sharp drop-off in sales in 2009 from 2008, a slow and gradual recovery in demand was observed, as indicated by the 11.7% increase in sales volume in the fourth quarter from the first quarter of 2009. Despite the government incentives announced, the associated impacts were not reflected in steel demand in 2009.

 

The North America BO accounted for 35.3% of overall Gerdau shipments, reaching 4.9 million tonnes. The Company’s Canadian operations sell a significant portion of their production in the United States.

 

Latin America BO

 

The Latin America BO comprises 16 steel units (including joint ventures and associate companies), 30 retail facilities, 16 fab shops (including joint ventures and associate companies) and 10 scrap processing facilities (including associate companies) located in 9 countries. The entire operation is focused on the respective domestic markets of each country, operating mini-mills facilities with annual manufacturing capacity of 2.9 million tonnes of finished steel products. The Latin American operation accounted for 14.4% of overall Gerdau shipments, representing 2.0 million tonnes of finished products in 2009, a 9.7% decrease compared with 2008. The Latin America BO was the business operation least affected by the crisis in terms of sales volume. At the Mexico and Peru operations, sales volume remained virtually stable in 2009 in relation to 2008, while the Colombia and Chile operations registered lower sales in the same comparison period. The main representative countries in the Latin America BO are Chile, Mexico, Colombia and Peru. Gerdau also operates in the markets of Uruguay, Argentina, Dominican Republic, Venezuela and Guatemala.

 

Chile - AZA was acquired in 1992, and has installed capacity of 490,000 tonnes of crude steel and 470,000 tonnes of rolled steel. Since the end of 2000, Gerdau AZA 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 records as well as generate quality certificates and place orders. Gerdau AZA sells its products to more than 150 clients, which are both distributors and end-users.

 

Colombia - Diaco was acquired in September 2005, which the Company believes to have a market share of 29.0% of the Colombian steel market. This company sells its products to more than 646 clients, reaching more than 2,700 end-users, in civil construction, industry and others. Colombian units have annual installed capacity of 580,000 tonnes of crude steel and 640,000 tonnes of rolled products.

 

Peru - Siderperú was acquired in June of 2006 and is one of the main steel companies in Peru, with more than 50 years of experience in this business. The company sells its products to approximately 210 clients in the construction, manufacturing and mining sectors and has more than 180 distributors. Siderperú has annual installed capacity of 600,000 tonnes of crude steel and 960,000 tonnes of rolled products.

 

Mexico - Located in the Mexico City metropolitan area, Sidertul produces rebars and structural shapes, with its products primarily used in the domestic market. The Company sells its products to clients and distributors from the construction and manufacturing sectors. Sidertul sells products to around 200 clients and has annual installed capacity of 500,000 tonnes of crude steel and 340,000 tonnes of rolled products.

 

Specialty Steel BO

 

The Specialty Steel BO is composed of the operations in Brazil (Piratini and Aços Villares), in the United States (MacSteel) and Spain (Corporación Sidenor). This operation, in partnership with its customers, produces engineering steel (SBQ), tool steel,  stainless steel, rolling mill rolls, large forged and casted engineering pieces. In order to meet the continuous need for innovation, this operation is constantly developing new products, such as micro-alloyed steel for high-power and low-emissions diesel engines, clean steel for application in bearings, and steel with improved machining characteristics that allows higher machining speeds and lower tooling replacement, among others.

 

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The Specialty Steel BO recorded a decline of 30.2% in sales volume in 2009 from the prior year, with various different impacts felt in each country. Spain was the country most affected, followed by Brazil. In the United States, specialty steel sales remained stable, but since the operations were acquired in May 2008, the comparison base is different.

 

In Brazil, Gerdau specialty steel operations are located in Rio Grande do Sul (Piratini) and in São Paulo (Aços Villares). Both operations have a combined annual capacity of 1.4 million tonnes of crude steel and 1.4 million tonnes of rolled steel, which is sold in the domestic and export markets. The two companies combined have more than 400 customers located mainly in Brazil.

 

Gerdau maintains a presence in Europe through Corporación Sidenor, which sells specialty steel to the entire continent. Sidenor has more than 450 clients located mainly in Spain, France, Germany and Italy. Sidenor has an annual installed capacity of 1.2 million tonnes of crude steel and rolled products.

 

Gerdau maintains a presence in North America through MacSteel, the largest SBQ (Special Bar Quality) in the United States. MacSteel operates three mini-mills, located in Jackson, Michigan; Monroe, Michigan; and Fort Smith, Arkansas. The Company also operates six downstream operations located in the states of Michigan (two), Ohio, Indiana (two) and Wisconsin. MacSteel has an annual installed capacity of 1.2 million tonnes of crude steel and 1.1 million tonnes of rolled products. MacSteel has more than 240 customers located mainly in the United States, Canada and Mexico.

 

There are commercial and operational synergies among the steel units in this business operation through a centralized marketing and production strategies.

 

Exports

 

In the middle of 2009 an international trade area was created to be responsible for trading all Gerdau’s business operations exports (commercial quality products) and imports (finished products from third parties). This area is responsible for selling products directly to final overseas users and indirectly through trading companies. Sales are negotiated worldwide (i) primarily through CIF (Cost, Insurance and Freight) and (ii) guaranteed at sight through letters of credit issued by customers through prime European and U.S. banks. Great part of the exports is negotiated intercompany and some units are both importers and exporters, which allow us to have a great synergy in terms of logistic, production and product line. Brazil BO has always been the most relevant operation in terms of exports.

 

Brazil BO had been exporting a large part of its production since 2003, but due to the stronger domestic market since 2007, a portion of sales has been reallocated from exports to the domestic market. In 2009, exports accounted for 29.5% of the Brazil BO sales. Brazil BO exports generated R$1,705.9 million in revenue in 2009 totaling 1.5 million tones (excluding shipments to subsidiaries), a decrease of 12.3% from 2008, due to the international crisis which negatively affected the international steel trading. The export strategy has allowed Gerdau to develop a client base that is more evenly distributed throughout the world, with exports going mainly to Asia, South America and Africa.

 

The following table presents the Company’s consolidated exports from its Brazil BO by destination for the periods indicated:

 

Gerdau S.A. Consolidated
Exports from Brazil by Destination

 

Year ended December 31,

 

(percent)

 

2009

 

2008

 

2007

 

Total including shipments to subsidiaries (1,000 tonnes)

 

1,858

 

2,315

 

2,449

 

Africa

 

19

%

5

%

13

%

Central America

 

2

%

4

%

16

%

North America

 

7

%

7

%

11

%

South America

 

19

%

23

%

23

%

Asia

 

40

%

54

%

27

%

Europe

 

13

%

6

%

10

%

Oceania

 

0

%

1

%

0

%

 

The North America BO exported around 340,000 tonnes, accounting for 6.9% of the total BO sales. Latin America BO exported about 80,000 tonnes, accounting for 4.0% of the total BO sales.

 

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Production Process

 

In Brazil, the Company has a decentralized production process, using both mini-mills and integrated facilities. In general, the Company has used the mini-mill model to produce steel products outside of Brazil.

 

Non-Integrated Process (Mini-Mills)

 

The Company operates 47 mini-mills worldwide (excluding joint ventures and associate companies). Mini-mills are equipped primarily with electric arc furnaces that can melt steel scrap and produce the steel product at the required specifications. After loading the furnace with a preset mixture of raw material (i.e., steel scrap, pig iron and sponge iron), electric power is applied in accordance with a computer controlled melting profile. The Company’s mini-mill production process generally consists of the following steps: obtaining raw material, melting, casting, rolling and drawing. The basic difference between this process and the integrated mill production process described below is in the first processing phase, i.e., the steelmaking process. Mini-mills are smaller plants than integrated facilities and the Company believes they provide certain advantages over integrated mills, including:

 

·      lower capital costs,

 

·      lower operational risks due to the low concentration of capital and installed capacity in a single production plant,

 

·      proximity of production facilities to raw-material sources,

 

·      proximity to local markets and easier adjustment of production levels, and

 

·      more effective managerial structure due to the relative simplicity of the production process.

 

Integrated Process

 

The Company operates 5 integrated mills, of which 4 are located in Brazil and 1 in Peru. The Ouro Branco unit is the largest integrated facility the Company operates. Although it produces steel using a blast furnace, this mill has some of the advantages of a mini-mill since it is located very close to its main suppliers and the ports from which the Company exports most of its production.

 

The Company’s steelmaking process in integrated facilities consists of four basic processes: raw material preparation, pig-iron production, steel production and production of crude steel (billets, blooms and slabs). In the primary stage of iron making, sinter (a mixture of iron ore and limestone), coke and other raw materials are consumed in the blast furnace to produce pig iron. Coke acts as both a fuel and a reducing agent in this process. The Company’s blast furnaces have installed capacity of 5.9 million tonnes of liquid pig iron per year.

 

The pig iron produced by the blast furnace is transported by rail to the desulphurization unit to reduce the sulfur content in the steel. After the desulphurization process, the low-sulfur pig-iron is transformed into steel through LD-type oxygen converters. The LD steelmaking process utilizes molten pig iron to produce steel by blowing oxygen over the metallic charge inside the converters. The process does not require any external source of energy, which is fully supplied by the chemical reactions that occur between the oxygen and the molten pig iron impurities. The LD steelmaking process is presently the most widely used in the world.

 

Some mills further refine the LD converters’ output with ladle furnaces. Liquid steel is then poured into ingot molds and allowed to solidify into ingots. The molds are stripped away and the ingots are transported by rail to the soaking pits, where they are heated to a uniform rolling temperature. The heated ingots are rolled in the primary rolling mill to produce slabs and blooms, some of which are rolled in the secondary rolling mills to produce blooms and billets. At this point in the process, the Company either sells a portion of the product to other manufacturers where the rolling process must take place in order to produce steel ready for final use, or the Company performs the rolling process itself, transforming the product into heavy structural shapes or wire rods.

 

Production Inputs

 

Gerdau’s production processes are based mainly on the mini-mill concept, with mills equipped with electric arc furnaces that can melt ferrous scrap and produce steel products at the required specifications. The main raw material used at these mills is ferrous scrap, which at some plants is blended with pig iron. The component proportions of this mixture may change in accordance with prices and availability in order to optimize raw material costs. Iron, iron ore (used in blast furnaces and in one Direct Reduction Iron - DRI plant) and ferroalloys are also important.

 

Although international ferrous scrap prices are determined by the U.S. domestic market (since the United States is the largest scrap exporter), the price of ferrous scrap in Brazil varies from region to region and is influenced by demand and transportation costs. Gerdau is the largest consumer of ferrous scrap in Brazil.

 

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Brazil BO and Specialty Steel BO - The Company’s Brazilian mills use scrap and pig iron purchased from local suppliers. Due to the nature of the raw materials used in its processes, Gerdau has medium and long-term supply contracts with scrap generators and short-term contracts with some suppliers for its mini-mills in Brazil, acquiring scrap as necessary for the mills’ needs. Scrap for the Brazilian Operation is priced in Brazilian reais, thus input prices are not directly affected by currency fluctuations.

 

In the Ouro Branco mill the main raw materials include: (i) coal imported from Canada, Australia and the United States, anthracite from Vietnam and the Ukraine and coke petroleum purchased from Petrobras; (ii) ferroalloys, of which 90.0% is purchased in the domestic market; and (iii) iron ore, which is partially produced from its own mines and partially supplied by large, medium, and small sized mining companies, most of them strategically located close to the plant. These three items accounted for about 40.0% of the total production costs of Ouro Branco mill in 2009. Due to its size, the Ouro Branco mill utilizes long-term contracts to guarantee raw material supplies.

 

North America BO - The main metallic input used by the Company’s mills in the United States is ferrous scrap. When ferrous scrap prices exceed acceptable levels, as occurred in 2004, the mills seek to modify input sources accordingly. Gerdau Ameristeel has consistently obtained adequate supplies of raw materials and is not dependent on a smaller number of suppliers.

 

Latin America BO - The main metallic input used by the Company’s mills in Latin America is ferrous scrap. The Latin American Operation is exposed to market fluctuations, varying its prices according to each local market.

 

Ferrous Scrap

 

There are two broad categories of ferrous scrap: (i) obsolete scrap which is steel from various sources, ranging from tin cans to car bodies and white goods; and (ii) industrial scrap, which is essentially factory steel bushelings and flashings, steel turnings and even scrap generated by the Company’s production processes themselves. In Brazil the use of scrap in electric arc furnaces varies between obsolete scrap and industrial scrap. The Specialty Steel plants use mainly industrial scrap.

 

In 2009 Gerdau utilized more than 10 million tonnes of scrap, accounting for significant gains through increasingly competitive operating costs.

 

Brazil BO - The price of scrap in Brazil varies by region, depending upon local supply and demand, and transportation costs. The Southeast region is the most industrialized in the country, generating the highest volume of scrap. Due to the high concentration of players in this region, the competition is more intense. The Company also has five shredders, including a mega-shredder at Gerdau Cosigua in Rio de Janeiro capable of processing shredded scrap in volumes that exceed 200 car bodies per hour.

 

Specialty Steel BO - The price of scrap in Brazil varies by region, depending upon local supply and demand and transportation costs. Prices for ferrous scrap at MacSteel are subject to market forces largely beyond the Company’s control, which include demand from U.S. and international steel producers, freight costs and speculation. At Corporación Sidenor, prompt (industrial) scrap is the main type of raw material used in the Spanish operation.

 

North America BO - Ferrous scrap is the primary raw material to this BO. It is a commodity whose availability varies in accordance with the level of economic activity, seasonality, export levels, and price fluctuations. Gerdau Ameristeel’s Jackson, Jacksonville, St. Paul, Wilton, Whitby, Midlothian and Petersburg mills all have on-site dedicated scrap processing facilities, including shredder operations that supply a significant portion of their scrap requirements. Gerdau Ameristeel MRM Special Sections receives a significant amount of its scrap from Manitoba Metals Recycling and the North Dakota scrap collection and processing yards. Given the fact that not all of the scrap it consumes is sourced from its own scrap yards, it buys residual requirements in the market either directly or through dealers that source and prepare scrap.

 

All of production facilities in North America are mini-mills, in which operating results are closely linked to the cost of ferrous scrap and scrap substitutes, the primary input of mini-mills. Ferrous scrap prices are relatively higher during winter months due to the impact of weather on collecting and supplying efforts. Approximately half of all steel products in North America are currently made in electric arc furnaces using ferrous scrap. Prices for ferrous scrap are subject to market forces largely beyond the Company’s control, which include demand from U.S. and international steel producers, freight costs and speculation.

 

Latin America BO - The price of scrap in the Latin America varies in accordance with demand, transportation costs and region. The Latin America BO has the most volatile scrap prices in comparison to the other Gerdau’s operations because it consolidates prices from seven countries.

 

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Pig Iron and Sponge Iron

 

Brazil BO - Brazil is an 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 it is an important component of the metal mix used to make steel in the mills. In Brazil, the price of pig iron is related to internal and external demand and to the cost of charcoal, the most volatile cost item in pig iron production.

 

The Company produces sponge iron at its industrial plant in the state of Bahia (Gerdau Usiba), whose entire production is used internally to manufacture steel products.

 

The Company does not have any Brazilian contracts for the supply of pig iron, negotiating amounts and delivery conditions directly with suppliers. 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.

 

North America BO - Scrap availability is a major factor in Gerdau Ameristeel’s operations. Sponge iron and pig iron can substitute a limited portion of the ferrous scrap used in electric arc furnace steel production. Gerdau Ameristeel does not utilize significant quantities of scrap substitutes in its mini-mills except for pig iron used for its chemical properties at the Beaumont facility, and to produce some special sections.

 

Iron Ore and Fluxes

 

Iron ore and fluxes are used in the blast furnace process at Gerdau’s plants at Ouro Branco, Barão de Cocais, Contagem, Divinópolis, and Sete Lagoas. Iron ore is purchased on its natural form as fine grains (pellet feed and sinter feed), as lump ore or agglomerated as pellets. Fine grain iron ore (sinter feed and pellet feed), are transformed into sinter. Lump ore and iron ore pellets are directly loaded into the blast furnace to increase productivity. Fluxes such as limestone, dolomite quartz and serpentinite are purchased in their natural form. Combined, iron ore and fluxes are the main inputs into the blast furnace process to produce pig iron. Pig iron is the main raw material used in the melt shop. In 2009, metal inputs consisted of 83.1% of molten pig iron, 14.2% of steel scrap and 2.7% of solid pig iron.

 

Part of the raw material is supplied from local companies adjacent to the plant to reduce transportation and storage costs, and part from its own mines that are also located close to the mill. The Company has acquired iron ore from MMX, Vale and other smaller suppliers located in the state of Minas Gerais near the steel plants.

 

Other Inputs

 

In addition to scrap, pig iron, sponge iron and iron ore, Gerdau’s operations use other inputs to produce steel 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, which is used in blast furnace mills, and natural gas, which is used at the DRI unit.

 

Ouro Branco unit’s important raw materials and inputs also include coking coal. Coal is used in the production of coke, the main reduction agent for sinter, iron ore and pellets in the blast furnace. Pulverized Coal Injection (PCI) is also used to reduce coke consumption, increase productivity and consequently the cost of pig iron. At the steel works, ferroalloys are used to make steels with special characteristics. Oxygen, nitrogen and argon are also used in some processes and supplied by an on-site company. The gas resulting from the production of coke, pig iron and steel, once cleaned, is used as fuel for several processes and for generating electricity to power the plant.

 

Gerdau has a metallurgical coke producer and coking coal reserves in Colombia. This producer has annual coke production capacity of 1.0 million tonnes.

 

The North American operations also use additional inputs. Various domestic and foreign companies supply other important raw materials or operating supplies required for the business, including refractory materials, ferroalloys and carbon electrodes that are readily available in the open market. Gerdau Ameristeel has obtained adequate quantities of these raw materials and supplies at competitive market prices. 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 Requirements

 

Steel production is a process that consumes large amounts of electricity, especially in electric arc mills. Electricity represents an important cost in the production process, along with natural gas, which is used in furnaces to re-heat billets in rolled steel production.

 

Dona Francisca Energética S.A. (DFESA) operates a hydroelectric power plant with nominal capacity of 125 MW located in Agudo, Rio Grande do Sul state (Brazil). Its corporate purpose is to operate, maintain and maximize use of the energy potential of the Dona Francisca Hydroelectric Plant. DFESA participates in a consortium (Consórcio Dona

 

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Francisca), in which it holds 95% stake, with the state power utility Companhia Estadual de Energia Elétrica (CEEE) which holds the remaining 5% stake. The shareholders of DFESA are Gerdau S.A. (51.8%), COPEL Participações S.A (23.0%), Celesc (23.0%), and Desenvix (2.2%).

 

Construction of the Caçu and Barra dos Coqueiros hydroelectric power plants in the state of Goiás, with total installed capacity of 155MW, is also currently underway. These power plants are expected to start up operations in 2010, with all power made available to the units located in Brazil’s Southeast.

 

Gerdau also holds the concession to operate the São João — Cachoeirinha Hydroelectric Plant Complex located in Paraná state. The complex will have total installed capacity of 105 MW. The start of construction is currently awaiting the granting of the environmental licenses.

 

The Company is currently analyzing power generation alternatives in all countries where it operates in order to assure supply at competitive costs.

 

In Brazil, the Company’s units hold long-term contracts with electricity suppliers and do not depend on a single contract. Energy is currently supplied to the Company’s industrial units under two types of contracts:

 

Contracts in the Regulated Contractual Environment in which the Company is a “Captive Consumer” are used at the following units: Riograndense, Aços Especiais Piratini, Guaíra, Usiba, Açonorte and Sorocaba. These involve state-owned companies or holders of government concessions. In these contracts, prices are defined by the National Electric Power Agency (ANEEL).

 

Contracts in the Free Market Environment in which Gerdau is a “Free Consumer” are used at the following units: Araçariguama, Cosigua, Cearense, Ouro Branco, Divinópolis, Barão de Cocais, Pindamonhangaba and Mogi das Cruzes. These units have power purchase agreements contracted directly with power generation companies and/or energy traders, with prices defined and adjusted according to rules predetermined by the parties. The transmission and distribution rates are regulated by ANEEL and revised annually. Ouro Branco generates approximately 70.0% of its energy needs internally, using gases generated by the steelmaking process. This keeps its exposure to the energy market significantly lower than in the case of mini-mills.

 

In Spain the company is currently negotiating a new power contract starting July 2010 through December 2011. Its natural gas contract also lasts until December 2011.

 

The supply of natural gas to all Brazilian units is regulated and performed under long-term contracts. The Barão de Cocais and Divinópolis units do not have access to natural gas supplies relying on blast furnace gases generated by its production process and other liquid fuels.

 

In Spain the company negotiated a new power contract starting July 2010 through December 2011. Its natural gas contract also lasts until December 2011.

 

In North America, there are two kinds of energy markets: regulated and deregulated. In the regulated market, agreements are established with local electric power concession holds and the rates are determined for each region. In the deregulated market, the price of power can change every 5 minutes (spot price) to reflect the actual cost of electricity generation. Although the deregulation of both the natural gas and wholesale electricity markets may create opportunities to reduce costs as a result of market competition, the prices of both these forms of energy have recently become more volatile and may remain so. The company has a small percentage of its natural gas supply at fixed prices through 2010.

 

In Chile, Colombia and Uruguay, both electricity and natural gas are purchased under long-term agreements. In Colombia, the electricity and natural gas agreements were renewed in 2009. In Chile, Gerdau AZA renegotiated its electric power agreement in 2008. Gerdau AZA negotiated a new natural gas supply agreement from the second half of 2009 based on imports of liquefied natural gas (LNG) that started last year with lower prices than alternative fuels. Currently the contract was extended to the end of 2011.

 

Argentina and Uruguay can rely on fuel substitutes in the event of natural gas supply curtailments (LPG and Fuel Oil, respectively). In 2008, Gerdau Sipar signed a contract with Petrobrás to supply its power requirements of the new plant as of May 2010. In view of the postponement of this project, this contract is being reviewed. The Natural gas supply contract expires in May 2010 and is already renegotiated.

 

In Peru electricity is purchased under a long-term agreement. The plant has no access to natural gas supply due to its location, and a project to transport natural gas from the south is currently under study.

 

A new power purchase agreement in the Dominican Republican was closed in 2009 with a 5-year term.

 

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In Mexico, the regional power utility (Luz y Fuerza del Cientro) was liquidated by the government and its operations were replaced by the state company CFE (Companía Federal de Electricidad), with no impact to the supply. New power contracts are under negotiation due to this fact.

 

Products

 

The Company supplies its customers with a wide range of products from five major product lines:

 

Crude Steel (Billets, Blooms and Slabs)

 

Crude steel products (billets, blooms and slabs) have relatively low added value compared to other steel products. Billets are bars from square sections of long steel that serve as inputs for the production of wire rod, rebars and merchant bars. They are the main product of the Company’s Ouro Branco unit. Blooms are used to manufacture products such as springs, forged parts, heavy structural shapes and seamless tubes. Slabs are used in the steel industry for the rolling of a broad range of flat rolled products. Slabs are mainly used to produce hot and cold rolled coils, heavy slabs and profiles.

 

Crude steel products may be produced using either the continuous casting or conventional process. In the conventional process, liquid steel is poured into ingot moulds for rolling. The hot ingots are sent to the primary rolling mill to be heated in soaking pits and then are rolled to produce crude steel products (billets, blooms and slabs). Although this conventional process is not widely used in Brazil, it is still employed at the Company’s Ouro Branco unit. The use of a conventional casting system may represent a competitive advantage since the Company believes it is one of the only companies manufacturing billets and blooms in Brazil, leading the Company to have captive customers for these products in Brazil and also outside the country.

 

Common Long Rolled Products

 

Common long rolled products represent a major portion of the Company’s production. The Company’s main long rolled products include rebars, merchant bars and profiles, which are used mainly by the construction and manufacturing industries.

 

Drawn Products

 

Drawn products include barbed and barbless fence wire, galvanized wire, fences, concrete reinforcing wire mesh, nails and clamps. These products are not exported and are usually sold to the manufacturing, construction and agricultural industries.

 

Specialty Steel Products

 

Specialty or high-alloy steel requires advanced manufacturing processes and normally includes some degree of customization. The Company produces specialty and stainless steel used in tools and machinery, chains, fasteners, railroad spikes and special coil steel at its Aços Villares and Piratini units in Brazil, at Corporación Sidenor units in Spain and at the MacSteel units in the United States.

 

In the United States, Gerdau Ameristeel produces special sections such as grader blades, smelter bars, light rails, super light I-beams, elevator guide rails and other products that are made on demand for the Company’s clients, which are mainly manufacturers.

 

It also supplies steel to its customers through its joint venture company Kalyani Gerdau Steel Inc. located in India. It is a joint venture with the Kalyani Group in India in which Gerdau has a 45% stake in the joint venture.

 

Flat Products

 

The Company’s Ouro Branco unit produces slabs, which are rolled into flat products such as hot and cold steel coils, heavy plates and profiles. In addition, the Company’s distribution subsidiary, Comercial Gerdau, resells flat steel products manufactured by other Brazilian steel producers, adding further value through additional processing at its four flat steel service centers.

 

Gerdau Ameristeel also supplies flat steel to its customers through its joint venture Gallatin located in Kentucky. Gallatin is a joint venture with ArcelorMittal, Canada, a leading flat steel producer, and has nominal installed capacity of 1.4 million tonnes of flat steel per year. Both partners in the joint venture have a 50.0% stake.

 

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Technology and Quality Management

 

All Gerdau mills have excellent quality management supported by a wide array of quality control tools. Product development projects are headed by specialists who use quality tools such as “Six Sigma”, a set of statistical procedures for improving the assessment of process variables, as well as “Quality Function Deployment”, a methodology through which technicians can identify the full range of customer requirements.

 

Given this level of quality management, 45 mills are ISO 9001 or ISO TS 16949 certified. In general, production , technical services and quality teams are responsible for developing new products to meet customer and market needs.

 

The Company uses a quality management system developed in house that applies tests for product design, manufacturing processes and final-product specifications. A specially trained team and modern technologies also exist to assure the Company’s high standards of quality. The Company’s technical specialists make planned visits, some may be randomly selected and some are scheduled visits, to its customers to check on the quality of the products delivered by the Company in order to guarantee the final user satisfaction for products purchased indirectly.

 

Due to the specialized nature of its business, the Company’s specialty steel mills are constantly investing in technological upgrading and in research and development. These mills are active in the automotive segment and maintain a technology department responsible for new products and the optimization of existing processes.

 

International machinery manufacturers and steel technology companies supply most of the sophisticated production equipment the Company uses. These suppliers generally sign technology transfer agreements with the purchaser and provide extensive technical support and staff training for the installation and commissioning of the equipment. The Company has technology transfer agreements with Nippon Steel, Sumitomo Steel, Thyssen, Daido Steel and BSW.

 

As is common with mini-mill steelmakers, the Company usually acquires technology in the market rather than developing new technology through intensive research and development, since steelmaking technology is readily available for purchase.

 

The Company is not dependent on patents or licenses or new manufacturing processes that are material to its business. See item “Information on the Extent of the Company’s Dependencefor further details.

 

Sales Terms and Credit Policy

 

The Company’s Brazilian sales are usually made on a 20/25-day settlement CIF (Cost, Insurance and Freight) basis. Comercial Gerdau, the retail arm of Gerdau in Brazil, sells on a 26-day settlement basis, mainly CIF. Brazilian customers are subject to a credit approval process. The concession of credit limits is controlled by a corporate-level system (SAP R/3) that can be accessed by all sales channels. The credit and collection department is responsible for evaluating, determining and monitoring credit in accordance with the credit limit policy. This policy provides for the active participation of staff from the various sales channels. At Comercial Gerdau, in particular, the criteria for retail sales also include practices such as the use of credit card services. Ouro Branco unit exports are guaranteed via letters of credit and/or pre-payment before the product is shipped. Exports to Gerdau’s subsidiaries may be sold on credit at market interest rates.

 

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 second and third quarters tending to be stronger than those in the first and fourth quarters, primarily due to weather-related slowdowns in the construction industry.

 

Corporación Sidenor S.A. has a Risk Committee that is responsible for analyzing customer credit.

 

North American specialty steel operations, Brazilian specialty steel operations and Latin American operations have their own credit departments for costumer’s credit analyses.

 

As a result of the implementation of these policies, the Company’s provision for doubtful accounts was only 3.1% on December 31, 2009, based on gross account receivables as per Note 6 and 2.0% on December 31, 2008. In the first quarter of 2010 this risk indicators reduced to 1.5%. Gerdau has improved its credit approval controls and enhanced the reliability of its sales process through the use of risk indicators and internal controls.

 

Logistics

 

Transportation costs are an important component of most steel mill businesses and represent a significant factor in maintaining competitive prices in the export market. The majority of the Company’s mills are strategically located in various different geographic regions. The Company believes that the proximity of its mills to raw material sources and

 

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important consumer markets gives it a competitive advantage in serving its customers and obtaining raw materials at competitive costs. This represents an important competitive advantage in inbound and outbound logistics.

 

To reduce logistic costs, Gerdau also uses different types of transportation modes (highway, rail and waterway) to receive raw materials and deliver products to its customers or ports of destination. Accordingly, the Company has developed long-term relationships with logistic companies specialized in delivering raw materials and steel products.

 

In Brazil, Gerdau has acquired in 1996 an interest in MRS Logística, Brazil’s principal rail company, which operates the railroad connecting the states of São Paulo, Rio de Janeiro and Minas Gerais, which are Brazil’s main economic centers. This interest provides for secure and efficient use of this mode to transport raw materials (scrap and pig iron) as well as final products. In North America, the Company owns a large number of rail cars for the same purpose.

 

Gerdau uses around 20 ports to deliver products from the entire Brazilian coastline. The majority of exports are shipped from the Praia Mole private terminal in Vitoria, Espírito Santo. Furthermore, this is Brazil’s most efficient and productive seaport for handling steel products, with more than 20 years of expertise in this business. Gerdau also owns ports specialized in iron ore deliveries that supply its steel units in the state of Bahia and in Peru.

 

Competition

 

The steel market is divided into manufacturers of long steel products, flat steel products and specialty steel.

 

The Company operates in the long steel market, which is the most important market for Gerdau, by supplying to the following customer segments: (i) construction, to which it supplies rebars, merchant bars, nails and meshes; (ii) manufacturing, to which it supplies products for machinery, agricultural equipment, tools and other industrial products; and (iii) other markets, to which it supplies wires and posts for agricultural installations and reforestation projects. In North America, the Company also supplies customers with special sections, including elevator guide rails and super light beams. The Company also provides its customers with higher value-added products at rebar fabrication facilities.

 

The Company operates in the flat steel market through its Ouro Branco unit that produces slabs, which are used to roll flat products such as hot and cold rolled steel coils, heavy plates and profiles. In addition, the Company’s distribution subsidiary, Comercial Gerdau, resells flat steel products manufactured by other Brazilian steel producers, adding further value through additional processing at its four flat steel service centers. Gerdau Ameristeel also supplies flat steel to its customers through its joint venture Gallatin. Gallatin is a joint venture with ArcelorMittal, a leading flat steel producer, and has nominal installed capacity of 1.4 million tonnes of flat steel per year.

 

The Company produces specialty and stainless steel used in tools and machinery, chains, fasteners, railroad spikes, special coil steel, grader blades, smelter bars, light rails, super light I-beams, elevator guide rails and other products that are made on demand for the Company’s customers at its Aços Villares and Piratini units in Brazil, at the units of its associated company Corporación Sidenor in Spain, at its MacSteel units in the United States and through its joint venture Kalyani Gerdau Steel Ltd. in India.

 

Competitive Position — Brazil

 

The Brazilian steel market is very competitive. In the year ended December 31, 2009, the Company was the largest Brazilian long steel producer and the second largest crude steel producer, according to the Brazilian Steel Institute (IABr - Instituto Aço Brasil). Meanwhile, ArcelorMittal Brasil was the second largest long steel producer and the first largest crude steel producer in Brazil during 2009.

 

The table below presents the Company’s main competitors and market share in Brazil’s crude steel market:

 

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Fiscal year ending December 31,

 

Brazilian crude steel producers (%)

 

2009(*)

 

2008

 

2007

 

ArcelorMittal Brasil (1)

 

34.4

 

31.0

 

30.3

 

Gerdau (2)

 

23.0

 

25.8

 

24.0

 

Usiminas (3)

 

21.3

 

23.8

 

25.7

 

CSN

 

16.5

 

14.8

 

15.8

 

Others

 

4.8

 

4.6

 

4.3

 

Total

 

100.0

 

100.0

 

100.0

 

 


Source: IABr - Instituto Aço Brasil

(1) Arcelor S.A. controls CST, Belgo and Acesita

(2) Includes Aços Villares

(3) Usiminas and Cosipa are part of the Usiminas Group

(*) Preliminary figures

 

World common long rolled steel demand is met principally by steel mini-mills and, to a much lesser extent, by integrated steel producers. Shipping, freight and demurrage costs are a major barrier to imports, and since the Company operates in Brazil primarily in the common long rolled product business, where profit margins are relatively narrow, the incentive for foreign competitors to enter the Brazilian market is low. In the Brazilian market, no single company competes against the Company across its entire product range. The Company believes that its business diversification and decentralization provide a competitive edge over its major competitors, where operations are more centralized.

 

In the domestic market, Gerdau is almost an exclusive supplier of blooms and billets to well-defined and loyal customers that have been purchasing from it regularly for over 15 years. Intense competition exists between the Company and Arcelor Mittal in the slab and wire rod markets. In the international market, the Company, in its export markets, faces strong competition in the commercial quality products line from Eastern Europe (CIS). The main competitors in the high quality products segment are Europeans and, to a lesser extent, the Japanese. The Company is a strong player due to its vast experience and the high quality of its services and products. Gerdau has a highly diversified list of traditional customers located all over the world.

 

Competitive Position — Outside Brazil

 

Outside Brazil, notably in North America, the Company’s subsidiary Gerdau Ameristeel has increased its market share through acquisitions. Gerdau Ameristeel is the second largest mini-mill steel producer in North America and has progressively increased its share in the North American market, with annual nominal capacity of 10.0 million tonnes of crude steel and 10.3 million tonnes of rolled products, according to the Company’s statistics.

 

Gerdau Ameristeel’s geographic market encompasses primarily the United States and Canada. The Company experiences substantial competition in the sale of each of its products from numerous competitors in the North American market. Rebar, merchant bars and structural shapes are commodity steel products for which pricing is the primary competitive factor. Due to the high cost of freight relative to the value of steel products, competition from nonregional producers is somewhat limited. Proximity of product inventories to customers, together with competitive freight costs and low-cost manufacturing processes, are key to maintaining margins on rebar and merchant bar products. Rebar deliveries are generally concentrated within a 350 mile radius of the mini-mills and merchant bar deliveries are generally concentrated within a 500 mile radius. Some products produced by several of our mini-mills are shipped greater distances, including overseas. Except in unusual circumstances, the customer’s delivery expense is limited to freight charges from the nearest competitive mill, and the supplier absorbs any incremental freight charges.

 

The Company’s principal competitors include Commercial Metals Company, Nucor Corporation, Steel Dynamics Inc., and ArcelorMittal Inc. Gallatin Steel competes with numerous other integrated and mini-mill steel producers.

 

Despite the commodity characteristics of the rebar, merchant bar and structural markets, Gerdau Ameristeel believes it distinguishes itself from many of its competitors due to the Company’s large product range, product quality, consistent delivery performance, capacity to service large orders and ability to fill most orders quickly from inventory. The Company believes it produces one of the largest ranges of bar products and shapes. The Company’s product diversity is an important competitive advantage in a market where many customers are looking to fulfill their requirements from a few key suppliers.

 

In Latin America, each country has a specific competitive position that depends on conditions in their respective markets. Most compete domestically and face significant competition from imports. More than 80% of shipments from Gerdau’s Latin American Operation originate from Chile, Peru, Colombia and Mexico. In Chile, the main barriers faced by Gerdau AZA sales are freight and transportation costs and the availability of imports. The Company estimates the share of the domestic long steel market held by Gerdau AZA at about 30%, and that Diaco has a 29.0% stake in the Colombian steel market. It also believes that Siderperú has market share of approximately 47.0% in the long products segment in Peru.

 

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In the Specialty Steel Operation, Corporación Sidenor holds approximately 10% of the specialty steel market in the European Union; in the U.S. market, Gerdau has roughly 20% share in the SBQ market through its subsidiary MacSteel; and in Brazil, Gerdau’s specialty steel units (Aços Villares and Piratini) are combined the largest player in that market.

 

Insurance

 

The Company maintains insurance coverage in amounts that it believes suitable to cover the main risks of its operating activities. The Company has hired insurance for its Ouro Branco mill against operating losses, which covers amounts up to approximately $4.3 billion (R$ 7,4 billion as of April 30, 2010), including material damage to installations ($3.3 billion) and losses of gross revenues ($997 million), such as halts in production due to business interruptions caused by accidents for a period up to twelve months. The Company’s current insurance policy relating to the Ouro Branco mill remains effective until April 30, 2011. The Company’s mini-mills are covered against operational losses under its policy.

 

Trade Investigations and Government Protectionism

 

Over the past several years, exports of steel products from various companies and countries, including Brazil, have been subject to antidumping, countervailing duties and other trade-related investigations in importing countries. Most of these investigations resulted in duties limiting the investigated companies’ ability to access such import markets. Until now, however, these investigations have not had a significant impact on the Company’s export volumes.

 

Mine Operating License

 

In Brazil, the Company’s mining operations are subject to government concessions, and its mining activities are subject to the limitations imposed by Brazil’s Federal Constitution and Mining Code and the laws, rules and regulations enacted pertaining to mining activities. Under the concession contracts, the Company was granted permission to commercially operate the mines located at Miguel Burnier, Várzea do Lopes, Dom Bosco and Gongo Soco in the state of Minas Gerais Brazil, for as long as the reserves last. Brazil’s Mining Code and Federal Constitution impose on companies that conduct mining activities, such as us, requirements concerning, among other things, the manner in which mineral deposits are used, worker health and safety, environmental protection and restoration, the prevention of pollution and the health and safety of the local communities where the mines are located.

 

In Colombian there are some mining operations, these concessions are ruled by the government and it’s ruled by regulations contained in the Mining Code (Law 685 of 2001 and Law 1382 of 2010). Under the concession rights given to the Company, exploration and exploitation projects of coking coal can be developed. The mines are located at Tausa, Cundinamarca; Cucunubá, Cundinamarca; Samacá and Ráquira, Boyacá; and Cúcuta, north of Santander. The period of the concessions is 30 years and it can be extended for more 30 years. The environmental requirements are also part of the rules that have to be fulfilled in order to develop the projects. Furthermore, there are other important matters such as security of the personnel and the payment of royalties.

 

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 them in the event of a breach of contract without affecting the Company’s operations.

 

In the case of a power outage, there are no alternative supply options 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 Brazil in 2001, when the federal government set targets for reducing consumption), the measures 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 regulatory agency of the Brazilian government. These may have a materially adverse impact on the Company’s results, with a consequent contraction in production in light of the availability of electricity and the adjustments to delivery schedules. Although such problems are not common in Brazil, some Gerdau small units may choose, as an alternative, to use generators to compensate for the energy shortage. Moreover, the Ouro Branco unit generates 70% of its power needs internally using gases generated in the steel-making process. During the period of electricity rationing in 2001, Gerdau overcame the crisis by reallocating production among its various industrial units and rationalizing the use of electricity. These measures resulted in efficiency and productivity gains that were incorporated into the production process after the critical period ended.

 

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Venezuela’s government issued a rationing enforcement as of December 2009, with a reduction commitment of 20% compared to 2009 consumption. The plant is acting to reduce consumption and increase efficiency in order to reduce production impacts from these limitations.

 

In terms of natural gas, the units in Rio Grande do Sul, Paraná and São Paulo are supplied by imported natural gas, through GASBOL (Brazil-Bolivia Pipeline), whereas the other units are supplied by domestic natural gas.

 

In the event of natural gas rationing, it would be possible to adapt equipment for the use of diesel and LPG.

 

Material Effects of Government Regulation

 

In addition to the government regulations that apply to its industry in general, the Company is not subject to any specific regulations that materially and adversely affect its business.

 

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C. ORGANIZATIONAL STRUCTURE

 

The Company’s operational structure (including its main operating subsidiaries engaged in steel production) was as follows on December 31, 2009:

 

 

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The table below shows the main consolidated companies and the investments controlled directly or indirectly by Gerdau on December 31, 2009, 2008 and 2007:

 

 

 

 

 

Equity Interests

 

 

 

 

 

Total capital (*)

 

Voting capital

 

Consolidated company

 

Country

 

2009

 

2008

 

2007

 

2009

 

2008

 

2007

 

Gerdau GTL Spain S.L.

 

Spain

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

Gerdau Internacional Empreendimentos Ltda. - Grupo Gerdau

 

Brazil

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

Gerdau Steel North America Inc.

 

Canada

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

Gerdau Ameristeel Corporation and subsidiaries (1)

 

USA/Canada

 

66,32

 

66,37

 

66,45

 

66,32

 

66,37

 

66,45

 

Gerdau Açominas S.A. and subsidiary (2)

 

Brazil

 

93,98

 

93,30

 

92,16

 

93,98

 

93,31

 

92,16

 

Gerdau Aços Longos S.A.

 

Brazil

 

93,96

 

93,30

 

92,16

 

93,97

 

93,31

 

92,16

 

Aços Villares S.A. (3)

 

Brazil

 

58,50

 

58,44

 

58,44

 

58,50

 

58,44

 

58,44

 

Gerdau Steel Inc.

 

Canada

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

Gerdau Holdings Inc and subsidiaries (4)

 

USA

 

100,00

 

100,00

 

 

100,00

 

100,00

 

 

Paraopeba - Fixed-income investment fund (5)

 

Brazil

 

94,15

 

94,15

 

97,00

 

94,15

 

94,15

 

97,00

 

Corporación Sidenor S.A. and subsidiaries (6)

 

Spain

 

60,00

 

60,00

 

40,00

 

60,00

 

60,00

 

40,00

 

Gerdau América Latina Participações S.A.

 

Brazil

 

94,22

 

89,35

 

89,35

 

94,22

 

89,36

 

89,36

 

Axol S.A.

 

Uruguay

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

100,00

 

Gerdau Chile Inversiones Ltda. and subsidiaries (7)

 

Chile

 

100,00

 

99,99

 

99,99

 

100,00

 

99,99

 

99,99

 

Gerdau Aços Especiais S.A.

 

Brazil

 

94,35

 

93,30

 

92,16

 

94,35

 

93,31

 

92,16

 

Gerdau Hungria Holdings Limited Liability Company and subsidiaries (8)

 

Hungary

 

98,75

 

98,75

 

98,75

 

98,75

 

98,75

 

98,75

 

Gerdau Comercial de Aços S.A.

 

Brazil

 

95,58

 

93,30

 

92,16

 

95,59

 

93,31

 

92,16

 

Aramac S.A.

 

Uruguay

 

100,00

 

100,00

 

100,00