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 I
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
Item 16H. Mine Safety Disclosure
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, and Short and Long-Term Investments
Note 5 - Trade Accounts Receivable
Note 6 - Inventories
Note 7 - Tax Credits
Note 8 - Income and Social Contribution Taxes
Note 9 - Investments
Note 10 - Property, Plant and Equipment
Note 11 - Goodwill
Note 12 - Intangible Assets
Note 13 - Loans and Financing
Note 14 - Debentures
Note 15 - Financial Instruments
Note 16 - Taxes Payable
Note 17 - Tax, Civil and Labor Claims and Contingent Assets
Note 18 - Related-Party Transactions
Note 19 - Employee Benefits
Note 20 - Environmental Liabilities
Note 21 - Obligations with Fidc - Investment Fund in Credit Rights
Note 22 - Equity
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-12.01 a18-2312_1ex12d01.htm
EX-12.02 a18-2312_1ex12d02.htm
EX-13.01 a18-2312_1ex13d01.htm
EX-13.02 a18-2312_1ex13d02.htm
EX-23.01 a18-2312_1ex23d01.htm
EX-23.02 a18-2312_1ex23d02.htm

Gerdau Earnings 2017-12-31

Balance SheetIncome StatementCash Flow

20-F 1 a18-2312_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, 2017

 

 

OR

 

 

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. das Nações Unidas, 8,501 – 8° andar
São Paulo, São Paulo - Brazil CEP 05425-070

(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, 2017 was:

 

 

573,627,483 Common Shares, no par value per share

 

1,146,031,245 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   o No

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Emerging growth company o

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. o

 


†The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

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   o 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

2

 

 

 

PART I

 

4

 

 

 

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

4

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

4

ITEM 3.

KEY INFORMATION

4

ITEM 4.

COMPANY INFORMATION

21

ITEM 4A.

UNRESOLVED SEC STAFF COMMENTS

53

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

54

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

82

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED-PARTY TRANSACTIONS

94

ITEM 8.

FINANCIAL INFORMATION

97

ITEM 9.

THE OFFER AND LISTING

102

ITEM 10.

ADDITIONAL INFORMATION

108

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK

123

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

124

 

 

 

PART II

 

125

 

 

 

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

125

ITEM 14.

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

125

ITEM 15.

CONTROLS AND PROCEDURES

125

ITEM 16.

[RESERVED]

126

ITEM 16A.

AUDIT COMMITTEE FINANCIAL EXPERT

126

ITEM 16B.

CODE OF ETHICS

126

ITEM 16C.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

127

ITEM 16D.

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

127

ITEM 16E.

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

128

ITEM 16F.

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

128

ITEM 16G.

CORPORATE GOVERNANCE

128

ITEM 16H

MINE SAFETY DISCLOSURE

129

 

 

 

PART III

 

129

 

 

 

ITEM 17.

FINANCIAL STATEMENTS

129

ITEM 18.

FINANCIAL STATEMENTS

129

ITEM 19.

FINANCIAL STATEMENTS AND EXHIBITS

129

 

i



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” is a reference 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” is a reference 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 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 Açominas steel mill;

 

(iv)          “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)  “Euro” or “€” are to the official currency of members of the European Union, (iii) “billions” are to thousands of millions, (iv) “km” are to kilometers, and (vi) “tonnes” are to metric tonnes;

 

(v)           “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;

 

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

 

(vii)         “Consolidated shipments” means the combined volumes shipped from all our operations in Brazil, South America, North America and Asia, excluding our joint ventures and associate companies;

 

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

 

(ix)          “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;

 

(x)           “Brazil BD” means Brazil Business Division, “North America BD” means North America Business Division, “South America BD” means South America Business Division and “Special Steel BD” means Special Steel Business Division.

 

(xi)          “proven or probable mineral reserves” has the meaning defined by SEC in Industry Guide 7.

 

The Company has prepared the Consolidated Financial Statements included herein in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). The following investments are accounted following the equity method: Bradley Steel Processor and MRM Guide Rail, all in North America, of which Gerdau Ameristeel holds 50% of the total capital, the investment in the holding company Gerdau Metaldom Corp., in which the Company holds a 45% stake, in the Dominican Republic, the investment in the holding company Corsa Controladora, S.A. de C.V., in which the Company holds a 49% stake, which in turn holds the capital stock of Aceros Corsa S.A. de C.V., in Mexico, the investment in Gerdau Corsa S.A.P.I. de C.V., in Mexico, in which the Company holds a 50% stake and the investment in Dona Francisca Energética S.A, in Brazil, in which the Company holds a 51.82% stake, the investment in the Diaco S.A., in which the Company holds a 49.87% stake, in Colombia and the investment in Gerdau Summit Aços Fundidos e Forjados S.A., in Brazil, in which the Company holds a 58.73% stake.

 

Unless otherwise indicated, all information in this Annual Report is stated as of December 31, 2017.  Subsequent developments are discussed in Item 8.B—Financial Information—Significant Changes.

 

2



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.

 

3



Table of Contents

 

PART I

 

ITEM 1.                IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

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

 

ITEM 2.                OFFER STATISTICS AND EXPECTED TIMETABLE

 

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

 

ITEM 3.                KEY INFORMATION

 

A.            SELECTED FINANCIAL DATA

 

The selected financial information for the Company included in the following tables should be read in conjunction with the IFRS financial statements of the Company, appearing elsewhere in this Annual Report,  and section “Operating and Financial Review and Prospects”. The consolidated financial data of the Company as of and for each of the years ended on December 31, 2017, 2016, 2015, 2014 and 2013 are derived from the financial statements prepared in accordance with IFRS and presented in Brazilian Reais.

 

IFRS Summary Financial and Operating Data

 

 

 

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

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

 

NET SALES

 

36,917,619

 

37,651,667

 

43,581,241

 

42,546,339

 

39,863,037

 

Cost of sales

 

(33,312,995

)

(34,187,941

)

(39,290,526

)

(37,406,328

)

(34,728,460

)

 

 

 

 

 

 

 

 

 

 

 

 

GROSS PROFIT

 

3,604,624

 

3,463,726

 

4,290,715

 

5,140,011

 

5,134,577

 

Selling expenses

 

(524,965

)

(710,766

)

(785,002

)

(691,021

)

(658,862

)

General and administrative expenses

 

(1,129,943

)

(1,528,262

)

(1,797,483

)

(2,036,926

)

(1,953,014

)

Impairment of assets

 

(1,114,807

)

(2,917,911

)

(4,996,240

)

(339,374

)

 

Gains and losses on assets held for sale and sales of interest in subsidiaries and associate company

 

(721,682

)

(58,223

)

 

636,528

 

 

Other operating income

 

260,618

 

242,077

 

213,431

 

238,435

 

318,256

 

Other operating expenses

 

(168,887

)

(114,230

)

(116,431

)

(150,542

)

(140,535

)

Reversal of contingent liabilities, net

 

929,711

 

 

 

 

 

Equity in earnings (losses) of unconsolidated companies

 

(34,597

)

(12,771

)

(24,502

)

101,875

 

54,001

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) BEFORE FINANCIAL INCOME (EXPENSES) AND TAXES

 

1,100,072

 

(1,636,360

)

(3,215,512

)

2,898,986

 

2,754,423

 

Financial income

 

226,615

 

252,045

 

378,402

 

276,249

 

292,910

 

Financial expenses

 

(1,726,284

)

(2,010,005

)

(1,780,366

)

(1,397,375

)

(1,053,385

)

Exchange variations, net

 

(4,057

)

851,635

 

(1,564,017

)

(476,367

)

(544,156

)

Reversal of monetary update of contingent liabilities, net

 

369,819

 

 

 

 

 

Gains and losses on financial instruments, net

 

(9,441

)

(38,930

)

87,085

 

36,491

 

(2,854

)

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) BEFORE TAXES

 

(43,276

)

(2,581,615

)

(6,094,408

)

1,337,984

 

1,452,646

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

(313,758

)

(110,511

)

(158,450

)

(571,926

)

(318,422

)

Deferred

 

18,367

 

(193,803

)

1,656,872

 

722,315

 

559,478

 

Income and social contribution taxes

 

(295,391

)

(304,314

)

1,498,422

 

150,389

 

241,056

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INCOME (LOSS)

 

(338,667

)

(2,885,929

)

(4,595,986

)

1,488,373

 

1,693,702

 

 

 

 

 

 

 

 

 

 

 

 

 

ATTRIBUTABLE TO:

 

 

 

 

 

 

 

 

 

 

 

Owners of the parent

 

(359,360

)

(2,890,811

)

(4,551,438

)

1,402,873

 

1,583,731

 

Non-controlling interests

 

20,693

 

4,882

 

(44,548

)

85,500

 

109,971

 

 

 

(338,667

)

(2,885,929

)

(4,595,986

)

1,488,373

 

1,693,702

 

 

4



Table of Contents

 

 

 

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

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

 

Basic earnings (loss) per share  — in R$

 

 

 

 

 

 

 

 

 

 

 

Common

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

0.93

 

Preferred

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

0.93

 

Diluted earnings (loss) per share  — in R$

 

 

 

 

 

 

 

 

 

 

 

Common

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

0.93

 

Preferred

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

0.93

 

Cash dividends declared per share  — in R$

 

 

 

 

 

 

 

 

 

 

 

Common

 

0.08

 

0.05

 

0.15

 

0.25

 

0.28

 

Preferred

 

0.08

 

0.05

 

0.15

 

0.25

 

0.28

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average Common Shares outstanding during the year (1)

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

Weighted average Preferred Shares outstanding during the year (1)

 

1,137,012,265

 

1,132,626,373

 

1,117,034,926

 

1,132,483,383

 

1,129,184,775

 

Number of Common Shares outstanding at year end (2)

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

Number of Preferred Shares outstanding at year end (2)

 

1,137,327,184

 

1,137,018,570

 

1,114,744,538

 

1,132,613,562

 

1,132,285,402

 

 


(1) The information on the numbers of shares presented above corresponds to the weighted average quantity during each year.

 

(2) The information on the numbers of shares presented above corresponds to the shares at the end of the year.

 

 

 

On December 31,

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

 

 

 

(Expressed in thousands of Brazilian Reais - R$)

 

Balance sheet selected information

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

2,555,338

 

5,063,383

 

5,648,080

 

3,049,971

 

2,099,224

 

Short-term investments (1)

 

821,518

 

1,024,411

 

1,270,760

 

2,798,834

 

2,123,168

 

Current assets

 

17,982,113

 

17,796,740

 

22,177,498

 

20,682,739

 

18,177,222

 

Current liabilities

 

7,714,120

 

8,621,509

 

7,863,031

 

7,772,796

 

7,236,630

 

Net working capital (2)

 

10,267,993

 

9,175,231

 

14,314,467

 

12,909,943

 

10,940,592

 

Property, plant and equipment, net

 

16,443,742

 

19,351,891

 

22,784,326

 

22,131,789

 

21,419,074

 

Net assets (3)

 

23,893,941

 

24,274,653

 

31,970,383

 

33,254,534

 

32,020,757

 

Total assets

 

50,301,761

 

54,635,141

 

70,094,709

 

63,042,330

 

58,215,040

 

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

 

2,004,341

 

4,458,220

 

2,387,237

 

2,037,869

 

1,810,783

 

Long-term debt, less current portion

 

14,457,315

 

15,959,590

 

23,826,758

 

17,148,580

 

14,481,497

 

Debentures - short term

 

 

 

 

 

27,584

 

Debentures - long term

 

47,928

 

165,423

 

246,862

 

335,036

 

386,911

 

Equity

 

23,893,941

 

24,274,653

 

31,970,383

 

33,254,534

 

32,020,757

 

Capital

 

19,249,181

 

19,249,181

 

19,249,181

 

19,249,181

 

19,249,181

 

 

 


(1)  Includes held for trading.

(2)  Total current assets less total current liabilities.

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

 

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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 real 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

 

March 2018 (through March 29)

 

3.3238

 

3.2792

 

3.3338

 

3.2246

 

February 2018

 

3.2598

 

3.2419

 

3.2821

 

3.1730

 

January 2018

 

3.1624

 

3.2106

 

3.2697

 

3.1391

 

December 2017

 

3.3080

 

3.2919

 

3.3332

 

3.2322

 

November 2017

 

3.2616

 

3.2593

 

3.2920

 

3.2136

 

October 2017

 

3.2769

 

3.1912

 

3.2801

 

3.1315

 

September 2017

 

3.1680

 

3.1347

 

3.1932

 

3.0852

 

2017

 

3.3080

 

3.1925

 

3.8707

 

3.0510

 

2016

 

3.2591

 

3.4833

 

4.1558

 

3.1193

 

2015

 

3.9048

 

3.3399

 

4.1949

 

2.5754

 

2014

 

2.6562

 

2.3547

 

2.7403

 

2.1974

 

2013

 

2.3426

 

2.1601

 

2.4457

 

1.9528

 

 

Dividends

 

The Company’s total authorized capital stock is composed of common and preferred shares. As of December 31, 2017, the Company had 571,929,945 common shares and 1,137,327,184 non-voting preferred shares outstanding (excluding treasury stock).

 

The following table details dividends and interest on equity paid to holders of common and preferred stock since 2013. The figures are expressed in Brazilian reais and U.S. dollars.  The exchange rate used for conversion to U.S. dollars was based on the date of the resolution approving the dividend.

 

Dividends 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 paid per share, except where stated otherwise:

 

Period

 

Date of
Resolution

 

R$ per Share
Common or
Preferred Stock

 

$ per Share
Common or
Preferred
Stock

 

 

 

 

 

 

 

 

 

1st Quarter 2013

 

05/07/2013

 

0.0200

 

0.0099

 

2nd Quarter 2013 (1)

 

08/01/2013

 

0.0700

 

0.0305

 

3rd Quarter 2013 (1)

 

10/31/2013

 

0.1200

 

0.0545

 

4th Quarter 2013

 

02/21/2014

 

0.0700

 

0.0296

 

1st Quarter 2014 (1)

 

05/07/2014

 

0.0700

 

0.0312

 

2nd Quarter 2014

 

07/30/2014

 

0.0600

 

0.0265

 

3rd Quarter 2014 (1)

 

11/05/2014

 

0.0500

 

0.0199

 

4th Quarter 2014

 

03/04/2015

 

0.0700

 

0.0235

 

1st Quarter 2015 (1)

 

06/05/2015

 

0.0600

 

0.0197

 

2nd Quarter 2015 (1)

 

08/12/2015

 

0.0500

 

0.0144

 

3rd Quarter 2015

 

10/29/2015

 

0.0400

 

0.0102

 

2nd Quarter 2016

 

08/10/2016

 

0.0300

 

0.0096

 

3rd Quarter 2016

 

11/04/2016

 

0.0200

 

0.0062

 

2nd Quarter 2017

 

08/08/2017

 

0.0200

 

0.0064

 

3rd Quarter 2017

 

11/07/2017

 

0.0300

 

0.0092

 

4rd Quarter 2017

 

27/02/2018

 

0.0300

 

0.0092

 

 


(1) Payment of interest on equity.

 

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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 higher. 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”.

 

Gerdau has a Dividend Reinvestment Plan (DRIP), 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. Gerdau also provides its shareholders with 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.

 

D.            RISK FACTORS

 

We are subject to various risks and uncertainties resulting from changing competitive, economic, political and social conditions that could harm our business, results of operations or financial condition. The risks described below could adversely affect our business, consolidated financial position, results of operations or cash flows.    These risks are not the only ones we face.  Other risks that we do not presently know about or that we presently believe are not material could also adversely affect us.

 

Risks Relating to our Business and the Steel Industry

 

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

 

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 could cause write-downs of its inventories. In addition, the demand for steel products, and hence the financial condition and results of operations 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, since the second half of 2008, and especially in the beginning of 2009, the U.S. and European economies experienced a significant slowdown, in turn affecting many other countries. Slow growth in steel consumption was not accompanied by a corresponding slowdown in capacity expansion over the last few years, resulting in an even greater excess of global steel capacity. Since then, the price has experienced a high volatility. A material decrease in demand for steel or exports by countries not able to consume their production could have a significant adverse effect on the Company’s financial condition and results of operations.

 

Global crises and subsequent economic slowdowns may adversely affect global steel demand. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

Historically, the steel industry has been highly cyclical and deeply impacted by economic conditions in general, such as world production capacity and fluctuations in steel imports/exports and the respective import duties. After a steady period of growth between 2004 and 2008, the marked drop in demand resulting from the global economic crisis of 2008-2009 once again demonstrated the vulnerability of the steel market to volatility of international steel prices and raw materials. That crisis was caused by the dramatic increase of high risk real of estate financing defaults and foreclosures in the United States, with serious consequences for bank and financial markets throughout the world. Developed markets, such as North America and Europe, experienced a strong recession due to the collapse of real estate financings and the shortage of global credit. As a result, the demand for steel products suffered a decline in 2009, but since 2010 has been experiencing a gradual recovery, principally in the developing economies. The steel sector is experiencing challenges mainly due to excess global steel capacity, the Chinese economic slowdown, and the entry of imported steel into countries with more open economies.

 

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The economic downturn and turbulence in the global economy can negatively impact the consuming markets, affecting the business environment with respect to the following:

 

·      Decrease in international steel prices;

 

·      Slump in international steel trading volumes;

 

·      Crisis in automotive industry and infrastructure sectors; and

 

·      Lack of liquidity in the international market.

 

If the Company is not able to remain competitive in these shifting markets, our profitability, margins and income may be negatively affected. A decline in this trend could result in a decrease in the Company’s shipments and revenues. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

Our results and financial condition are affected by global and local market conditions that we do not control and cannot predict.

 

We are subject to the risks arising from adverse changes in domestic and global economic and political conditions. Our industry is cyclical by nature and fluctuates with economic cycles, including the current global economic instability. The global financial markets experienced significant disruptions in 2008 and the United States, Europe and other economies went into recession. The recovery from the lows of 2008 and 2009 was uneven and is facing new challenges, including the escalation of the European sovereign debt crisis since 2011, the United Kingdom’s decision to withdraw from the European Union and increasing political uncertainty in a number of countries. It is unclear whether the European sovereign debt crisis will be contained and what effects it and the United Kingdom’s decision to withdraw from the European Union may have. In addition, on January 20, 2017, Donald Trump became the President of the United States. We cannot predict the effects of Donald Trump’s administration or its trade and other policies. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies that have been adopted by the central banks and financial authorities of some of the world’s leading economies, including China. These policies may have a negative impact on the global and local economy, and consequently our business, financial condition and results of operations. We cannot predict if the actions taken in the United States, Europe, China and elsewhere in the world to address this situation will be successful in reducing the duration and impact of the economic instability and political uncertainty. Global economic weakness may prompt banks to limit or deny lending to us or to our customers, which could have a material adverse effect on our liquidity, on our operations and on our ability to carry out our announced capital investment programs and may prompt our customers to slow down or reduce the purchase of our products. We may experience longer sales cycles, difficulty in collecting sales proceeds and lower prices for our products. We cannot provide any assurance that any of these events will not have a material adverse effect on market conditions, the prices of our securities, our ability to obtain financing and our results of operations and financial condition.

 

Gerdau faces significant competition in relation to their steel products, including with regard to prices of other domestic and foreign producers, which may adversely affect its profitability and market share.

 

The global steel industry is highly competitive with respect to price, quality of products and customer service, as well as in relation to technological advances that allow the reduction of production costs. Brazilian exports of steel products are influenced by several factors, including protectionist policies of other countries, foreign exchange policy of the Brazilian government and growth rate of the world economy. Moreover, continuous advances in material sciences and the resulting technologies facilitate the improvement of products such as plastic, aluminum, ceramics and glass, allowing them to replace steel.

 

Due to the high initial investment costs, the operation of a steel plant on a continuous basis may encourage mill operators to maintain high production levels, even in periods of low demand, which would increase the pressure on industry profit margins. A competitive pressure that forces the fall in steel prices can also affect the profitability of Gerdau.

 

The steel industry has historically suffered from excess production capacity, which has recently worsened due to a substantial increase in production capacity in emerging countries, particularly China and India and other emerging markets. China is currently the largest global steel producer. In addition, China and certain steel exporting countries have favorable conditions (excess steel capacity, devalued currency or high market prices for steel products in markets outside these countries) which may significantly impact the price of steel in other markets. If Gerdau is unable to remain competitive with China and other steel-producing countries, its financial condition and results of operations may be adversely affected in the future.

 

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An increase 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 the Company operates.

 

One significant factor in the global steel market has been China’s high steel production capacity, which has been exceeding its domestic consumption needs. This has made China a net exporter of steel products, increasing its importance in different countries of the transoceanic market and consequently pushing down international steel prices. Moreover, China’s lower growth rate has resulted in a slower pace of steel consumption in the country, consequently reducing demand for imported raw materials and putting pressure on global commodity prices. Any intensification of these factors could adversely affect the Company’s exports, results of operations and financial condition.

 

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 mills accounted for 78.0% of total crude steel output as of and for the year ended on December 31, 2017, 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 suppliers 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 corresponding increase in finished steel selling 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. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

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

 

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

 

The Ouro Branco mill is the Company’s largest mill in Brazil, and its main metal input for the production of steel is iron ore. This unit represented 48.8% of the total crude steel output (in volume) of the Brazil Business Division. A shortage of iron ore in the domestic market may adversely affect the steel producing capacity of the Brazilian units, and an increase in iron ore prices could reduce profit margins.

 

The Company has iron ore mines in the Brazilian state of Minas Gerais. To mitigate its exposure to the volatility in iron ore prices, the Company invested in expanding the production capacity of these mines, which, commencing in 2012, met 100% of iron ore demand from the Ouro Branco Mill.

 

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 mill 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. The coking coal used in this mill is imported from Canada, the United States, Australia, Mozambique, Peru, Russia and Colombia. Although the market for the supply of coking coal is relatively balanced at the moment, and we have entered into long-term contracts with negotiable prices periodically to minimize the risks of shortages, a shortage of coking coal in the international market would adversely affect the steel producing capacity of the Ouro Branco mill. In addition, an increase in prices could reduce profit margins. Another related risk is the currency depreciation to which the Ouro Branco Mill is exposed, since all coking coal consumed by the operation is imported.

 

As a result, the Company’s financial condition and results of operations may be adversely affected.

 

Risks Relating to our Operations

 

The Company’s projects are subject to risks that may result in increased costs or delay or prevent their successful implementation.

 

The Company invested to further increase productivity of its operations. These projects are subject to a number of risks that may adversely affect the Company’s growth prospects and profitability, including the following:

 

·      the Company may encounter delays, availability problems or higher than expected costs in obtaining the necessary equipment, services and materials to build and operate a project;

 

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·      the Company’s efforts to develop projects according to schedule may be hampered by a lack of infrastructure, including availability of overburden and waste disposal areas as well as reliable power and water supplies;

 

·      the Company may fail to obtain, lose, or experience delays or higher than expected costs in obtaining or renewing the required permits, authorizations, licenses, concessions and/or regulatory approvals to build or continue a project; and

 

·      changes in market conditions, laws or regulations may make a project less profitable than expected or economically or otherwise unfeasible.

 

Any one or a combination of the factors described above may materially and adversely affect the Company’s financial condition and results of operations.

 

Unexpected equipment failures may lead to production curtailments or shutdowns.

 

Unexpected interruptions in the production capabilities at Gerdau’s principal sites and installations would increase production costs, reducing shipments and earnings for the affected period. These interruptions result from: (i) unpredictable/periodic equipment failures, which are essential to the development of the production processes of Gerdau, such as steelmaking equipment, such as its electric arc furnaces, continuous casters, gas-fired reheat furnaces, rolling mills and electrical equipment, including high-output transformers; and/or (ii) unanticipated events such as fires, explosions or violent weather conditions. As a result, Gerdau has experienced and may in the future experience material plant shutdowns or periods of reduced production. Unexpected interruptions in production capabilities would adversely affect Gerdau’s productivity and results of operations. Moreover, any interruption in production capability may require Gerdau to make additions to fixed assets to remedy the problem, which would reduce the amount of cash available for operations. Gerdau’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 adversely affect the business, results of operations, cash flows and financial condition.

 

Failure to obtain the necessary permits and licenses could adversely affect our operations.

 

We depend on the issuance of permits and licenses from governmental agencies in order to undertake certain of our activities. In order to obtain licenses activities that are expected to have a significant environmental impact, certain investments in conservation are required to offset any such impact. The operational licenses require, among other things, that we periodically report our compliance with emissions standards set by environmental agencies. Failure to obtain, renew or comply with our operating licenses may cause delays in our deployment of new activities, increased costs, monetary fines or even suspension of the affected activity, which may materially adversely affect us.

 

Climate change may negatively affect our business, financial condition, results of operations and cash flows.

 

A significant number of scientists, environmentalists, international organizations, regulators and other commentators sustain that global climate change has contributed, and will continue to contribute, to the increasing unpredictability, frequency and severity of natural disasters (including, but not limited to, hurricanes, droughts, tornadoes, freezes, other storms and fires) in certain parts of the world. As a result, a number of legal and regulatory measures as well as social initiatives have been introduced in numerous countries in an effort to reduce carbon dioxide and other greenhouse gas emissions and combat global climate change. Such reductions in greenhouse gas emissions could result in increased energy, transportation and raw material costs and may require us to make additional investments in facilities and equipment. Although we cannot predict the impact of changing global climate conditions, if any, or if legal, regulatory and social responses to concerns about global climate change, any such occurrences may negatively affect our business, financial condition, results of operations and cash flows.

 

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

 

Crude steel production is an energy-intensive process, especially in melt shops with electric arc furnaces. Electricity represents an important production component at these units, as also does natural gas, although to a lesser extent. Electricity cannot be replaced at Gerdau’s mills and power rationing or shortages could adversely affect production at those units. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

Layoffs in the Company’s labor force could generate costs or negatively affect the Company’s operations.

 

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

 

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Table of Contents

 

down cycle that could generate severance costs. Moreover, the Company could be adversely affected by labor disruptions involving unrelated parties that may provide goods or services to the Company. Strikes and other labor disruptions at any of the Company operations could adversely affect the operation of facilities and the timing of completion and the cost of capital of our projects.

 

We could be harmed by a failure or interruption of our information technology systems or automated machinery.

 

We rely on our information technology systems and automated machinery to effectively manage our production processes and operate our business. Advanced technology systems and machinery are nonetheless subject to defects, interruptions and breakdowns. Any failure of our information technology systems and automated machinery to perform as we anticipate could disrupt our business and result in production errors, processing inefficiencies and the loss of sales and customers, which in turn could result in decreased revenue, increased overhead costs and excess or out-of-stock inventory levels resulting in a material adverse effect on our business results. Although we have procedures in place to prevent and minimize the impact of a potential failure, including a disaster recovery system, a back-up site for our management systems, 24/7 monitoring of our servers and a cybersecurity program, there is no assurance that these will work properly or that there will not be an impact on our results of operations or financial condition.

 

In addition, our information technology systems and automated machinery may be vulnerable to damage or interruption from circumstances beyond our control, including fire, natural disasters, systems failures, viruses, cyber-attacks and other security breaches, including breaches of our production processing systems that could result in damage to our automated machinery, production interruptions or access to our confidential financial, operational or customer data. Any such damage or interruption could have a material adverse effect on our business results, including as a result of our facing significant fines, customer notice obligations or costly litigation, harming our reputation with our customers or requiring us to expend significant time and expense developing, repairing or upgrading our information technology systems and automated machinery.

 

Further, while we have some backup data-processing systems that could be used in the event of a catastrophe or a failure of our primary systems, we do not yet have an integrated disaster recovery plan or a backup data center that covers all of our units. While we endeavor to prepare for failures of our network by providing backup systems and procedures, we cannot guarantee that our current backup systems and procedures will operate satisfactorily in the event of a regional emergency. Any substantial failure of our backup systems to respond effectively or on a timely basis could have a material adverse effect on our business and results of operations.

 

We are subject to information technology risks related to breaches of security pertaining to sensitive company, customer, employee and vendor information as well as breaches in the technology used to manage operations and other business processes.

 

Our business operations rely upon secure information technology systems for data capture, processing, storage and reporting. Despite careful security and controls design, implementation, updating and independent third party verification, our information technology systems, and those of our third party providers, could become subject to employee error or malfeasance, cyber-attacks, or natural disasters. Network, system, application and data breaches could result in operational disruptions or information misappropriation. Access to internal applications required to plan our operations, source materials, manufacture and goods and account for orders could be denied or misused. Theft of intellectual property or trade secrets, and inappropriate disclosure of confidential company, employee, customer or vendor information, could stem from such incidents. Any of these operational disruptions and/or misappropriation of information could result in lost sales, business delays, negative publicity and could have a material effect on our business.

 

Risks Relating to our Mining Operations

 

Our mineral resource estimates are based in interpretations and premises and may materially differ from mineral quantities that we may be able to actually extract.

 

Our mining resources are estimated quantities of ore and minerals. There are numerous uncertainties inherent in estimating quantities of resources, including many factors beyond our control. Reserve engineering involves estimating deposits of minerals that cannot be measured in an exact manner, and the accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation and judgment. In addition, estimates of different engineers may vary. As a result, no assurance can be given that the amount of mining resources will be extracted or that they can be extracted at commercially viable rates, which could adversely affect the financial situation of the Company.

 

Moreover, when making determinations about whether to advance any projects to development, Gerdau relies upon estimated calculations as to the mineralized material on its properties. Since Gerdau has not conducted a feasibility study demonstrating proven or probable reserves, estimates of mineralized material presented are less certain than would be the case if the estimates were made in accordance with the SEC-recognized definition of proven and probable reserves. Furthermore, until ore is actually mined and processed, any mineral reserves and grades of mineralization must be considered as estimates only. These estimates are imprecise and

 

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depend on geological interpretation and statistical inferences drawn from drilling and sampling analysis, which may prove to be unreliable. We cannot assure that these mineralized material estimates will be accurate or that this mineralized material can be mined or processed profitably and any decision to move forward with development is inherently risky. Further, there can be no assurance that any minerals recovered in small scale tests will be duplicated in large scale tests under on-site conditions or production scale. Any material changes in estimates of mineralized material will affect the economic viability of placing a property into production and such property’s return on capital. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

The Company has no proven or probable reserves, and the Company’s decision to commence industrial production, in order to supply its steelmaking works as well as sell any surplus volume, is not based on a study demonstrating economical recovery of any mineral reserves and is therefore inherently risky. Any funds spent by the Company on exploration or development could be lost.

 

The Company has not established any proven or probable mineral reserves at any of its properties. All exploration activities are supported based on mineral resources classified as mineralized materials, as they are not compliant with the definitions established by the SEC of proven or probable reserves. The Company is conducting a comprehensive exploration study to establish, in accordance with SEC definitions, the amount of mineralized material that could be transformed to proven or probable reserves. Thus, part of the volume of mineralized materials informed discussed herein may never reach the development or production stage.

 

In order to demonstrate the existence of proven or probable reserves, it would be necessary for Company to perform additional exploration to demonstrate the existence of sufficient mineralized material with satisfactory continuity and obtain a positive feasibility study which demonstrates with reasonable certainty that the deposit can be economically and legally extracted and produced. The absence of proven or probable reserves makes it more likely that the Company’s properties may cease to be profitable and that the money spent on exploration and development may never be recovered, which could adversely affect the financial condition and results of operations of the Company.

 

Drilling and production risks could adversely affect the mining process.

 

Once mineral deposits are discovered, it can take a number of years from the initial phases of drilling until production is possible, during which time the economic feasibility of production may change.  Substantial time and expenditures are required to:

 

·      establish mineral reserves through drilling;

 

·      determine appropriate mining and metallurgical processes for optimizing the recovery of metal contained in ore;

 

·      obtain environmental and other licenses;

 

·      construct mining, processing facilities and infrastructure required for greenfield properties; and

 

·      obtain the ore or extract the minerals from the ore.

 

If a mining project proves not to be economically feasible by the time we are able to profit from it, the Company may incur substantial losses and be obliged to take write-offs.  In addition, potential changes or complications involving metallurgical and other technological processes arising during the life of a project may result in delays and cost overruns that may render the project not economically feasible and could adversely affect the financial condition and results of operations of the Company.

 

The Company has two mining tailing dams and any accident or defect affecting the structural integrity of either of them could affect its image, results of operations, cash flows and financial condition.

 

Gerdau has two mining tailing dams in the state of Minas Gerais. The Bocaina Dam has been inactive since 2011 and is practically dry, which is a factor that minimizes the risk. It is periodically monitored and its instrumentation data are within the safety limits. Meanwhile, the Alemães Dam is currently operating at its maximum capacity and is regularly monitored. The instrumentation data are within the safety limits.

 

Both dams are classified as Class C (low risk) in accordance with the National Mining Dam Registry available on the website of the National Department of Mineral Production (DNPM).

 

Gerdau adopts rigorous standards of engineering control and environmental supervision and conducts an annual Geotechnical Stability Audit to ensure the stability of the two dams. Gerdau has a Mining Dam Emergency Action Plan for each of the dams and both documents are filed at the regulatory agencies, as required by governing law.

 

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An accident involving a dam could result in serious adverse consequences, including:

 

·      Temporary/permanent shutdown of mining activities and consequently the need to buy iron ore to supply mills;

 

·      Large expenditures on contingencies and on recovering the regions and people affected;

 

·      High investments to resume operations;

 

·      Payment of fines and damages;

 

·      Potential environmental impacts.

 

Any one or more of these consequences could have a material adverse impact on our results of operations, cash flow and financial condition.

 

Financial Risks

 

Any downgrade in the Company’s credit ratings could adversely affect the availability of new financing and increase its cost of capital.

 

In 2007, the international rating agencies, Fitch Ratings and Standard & Poor’s, classified the Company’s credit risk as “investment grade”, enabling the Company to access more attractive borrowing rates. In December 2011, Moody’s assigned the investment grade rating “Baa3” for all of Gerdau’s ratings. With the deterioration of the Brazilian economy, S&P, Fitch and Moody’s downgraded Brazil’s sovereign rating. Despite the loss of Brazil’s investment grade rating in 2015, the Company maintained its investment grade rating by Fitch and Standard & Poor’s. However, the Company lost its investment grade rating by Moody’s.

 

The loss of any more of Gerdau’s investment grade ratings could increase its cost of capital, impair its ability to obtain capital and adversely affect its financial condition and results of operations.

 

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, together with the change in rating by the credit rating agencies, could have important consequences, including the following:

 

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

 

·      It may limit the ability to declare dividends on its 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, additions to fixed assets and future business opportunities;

 

·      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;

 

·      The Company may be required to adjust the level of funds available for additions to fixed assets; and

 

As a result, the Company’s financial condition and results of operations may be adversely affected.

 

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In September 2015, the Company concluded the process of eliminating financial covenants in all of its contracts. Since October 2015, only financial transactions with BNDES include covenants relating to the Company’s indebtedness ratios, but with distinct characteristics in relation to those contained in the contracts with commercial banks (for more information, see Item 5.B.—Liquidity and Capital Resources — Indebtedness Ratios). In the event of a failure to satisfy the annual tests, the Company would have a grace period and a subsequent renegotiation of the security for the financing, and an event of default would not occur.

 

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 results of operations 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, the North America Business Division 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 results of operations. 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.

 

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.

 

The Brazilian real depreciated against the U.S. dollar by 47.0% in 2015, appreciated by 16.5% in 2016 and depreciated by 1.5% in 2017.

 

The Company held debt denominated in foreign currency, mainly U.S. dollars, in an aggregate amount of R$13.3 billion at December 31, 2017, representing 81.0% of its consolidated gross debt (loans, financings, and debentures). Significant further 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. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

We are subject to LIBOR-based risks.

 

On July 27, 2017, the head of the Financial Conduct Authority, or the FCA, announced the desire to phase out the use of LIBOR by the end of 2021. Because the statements made by the head of the FCA are recent in nature, there is no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. As such, the potential effect of any such event on our net investment income cannot yet be determined and, at this time, it is not possible to predict the effect of any establishment of alternative reference rates or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere. Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may have a material adverse effect on our business, financial condition and results of operations.

 

Unfavorable outcomes in judicial, administrative and regulatory litigation may negatively affect our results of operations, cash flows and financial condition.

 

We are involved in several tax, civil and labor disputes involving significant monetary claims.

 

The principal litigations are described more fully in “Legal Proceedings.” Among the material matters for which no reserve has been established are the following:

 

·      The Company and its subsidiary Gerdau Aços Longos S.A. and Gerdau Açominas S.A., have other lawsuits related to the ICMS (state VAT) which are mostly related to credit rights and rate differences, whose demands totaled R$ 443,137 thousands.

 

·      The Company and certain of its subsidiaries in Brazil are parties to claims related to: (i) Imposto sobre Produtos Industrializados - IPI, substantially related to IPI credit on inputs, whose demands total the updated amount of R$ 309,581 thousands; (ii) PIS and COFINS, substantially related to non-approval of compensation of credits on inputs totaling R$ 438,843, (iii) social security contributions in the total of R$ 76,866 thousands and (iv) other taxes, which updated total amount is currently R$ 370,175 thousands.

 

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·      Subsidiary Gerdau Aços Longos S.A. is a party to an administrative proceeding relating to Withholding Income Tax, in the amount of R$ 122,029 thousands, assessed on the remittance abroad of interest charged on export financings under Export Prepayment or Export Advance Agreements. The Company submitted an administrative claim challenging the tax assessment on January 13, 2017, which was rejected by the Brazilian Federal Revenue Judgment Office (Delegacia de Julgamento da Receita Federal do Brasil), on June 5, 2017, reason for which the Company submitted a voluntary appeal, on July 4, 2017, which is currently pending on  the Brazilian Board of Tax Appeals (Conselho Administrativo de Recursos Fiscais — “CARF”, administrative body of the Ministry of Finance of Brazil).

 

·      The Company (as successor of Gerdau Aços Especiais S.A.) and its subsidiary Gerdau Internacional Empreendimentos Ltda., are parties to administrative and judicial proceedings relating to IRPJ — Corporate Income Tax and CSLL — Social Contribution Tax, in the current amount of R$ 1,488,989 thousands. Said proceedings relate to profits generated abroad, of which (i) R$ 1,317,381 thousands correspond to two proceedings involving Gerdau Internacional Empreendimentos Ltda., of which (i.a.) R$ 951,736 thousands relate to a proceeding that is no longer subject to appeal in CARF and was referred for judicial collection, which collection is being challenged in the competent judicial lower court; and (i.b) R$ 365,645 thousands relate to a voluntary appeal which was partially granted in the lower tribunal of the Brazilian Board of Tax Appeals (Conselho Administrativo de Recursos Fiscais — “CARF”, administrative body of the Ministry of Finance of Brazil), and was subject to special appeal which was partially granted in CARF’s superior tribunal with the publication of the judgment on May 25, 2017, and is currently awaiting due diligence by the Internal Revenue Service, as determined by the CARF decision, and new appeals may be filed after the conclusion of such procedure; and (ii) R$ 171,608 thousands correspond to a proceeding involving the Company, whose voluntary appeal in CARF’s lower tribunal was dismissed, for which a special appeal was filed, and currently awaits judgment in CARF’s superior tribunal.

 

·      The Company (as successor of Gerdau Aços Especiais S.A.) and its subsidiaries Gerdau Aços Longos S.A. and Gerdau Açominas S.A. are parties to administrative proceedings relating to the disallowance of the deductibility of goodwill generated in accordance with Article 7 and 8 of Law 9,532/97 — as a result of a corporate restructuring carried out in 2004/2005 — from the tax base of the Corporate Income tax - IRPJ and Social Contribution on Net Income - CSLL. The total updated amount of the proceedings is R$ 6,217,810 thousands, of which (i) R$ 4,963,398 thousands correspond to four proceedings involving the Company and its subsidiaries Gerdau Aços Longos S.A. and Gerdau Açominas S.A., for which administrative discussions already ended and are currently in the administrative collection stage; and the Companies obtained injunctive relief to permit it to offer a judicial guarantee using a liability insurance policy, for judicial discussions on Motion to Stay Execution by the subsidiary Gerdau Aços Longos S.A. were initiated, in their respective proceedings, which total the amount of R$ 3,195,379 thousands, and also by the Company, in its respective lawsuit, which amounts to R$ 364,370 thousands; (ii) R$ 600,101 thousands correspond to two proceedings involving Gerdau Aços Longos S.A., whose voluntary appeal is currently pending in CARF’s lower tribunal; (iii) R$ 531,138 thousands correspond to two proceeding involving the subsidiary Gerdau Aços Longos S.A., whose voluntary appeal was dismissed in CARF’s lower tribunal and having been presented Request for Clarification against those decisions, which are pending of judgment; and (iv) R$ 123,172 thousands correspond to one proceeding involving the Company (as successor of Gerdau Aços Especiais S.A.), whose Request for Clarification, which was filed against a decision that dismissed its Voluntary Appeal, was rejected on December 7, 2017, then the Company became aware of that on December 12, 2017 and it is opposing the appropriate appeal.

 

Some of the decisions obtained at the CARF related to those proceedings along with other matters involving the Company included in the scope of the so-called Operation Zelotes (the “Operation”) are being investigated by Brazilian federal authorities including the Judiciary Branch, with the purpose of verifying the occurrence or not of alleged illegal acts.

 

Considering the involvement of Gerdau’s name in press reports concerning the Operation, the Board of Directors decided to engage outside counsel, which report to a Special Committee of the Board, to conduct an investigation to determine, among other things: (i) whether, in light of current knowledge, proper protocol was followed in the relationship of the Company with governmental authorities, including CARF, and in the hiring of firms representing the Company in cases before CARF; (ii) whether such firms have remained within the scope of their work/hiring; (iii) whether the engagement terms for such firms included clauses intended to prevent activity that violates ethical codes or laws currently in force; (iv) whether the engagement terms for such firms included the establishment of sanctions for any violations (whether contractual breaches or otherwise); and (v) if there is any evidence of fraud, deceit, bad faith, or any expression of an intent to commit an illegal act on the part of directors and/or officers of the Company in the relationship of the Company with governmental authorities, including CARF, in the negotiation, signing or carrying out of the aforementioned contracts (the “Internal Investigation”).

 

The Internal Investigation is ongoing, and as of the date of the approval of these interim financial statements, the Company believes it is not possible to predict either the duration or the outcome of the Operation or of the Internal Investigation. Additionally, the Company believes that currently there is not enough information to determine whether a provision for losses is required or disclose any contingency.

 

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The Company’s legal advisors confirm that the procedures adopted by the Company with respect to the tax treatment of profits abroad and the deductibility of goodwill were strictly legal, and, therefore, the likelihood of loss with respect to said proceedings is possible (but not likely).

 

The failure to pay by our clients or the non-receipt, by the Company, of the credits held before financial institutions and originated from financial investments could adversely affect the Company’s revenues.

 

Gerdau may suffer losses from the default of our clients. Gerdau has a broad base of active clients and, in the case of default of a group of clients, Gerdau may suffer an adverse effect on its business, financial condition, results of operations and cash flows.

 

This risk arises from the possibility of the Company not receiving the amounts due to it from sales transactions or credits payable by financial institutions, which originated from our financial investments, which could also have an adverse effect on the business, financial condition, results of operations and cash flows of Gerdau.

 

Regulatory Risks

 

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.

 

Gerdau 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 Gerdau from selling in these markets. There are no assurances that importing countries will not impose quotas, ad valorem taxes, tariffs or increase import duties, which could adversely affect the Company’s financial condition and results of operations.

 

Costs related to compliance with environmental regulations could increase if requirements become stricter, which could have a negative effect on the Company’s results of operations.

 

The Company’s industrial units and other activities must comply with a series of federal, state and municipal laws and regulations regarding the environment and the operation of plants in the countries in which they operate.  These regulations include procedures relating to control of air emissions, disposal of liquid effluents and the handling, processing, storage, disposal and reuse of solid waste, hazardous or not, as well as other controls necessary for a steel company.

 

Non-compliance with environmental laws and regulations could result in administrative or criminal sanctions and closure orders, in addition to the obligation of repairing damage caused to third parties and the environment, such as clean-up of contamination.  If current and future laws become stricter, spending on fixed assets and costs to comply with legislation could increase and negatively affect the Company’s financial situation.  Moreover, future acquisitions could subject the Company to additional spending and costs in order to comply with environmental legislation. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

Laws and regulations to reduce greenhouse gases and other atmospheric emissions could be enacted in the near future, with significant, adverse effects on the results of the Company’s operations, cash flows and financial situation.

 

One of the possible effects of the expansion of greenhouse gas reduction requirements is an increase in costs, mainly resulting from the demand for renewable energy and the implementation of new technologies in the productive chain.  On the other hand, demand is expected to grow constantly for recyclable materials such as steel, which, being a product that could be recycled numerous times without losing its properties, results in lower emissions during the lifecycle of the product.

 

The Company expects operations overseas to be affected by future federal, state and municipal laws related to climate change, seeking to deal with the question of greenhouse gas (GHG) and other atmospheric emissions.  Thus, one of the possible effects of this increase in legal requirements could be an increase in energy costs. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

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Our operations expose us to risks and challenges associated with conducting business in compliance with applicable anti-bribery anti-corruption and antitrust laws and regulations.

 

We have operations in Brazil and other countries in South America, North America and Asia. We face several risks and challenges inherent in conducting business internationally, where we are subject to a wide range of laws and regulations such as the Brazilian Anti-Corruption Law (Law 12.846/2013), Antitrust Law (Law 12.529/2011), the U.S. Foreign Corrupt Practices Act, or FCPA, and similar anti-bribery, anti-corruption and antitrust laws in other jurisdictions. In recent years there has been an increased focus on corruption in Brazil and also the investigation and enforcement activities of the United States under the FCPA and by other governments under similar laws and regulations. These laws generally prohibit corrupt payments to governmental officials and certain payments, gifts or remunerations to or from clients and suppliers.

 

Violations of these laws and regulations could result in fines, criminal penalties and/or other sanctions against us, our officers or our employees, requirements to impose more stringent compliance programs, and prohibitions on the conduct of our business and our ability to participate in public biddings for contracts. We may incur expenses and recognize provisions and other charges in respect of such matters. In addition, the increased attention focused upon liability issues as a result of investigations, lawsuits and regulatory proceedings could harm our brand or otherwise impact the growth of our business. The retention and renewal of many of our contracts depends on creating a sense of trust with our customers and any violation of these laws and regulations may irreparably erode that trust and may lead to termination of such relationships and have a material adverse effect on our financial condition and results of operations. If any of these risks materialize, our reputation, strategy, international expansion efforts and our ability to attract and retain employees could be negatively impacted, and, consequently our business, financial condition and results of operations could be adversely affected.

 

In March 2015, it was reported in the press that the Brazilian Federal Police had started an operation called Zelotes (the “Operation”), to investigate whether a number of corporate taxpayers attempted to influence the decisions of the Administrative Board of Tax Appeals (CARF) through illegal means. On April 6, 2015, the Company received an inquiry from the CVM requesting clarifications regarding news reports linking the Company to the Operation. The Company clarified that, up to that moment, it had not been contacted by any public authority concerning the Operation.

 

Considering the involvement of Gerdau’s name in press reports concerning the Operation, the Board of Directors decided to engage an external legal, which would report to a Special Committee of the Board, to conduct an investigation.

 

On February 25, 2016, the Federal Police came to Gerdau’s premises to execute court ordered searches and seizures, taking documents and data for examination. The Federal Police also interviewed certain individuals associated with Gerdau, including its Chief Executive Officer and another current Board member. On that same date, the Company filed a press release with SEC and CVM and informed Bovespa and the New York Stock Exchange (NYSE). The internal investigation is ongoing, and the Company is cooperating with the Federal Police. See Note 17 to the Consolidated Financial Statements (Tax, Civil and Labor Claims and Contingent Assets) for further information.

 

Although the Company does not presently believe that these matters will have a material adverse effect on its business, given the inherent uncertainties in such situations, the Company can provide no assurance that these matters will not be material to its business in the future.

 

Our governance and compliance processes may fail to prevent regulatory penalties and reputational harm.

 

We operate in a global environment, and our activities extend over multiple jurisdictions and complex regulatory frameworks with increased enforcement activities worldwide. Our governance and compliance processes, which include the review of internal control over financial reporting, may not prevent future breaches of legal, accounting or governance standards. We may be subject to breaches of our Code of Ethics and Conduct, anti-corruption policies and business conduct protocols and to instances of fraudulent behavior, corrupt practices and dishonesty by our employees, contractors or other agents. Our failure to comply with applicable laws and other standards could subject us to fines, loss of operating licenses and reputational harm.

 

Risks Relating to Brazil

 

Any further downgrading of Brazil’s credit rating could adversely affect the price of our shares.

 

We can be adversely affected by investors’ perceptions of risks related to Brazil’s sovereign debt credit rating. Rating agencies regularly evaluate Brazil and its sovereign ratings, which are based on a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness metrics and the perspective of changes in any of these factors.

 

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Brazil has lost its investment grade sovereign debt credit rating by the three main U.S.-based credit rating agencies, Standard & Poor’s, Moody’s and Fitch. Standard & Poor’s downgraded Brazil’s sovereign debt credit rating from BBB-minus to BB-plus in September 2015, subsequently reduced it to BB in February 2016, and maintained its negative outlook on the rating, citing Brazil’s fiscal difficulties and economic contraction as signs of a worsening credit situation. In December 2015, Moody’s placed Brazil’s Baa3 sovereign debt credit rating on review and downgraded Brazil’s sovereign credit rating in February 2016 to Ba2 with a negative outlook, citing the prospect for further deterioration in Brazil’s indebtedness figures amid a recession and challenging political environment. Fitch downgraded Brazil’s sovereign credit rating to BB-plus with a negative outlook in December 2015, citing the country’s rapidly expanding budget deficit and worse-than-expected recession, and further downgraded Brazil’s sovereign debt credit rating in May 2016 to BB with a negative outlook. In January 2018, Standard & Poor’s downgraded Brazil’s sovereign debt credit rating from BB to BB-minus, citing that as doubts grew about the result of a presidential election in October and a push to trim its costly pension system, seen as vital to closing a huge fiscal deficit. In February 2018, Fitch downgraded Brazil’s sovereign debt credit rating from BB to BB-minus saying the country’s failure to put a social security overhaul to a vote undermines public finances.

 

Brazil’s sovereign credit rating is currently rated below investment grade by the three main credit rating agencies. Consequently, the prices of securities issued by Brazilian companies have been negatively affected. A prolongation or worsening of the current Brazilian recession and continued political uncertainty, among other factors, could lead to further ratings downgrades. Any further downgrade of Brazil’s sovereign credit ratings could heighten investors’ perception of risk and, as a result, adversely affect the price of our shares.

 

Brazil continues to experience political instability, which may adversely affect the Company.

 

Brazil’s political environment has historically influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect the confidence of investors and the general public, which have historically resulted in economic deceleration and heightened volatility in the securities issued by Brazilian companies.

 

Brazil has experienced heightened economic and political instability derived from various currently ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation, known as Lava Jato, which have negatively impacted the Brazilian economy and political environment and contributed to a decline in market confidence in Brazil.

 

As a result of these investigations, a number of senior politicians, including members of Congress, and high-ranking executive officers of major corporations and state-owned companies in Brazil, have been arrested, convicted of various charges relating to corruption, entered into plea agreements with federal prosecutors and/or have resigned or been removed from their positions as a result of these Lava Jato investigations.

 

Amidst this background of political and economic uncertainty, President Dilma Rousseff was suspended from office on May 12, 2016, when the Brazilian Senate voted to hold a trial on impeachment charges against her. President Rousseff was replaced by Vice-President Michel Temer, who served as acting President until Ms. Rousseff was permanently removed from office by the Senate on August 31, 2016. President Temer’s term of office is set to end in December 2018.

 

The potential outcome of Lava Jato as well as other ongoing corruption-related investigations is uncertain, but they have already had an adverse impact on the image and reputation of those companies that have been implicated as well as on the general market perception of the Brazilian economy, political environment and the Brazilian capital markets. The Company has no control over, and cannot predict, whether such investigations or allegations will lead to further political and economic instability or whether new allegations against government officials will arise in the future or will adversely affect the Company.

 

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

 

If Brazil experiences 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 our business. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

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Developments and the perception of risks in other countries, especially in the United States and emerging market countries, may adversely affect the market prices of our shares.

 

The market for securities issued by Brazilian companies is influenced, in some degree, by economic and market conditions in the United States and emerging market countries, especially other Latin American countries. The reaction of investors to economic developments in one country may cause the capital markets in other countries to fluctuate. Developments or adverse economic conditions in other emerging market countries have at times resulted in significant reductions of the investments from investment funds and declines in the amount of foreign currency invested in Brazil.

 

The Brazilian economy is also affected by international economic and market conditions, especially economic and market conditions in the United States. Share prices on the BM&FBOVESPA, for example, have historically been sensitive to fluctuations in United States interest rates as well as movements of the major United States stocks indexes.

 

Economic developments in other countries and securities markets could adversely affect the market prices of our shares, which could make it more difficult for us to access the capital markets and finance our operations in the future on acceptable terms, and could also have a material adverse effect on our financial condition and results of operations.

 

Risks Related to our Corporate Structure

 

The interests of the controlling shareholder may conflict with the interests of the non-controlling shareholders.

 

Subject to the provisions of the Company’s bylaws, the controlling shareholder has powers to:

 

·      elect a majority of the directors and nominate executive officers, establish the administrative policy and exercise full control of the Company´s management;

 

·      sell or otherwise transfer the Company´s shares; and

 

·      approve any action requiring the approval of shareholders representing a majority of the outstanding capital stock, including corporate reorganization, acquisition and sale of assets, and payment of any future dividends.

 

By having such power, the controlling shareholder can make decisions that may conflict with the interest of the Company and other shareholders, which could adversely affect the financial condition and the results of operations of the Company.

 

As a foreign issuer, we have different disclosure and other requirements than U.S. domestic registrants.

 

As a foreign issuer, we may be subject to different disclosure and other requirements than domestic U.S. registrants. For example, as a foreign issuer, in the United States, we are not subject to the same disclosure requirements as a domestic U.S. registrant under the United States Securities Exchange Act of 1934, as amended (the Exchange Act), including the requirements to prepare and issue quarterly reports on Form 10-Q or to file current reports on Form 8-K upon the occurrence of specified significant events, the proxy rules applicable to domestic U.S. registrants under Section 14 of the Exchange Act or the insider reporting and short-swing profit rules applicable to domestic U.S. registrants under Section 16 of the Exchange Act. In addition, we intend to rely on exemptions from certain U.S. rules which will permit us to follow Brazilian legal requirements rather than certain of the requirements that are applicable to U.S. domestic registrants.

 

Furthermore, foreign issuers are required to file their annual report on Form 20-F within 120 days after the end of each fiscal year, while U.S. domestic issuers that are accelerated filers are required to file their annual report on Form 10-K within 75 days after the end of each fiscal year. As a result of the above, even though we are required to file reports on Form 6-K disclosing the information which we have made or are required to make public pursuant to Luxembourg law, or are required to distribute to shareholders generally, and that is material to us, you may not receive information of the same type or amount that is required to be disclosed to shareholders of a U.S. company.

 

As a foreign issuer, we are permitted to, and we do, rely on exemptions from certain NYSE corporate governance standards, including the requirement that a majority of our board of directors consist of independent directors. This may afford less protection to our shareholders.

 

The NYSE’s rules require listed companies to have, among other things, a majority of their board members be independent and to have independent director oversight of executive compensation, nomination of directors and corporate governance matters. As a foreign issuer and a controlled Company, we are permitted to, and we will, follow home country practice in lieu of the above

 

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requirements. Brazilian law, the law of our home country, does not require that a majority of our board consist of independent directors or the implementation of a compensation committee or nominating a corporate governance committee, and our board include fewer, independent directors than would be required if we were subject to the NYSE rules applicable to most U.S. companies. As long as we rely on the foreign issuer exemptions to the NYSE rules, a majority of our board of directors is not required to consist of independent directors, our compensation committee is not required to be comprised entirely of independent directors, and we will not be required to have a nominating and corporate governance committee. Therefore, our board’s approach may be different from that of a board with a majority of independent directors, and, as a result, the management team’s oversight of the Company may be more limited than if we were subject to the NYSE rules applicable to most U.S. companies.

 

Risks Relating to Our Preferred Shares and ADSs

 

If we do not maintain a registration statement and no exemption from the Securities Act registration is available, U.S. Holders of ADSs may be unable to exercise preemptive rights with respect to our preferred shares.

 

We may not be able to offer our preferred shares to U.S. holders of ADSs residing in the U.S. pursuant to preemptive rights granted to holders of our preferred shares in connection with any future issuance of our preferred shares unless a registration statement under the Securities Act is effective with respect to such preferred shares and preemptive rights, or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file or maintain a registration statement relating to any preemptive rights offerings with respect to our preferred shares, and we cannot assure you that we will file or maintain any such registration statement. If such a registration statement is not filed and maintained and an exemption from registration does not exist, our depositary, will attempt to sell the preemptive rights, and you will be entitled to receive the proceeds of such sale. However, these preemptive rights will expire if the depositary does not sell them, and U.S. holders of ADSs will not realize any value from the granting of such preemptive rights. Even if a registration statement is effective, we may decide and are allowed to not extend any preemptive or subscription rights to U.S. Persons (as defined in Regulation S under the Securities Act) that are holders of our preferred shares and ADSs.

 

Judgments of Brazilian courts with respect to our preferred shares will be payable only in reais.

 

If proceedings are brought in the courts of Brazil seeking to enforce our obligations in respect of the preferred shares, we will not be required to discharge its obligations in a currency other than reais. Under Brazilian exchange control limitations, an obligation in Brazil to pay amounts denominated in a currency other than reais may only be satisfied in Brazilian currency at the exchange rate, as determined by the Central Bank, in effect on the date the judgment is obtained, and such amounts are then adjusted to reflect exchange rate variations through the effective payment date. The then prevailing exchange rate may not afford non-Brazilian investors with full compensation for any claim arising out of, or related to, our obligations under the preferred shares or the ADSs.

 

If an ADS holder surrenders its ADSs and withdraws preferred shares, it risks losing the ability to remit foreign currency abroad and certain Brazilian tax advantages.

 

An ADS holder benefits from the electronic certificate of foreign capital registration obtained by the custodian for our preferred shares underlying the ADSs in Brazil, which permits the custodian to convert dividends and other distributions with respect to the preferred shares into non-Brazilian currency and remit the proceeds abroad. If an ADS holder surrenders its ADSs and withdraws preferred shares, it will be entitled to continue to rely on the custodian’s electronic certificate of foreign capital registration for only five business days from the date of withdrawal. Thereafter, upon the disposition of or distributions relating to the preferred shares unless it obtain its own electronic certificate of foreign capital registration or qualifies under Brazilian foreign investment regulations that entitle some foreign investors to buy and sell shares on Brazilian stock exchanges without obtaining separate electronic certificates of foreign capital registration, such former holder of ADSs would not be able to remit abroad non-Brazilian currency. In addition, if an ADS holder does not qualify under the foreign investment regulations, it will generally be subject to less favorable tax treatment of dividends and distributions on, and the proceeds from any sale of, our preferred shares.

 

If an ADS holder attempts to obtain its own electronic certificate of foreign capital registration, it may incur expenses or suffer delays in the application process, which could delay its ability to receive dividends or distributions relating to our preferred shares or the return of its capital in a timely manner. The depositary’s electronic certificate of foreign capital registration may also be adversely affected by future legislative changes.

 

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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. das Nações Unidas, 8501 - 8º andar, São Paulo, SP, Brazil, and the telephone number is +55 (11) 3094 6300.

 

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 and the parent company of Gerdau S.A.

 

From 1901 to 1969, the Pontas de Paris nail factory grew and expanded its business into a variety of 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 12 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. In 1989, the Company acquired 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 non-controlling 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, and the former Ameristeel Corp., a producer of common long rolled products. In 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.

 

In December 2003, Gerdau Açominas S.A., signed a purchase agreement with the Votorantim Group. Under this contract, Gerdau Açominas S.A. has agreed to purchase the real estate and mining rights of Companhia Paraibuna de Metais, a company controlled by Votorantim Group, whose mines were located at Miguel Burnier, Várzea do Lopes and Gongo Soco in the state of Minas Gerais. The assets involved in this transaction include extraction concessions. The price agreed upon for the purchase of the real estate and mineral rights described above was US$ 30 million (R$88.1 million on the date of the acquisition). In 2012, Gerdau guaranteed its iron ore self-sufficiency for the integrated mill (Ouro Branco).

 

In September 2005, Gerdau acquired 36% of the stock issued by Sipar Aceros S.A., a long steel rolling mill, located in the Province of Santa Fé, Argentina. This interest, added to the 38% already owned by Gerdau represents 74% of the capital stock of Sipar Aceros S.A. In the same month, Gerdau concluded the acquisition of a 57% interest in Diaco S.A., the largest rebar manufacturer in Colombia. In January 2008, Gerdau acquired an additional interest of 40% for US$107.2 million (R$188.7 million on the acquisition date), increasing its interest to 99% of the capital stock, a figure that also takes into consideration the dilution of non-controlling interests, which explains the higher Gerdau share compared with the share in the two major acquisitions made. In June 2017, Gerdau concluded the operation to form a joint venture, based on the sale of its 50% interest in Gerdau Diaco, in Colombia, with Putney Capital Management. The transaction attributes an economic value to the joint venture of US$165 million (R$546 million on the transaction date).

 

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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 US$ 219.2 million (R$ 493.2 million on the acquisition date). In December 2008, Gerdau Hungria Holding Limited Liability Company acquired for US$ 288.0 million (R$ 674.0 million on the acquisition date) a 20% interest in Corporación Sidenor S.A. With this acquisition, Gerdau became the majority shareholder (60%) in Corporación Sidenor. In January 2013, as a result of the settlement of a put option held by the Santander Group, the Company acquired the remaining 40% of Corporación Sidenor S.A., for R$ 599.2 million. In May 2016, the Company closed the sale of Gerdau Holdings Europa S.A. in Spain (the subsidiary which held Corporación Sidenor S.A.). The transaction value was € 155 million (equivalent to R$ 621 million on the completion of the sale), with the possibility of receiving up to an additional  € 45 million (equivalent to R$ 180 million) within five years, depending on future business performance.

 

In June 2006, Gerdau 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 US$ 60.6 million (R$ 134.9 million on the acquisition date). In November 2006, Gerdau also won the bid for 324,327,847 shares issued by Siderperú, which represented 33% of the total capital stock, for US$ 40.5 million, totaling US$ 101.1 million (R$ 219.8 million on the acquisition date). This acquisition added to the interest already acquired earlier in the year, for an interest of 83% of the capital stock of Siderperú.

 

In March 2007, Gerdau acquired Siderúrgica Tultitlán, a mini mill located in the Mexico City that produces rebar and profiles. The price paid for the acquisition was US$ 259.0 million (R$ 536.0 million on the acquisition date).

 

In May 2007, Gerdau acquired an interest of 30% in Multisteel Business Holdings Corp., a holding of Indústrias Nacionales, C. por A. (“INCA”), a company located in Santo Domingo, Dominican Republic, that produces rolled products. This partnership allowed Gerdau to access the Caribbean market. The total cost of the acquisition was US$ 42.9 million (R$ 82.0 million on the acquisition date). In July 2007, Gerdau acquired an additional interest of 19% in Multisteel Business Holdings Corp., bringing its total interest in the Company to 49%. The total cost of this second acquisition was US$ 72.0 million (R$ 135.2 million on the acquisition date). In October 2014, Gerdau and Complejo Metalúrgico Dominicano S.A. confirmed the merger of operations of its companies Industrias Nacionales and METALDOM, becoming denominated Gerdau Metaldom. This merger is aimed at more efficiency and competitiveness in the Caribbean and Central America region and assures the supply of steel products for construction sector in the Dominican Republic.

 

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. The total cost of the acquisition was US$ 92.5 million (R$ 176.2 million on the acquisition date).

 

In the same month, Gerdau and the Kalyani Group from India initiated an agreement to establish a joint ventures for an investment in Tadipatri, India. The joint venture included an interest of 45% in Kalyani Gerdau Steel Ltd. The agreement provides for shared control of the joint venture, and the purchase price was US$ 73.0 million (R$ 127.3 million on the acquisition date). In May 2008, Gerdau announced the conclusion of this acquisition. In July 2012, the Company obtained control of Kalyani Gerdau Steel Ltds (KGS), which the Company had an interest of 91.28% as of the control acquisition date. In 2012, until the date Gerdau acquired control over KGS, Gerdau made capital increases in KGS, which resulted in an increase of its shareholder interest, going from 80.57% in December 31, 2011 to 91.28%.

 

In September 2007, Gerdau concluded the acquisition of Chaparral Steel Company, increasing Gerdau’s portfolio of products and including a comprehensive line of structural steel products. The total cost of the acquisition was US$ 4.2 billion (R$ 7.8 billion on the acquisition date), plus the assumption of certain liabilities.

 

In October 2007, Gerdau executed a letter of intent for the acquisition of a 49% interest 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. The acquisition price was US$ 110.7 million (R$ 186.3 million on the acquisition date). In February 2008, the Company announced the 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 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, Ohio, Indiana and Wisconsin. The purchase price for this acquisition was US$1.5 billion (R$2.4 billion on the acquisition date) in addition to the assumption of their debts and some liabilities. Gerdau concluded the acquisition in April 2008.

 

In June 2008, the parent company Metalúrgica Gerdau S.A. acquired a 29% stake of voting and total capital in Aços Villares S.A. from BNDESPAR for R$ 1.3 billion. As a payment, Metalúrgica Gerdau S.A. issued debentures to be exchanged for Gerdau S.A.’s common shares. In December 2009 the Company’s stake in Aços Villares S.A. owned through its subsidiary Corporación

 

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Sidenor S.A. was transferred to direct control of Gerdau S.A., for US$ 218 million (R$ 384 million on the acquisition date), which then owned a total 59% stake in Aços Villares S.A. On December 30, 2010, Gerdau S.A. and Aços Villares S.A. shareholders approved the merger into Gerdau S.A. of Aços Villares S.A. The transaction was carried out through a share exchange, whereby the shareholders of Aços Villares S.A. received one share in Gerdau S.A. for each lot of twenty-four shares held. The new shares were credited on February 10, 2011. As a result of the transaction, Aços Villares S.A. was delisted from the Brazilian stock exchange.

 

On August 30, 2010, Gerdau S.A. concluded the acquisition of all outstanding common shares issued by Gerdau Ameristeel that it did not yet hold either directly or indirectly, for US$ 11.00 per share in cash, corresponding to a total of US$ 1.6 billion (R$ 2.8 billion). With the acquisition, Gerdau Ameristeel was delisted from the New York and Toronto stock exchanges.

 

On July 14, 2015 the Company approved the acquisition of the minority interests described below, in the following companies: Gerdau Aços Longos S.A. (4.77%), Gerdau Açominas S.A. (3.50%), Gerdau Aços Especiais S.A. (2.39%) and Gerdau América Latina Participações S.A. (4.90%), with its counterparts Itaú Unibanco S.A. and ArcelorMittal Netherlands BV. The acquisitions of these interests, in a total amount of R$1,986 million, allowed Gerdau to hold more than 99% of the total capital of each of the subsidiaries. On August 10, 2015, the CVM requested clarification from Gerdau and the Company, referring to the statements of a shareholder concerning the transaction for the acquisition of minority stakes in subsidiaries by Gerdau. The shareholder alleged a potential conflict of interest in the transaction. In response, the Company has identified to the CVM that the referenced acquisition had exclusively commercial merits, was properly and unanimously approved by the Board of Directors of Gerdau and that the terms and conditions for the acquisition took into account a long term market perspective.

 

On December 29, 2017, the Company entered into a definitive agreement to sell some of its rebar-producing mills, as well as fabricated rebar units and distribution centers in the United States, to Commercial Metals, for US$600 million (R$2.0 billion on the sale date). The agreement includes mills in Jacksonville (Florida), Knoxville (Tennessee), Rancho Cucamonga (California) and Sayreville (New Jersey). The transaction is subject to authorization from regulatory agencies and typical settlement conditions.

 

In February 2018, the Company sold its two hydroelectric power plants based in Goias state, in Brazil, for R$835 million, to Kinross Brasil Mineração, a wholly-owned subsidiary of the Canadian mining company Kinross Gold Corporation. The hydroelectric power plants Caçu and Barra dos Coqueiros, which commenced operations in 2010, have a total capacity of 155 MW. The transaction is subject to regulatory clearances and customary closing conditions.

 

B.            BUSINESS OVERVIEW

 

Steel Industry

 

The world steel industry is composed of hundreds of steel producing facilities 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, in 2016 (the most recent year for which information is available), 25.7% of the total crude steel production in the world was through mini-mill process and the remaining 74.3% was through the integrated process.

 

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Crude Steel Production by Process in 2016*

 

 

 

Crude Steel
Production
(in million

 

Production by Process (%)

 

Blast Furnace

 

tonnes)

 

Mini-mill

 

Integrated

 

World

 

1,627

 

25.7

 

74.3

 

China

 

808

 

6.4

 

93.6

 

Japan

 

105

 

22.2

 

77.8

 

India

 

96

 

57.3

 

42.7

 

U.S.A.

 

78

 

67.0

 

33.0

 

Russia

 

71

 

30.8

 

69.2

 

S. Korea

 

69

 

30.7

 

69.3

 

Germany

 

42

 

29.9

 

70.1

 

Turkey

 

33

 

65.9

 

34.1

 

Brazil

 

31

 

21.1

 

78.9

 

 


Source: World Steel/World Steel In Figures

*Most recent year for which information available

 

Over the past 10 years, according to World Steel, total annual crude steel production has grown from 1,348.1 million tonnes in 2007 to 1,674.7 million tonnes in 2017, for an average annual increase of 2.9%.

 

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 increased by 2.8% from 1,628.5 million tonnes in 2016 to 1,674.7 million tonnes in 2017.

 

Crude Steel Production (in million tonnes)

 

 

Source: World Steel/Monthly Statistics

 

China is rebalancing its economy to move more towards a consumer-driven economy. GDP growth was aligned with the government expectation and despite the injection of credit into the construction and infrastructure sectors, the country showed a reduction in steel consumption for the third year in a row. In 2016, China’s crude steel production was 831.7 million tonnes, an increase of 2.9% compared to 2016. In 2017, China’s share of world steel production was 49.7% of world total crude steel.

 

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Crude Steel Production by Country in 2017 (million tonnes)

 

 

Source: World Steel/Monthly Statistics

 

Asia produced 1,151.8 million tonnes of crude steel in 2017, an increase of 5.7% compared to 2016, and its share of world steel production amounted to 69.0%. The EU-28 produced 168.7 million tonnes of crude steel in 2017, a increase of 4.1% compared to 2016, representing 10% of the global total. In 2017, crude steel production in North America increased 4.9% when compared to 2016, a total of 116.0 million tonnes. The CIS (Commonwealth of Independent States) showed a stable crude steel production with a total of 102.0 million tonnes in 2017.

 

The Brazilian Steel Industry

 

In 2017, Brazil was the world’s 9th largest producer of crude steel, with a production of 34.4 million tonnes, a 2.1% share of the world market and 78.7% of the total steel production in South America during the year.

 

Total sales of Brazilian steel products were 34.4 million tonnes in 2017, 31.3 million tonnes in 2016 and 33.3 million tonnes in 2015, exceeding domestic demand of 19.2 million tonnes in 2017, 18.4 million tonnes in 2016 and 21.3 million tonnes in 2015. In 2017, total steel sales in the domestic market increased 2.3% from 2016, going from 16.5 million tonnes to 16.9 million tonnes.

 

In 2017, the total of Brazilian steel products sales was 31.6 million tonnes. The breakdown of total sales was 69.1% or 21.8 million tonnes of flat steel products, formed by domestic sales of 10.1 million tonnes and exports of 11.7 million tonnes. The remaining 30.9% or 9.7 million tonnes represented sales of long steel products, which consisted of domestic sales of 6.8 million tonnes and exports of 2.9 million tonnes.

 

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

 

 

Source: Instituto Aço Brasil

 

Domestic demand — Historically, the Brazilian steel industry has been affected by significant variations in domestic steel demand. Although 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 2017, the Brazilian GDP increased by 1.0% and steel consumption increased by 4.3%.

 

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 has lagged total supply (total production plus imports).

 

In 2017, Brazilian steel exports totaled 14.6 million tonnes, representing 46.4% of total sales (domestic sales plus exports). 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 9.5 million tonnes in 2017, 8.4 million tonnes in 2016 and 8.7 million tonnes in 2015, representing 64.9%, 64.3% and 63.5% of Brazil’s total exports of steel products, respectively.

 

Brazilian Production and Apparent Demand for Steel Products (million tonnes)

 

 

Source: Instituto Aço Brasil

 

Brazil used to be a small importer of steel products. Considering the reduction in the international steel prices during 2010, the appreciation of the Brazilian real against the U.S. dollar and the decrease in demand for steel products in developed countries, the Brazilian levels of imports increased from 2.3 million tonnes in 2009 to 5.9 million tonnes in 2010 (excluding the imports made by the steel mills to avoid double counting), representing 22.0% of apparent domestic consumption. In 2015, imports were 3.2 million tonnes, decreased to 1.9 million tonnes in 2016 and increased to 2.3 million tonnes in 2017. In 2017, imports represented 12.0% of apparent domestic consumption, an increase compared to 2016, which was mainly due to higher prices in the domestic market compared to the international market.

 

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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 from small miners in Brazil is very competitive if compared to the cost of iron ore in China, for example.

 

In Brazil, most of the scrap metal consumed by steel mills comes from Brazil’s southeast and south regions. Mill suppliers deliver scrap metal obtained from obsolete products and industrial scrap directly to the steel mills.

 

Brazil is a major producer of pig iron. Most of the pig iron used in the steel industry comes from the state of Minas Gerais and the Carajás region, where it is produced by various small and midsized producers. The price of pig iron follows domestic and international markets, with charcoal and iron ore the main components of its cost formation.

 

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 and low priced imports. 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.

 

Crude Steel Production by North American Countries (million tonnes)

 

 

Source: World Steel/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 have 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 George W. 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.  More recently, in a White House signing ceremony on March 8, 2018,  President Donald Trump announced he was imposing import tariffs of 25% on steel and 10% on aluminum. After invoking a rarely-used Cold War-era law last year, Commerce Secretary Wilbur Ross concluded imports were a threat, and he recommended the imposition of  these  new restrictions covering an estimated $46.1 billion of imports, or about 2% of total U.S. goods imports in 2017.

 

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The North American steel industry has experienced a significant amount of consolidation in the last decade.  Bankrupt steel companies, once overburdened with underfunded pension, healthcare and other legacy costs, were 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.  Gerdau’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 steel industry demonstrated strong performance through the middle of 2006, resulting from the increased global demand for steel related products and a continuing consolidation trend among steel producers. 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 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. Since the beginning of 2010, the economy in North America has been showing signs of upturn, contributing to a gradual recovery in the steel industry, with an important improvement in the non-residential and automotive sector. The Company believes that this trend should continue throughout 2018.

 

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Company Profile

 

Gerdau S.A. is mainly dedicated to the production and commercialization of steel products in general, through its mills located in Argentina, Brazil, Canada, Chile, Colombia, the United States, India, Mexico, Peru, the Dominican Republic, Uruguay and Venezuela.

 

Gerdau is the leading manufacturer of long steel in North and South America.  Gerdau believes it is one of the major global suppliers of special steel for the automotive industry.  In Brazil, Gerdau also produces flat steel and iron ore, activities that are expanding Gerdau’s product mix and the competitiveness of its operations. In addition, Gerdau believes it is one of Latin America’s biggest recycler and, worldwide, transforms millions of tonnes of scrap metal into steel every year, reinforcing its commitment to sustainable development in the regions where it operates.  Gerdau’s shares are listed on the New York, São Paulo and Madrid stock exchanges.

 

Gerdau holds significant market share in the steel industries of almost all countries where it operates and was classified by World Steel Association as the world’s 18th largest steel producer based on its consolidated crude steel production in 2016, the most recent year for which information is available.

 

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 three integrated steel mills, including its largest mill, Ouro Branco, located in the state of Minas Gerais.  Gerdau currently has a total of 41 steel producing facilities globally.

 

As of December 31, 2017, Gerdau’s total consolidated installed annual capacity, excluding investments in joint ventures and associate companies, was approximately 26.1 million tonnes of crude steel and 21.1 million tonnes of rolled steel products. The Company had total consolidated assets of R$ 50.3 billion, shareholders’ equity (including non-controlling interests) of R$ 23.9 billion, consolidated net sales of R$ 36.9 billion and a total consolidated net loss (including non-controlling interests) of R$338.7 million for the period ended on December 31, 2017.

 

Gerdau offers a wide array of steel products, which can be manufactured according to the customer’s specifications.  The product mix includes crude steel (slabs, blooms and billets) sold to rolling mills, finished products for the construction industry such as rebars, wire rods, structural, hot rolled coils and heavy plates; finished products for consumer goods industry such as commercial bars, light shapes and mesh wire and products for farming and agriculture such as poles, smooth wire and barbed wire.  Gerdau also produces special steel products, normally with a certain degree of customization, utilizing advanced technology, for the manufacture of tools and machinery, chains, locks and springs, mainly for the automotive and mechanical industries.

 

A significant portion of Gerdau’s steel production assets are located outside Brazil, particularly in the United States and Canada, as well as in Latin America and Asia. Gerdau currently operates 16 steel production units in the United States, Canada and Mexico, and believes that it is one of the market leaders in North America in terms of production of certain long steel products, such as rebars, wire rods, commercial bars and beams.

 

Gerdau’s operating strategy is based on the acquisition and/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, Gerdau also exports a substantial portion of its production to other countries.

 

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

 

Operations

 

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

 

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The Company manages its Business Divisions as follows:

 

·                  Brazil BD (Brazil Business Division) - includes operations in Brazil (excluding Special Steel) and iron ore operation in Brazil;

 

·                  North America BD (North America Business Division) - includes all operations in North America (Canada, United States and Mexico), except special steels, in addition to associate and joint ventures, both of which are located in Mexico;

 

·                  South America BD (South America Business Division) - includes all operations in South America (Argentina, Chile, Peru, Uruguay and Venezuela), except the operations in Brazil, in addition to the joint venture in the Dominican Republic and Colômbia; and

 

·                  Special Steel BD (Special Steel Business Division) - includes the special steel operations in Brazil, the United States and India.

 

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

 

Shipments

 

Gerdau S.A. Consolidated
Shipments by Business
Operations (1)

 

Year ended December 31,

 

(1,000 tonnes)

 

2017

 

2016

 

2015

 

TOTAL

 

14,938

 

15,558

 

16,970

 

Brazil

 

5,608

 

6,067

 

6,457

 

North America

 

6,313

 

5,965

 

6,232

 

South America

 

1,723

 

2,088

 

2,222

 

Special Steel

 

1,977

 

2,102

 

2,621

 

Eliminations and Adjustments

 

(683

)

(665

)

(562

)

 


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

 

Net Sales

 

Gerdau S.A. Consolidated Net
Sales by Business Divisions (1)

 

Year ended December 31,

 

(R$ million)

 

2017

 

2016

 

2015

 

TOTAL

 

36,918

 

37,652

 

43,581

 

Brazil

 

12,563

 

11,635

 

12,977

 

North America

 

15,433

 

15,431

 

17,312

 

South America

 

4,026

 

4,776

 

5,477

 

Special Steel

 

6,229

 

6,885

 

8,882

 

Eliminations and Adjustments

 

(1,333

)

(1,075

)

(1,067

)

 


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

 

Production

 

Gerdau S.A. Consolidated

 

Year ended December 31,

 

annual production (million tonnes)

 

2017

 

2016

 

2015

 

Crude Steel Production

 

16,120

 

15,677

 

16,862

 

Rolled Steel Production

 

14,047

 

13,616

 

14,604

 

Iron Ore Production

 

7,265

 

8,647

 

  7,419

 

 

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Brazil Business Division

 

Steel information

 

The Brazil Business Division 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 forecasted monthly. The Brazil Business Division 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 Business Division, sales volume in 2017 fell by 7.6% compared to 2016, mainly influenced by the 15.6% reduction in exports due to the low profitability caused by higher costs. In the domestic market, the reduction of 2.5% was caused by the slowdown in the construction industry.

 

In 2017, around 15% of the production sold in Brazil was distributed through Gerdau’s distribution channel, with stores throughout Brazil and downstream facilities serving a significant number of customers. Another important distribution channel is the independent distributors’ network, formed by 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 Gerdau employees and authorized sales representatives working on commission. This Business Division has annual crude steel installed capacity of 9.2 million tonnes and 7.1 million tonnes of finished steel products.

 

Iron ore information

 

Gerdau’s mineral assets were incorporated to its business through the acquisition of lands and mining rights of Grupo Votorantim, in 2004, encompassing the Miguel Burnier, Várzea do Lopes, and Gongo Soco compounds, located in the iron producing region in the state of Minas Gerais, Brazil. From 2004 to 2010, several geological surveys (drilling and superficial geological mapping) were conducted in order to obtain further information on the acquired resources.

 

North America Business Division

 

The North America Business Division has an annual production capacity of 11.5 million tonnes of crude steel and 8.6 million tonnes of finished steel products. It has a vertically integrated network of 16 steel units for the operation of steel units , scrap recycling facilities, downstream operations and rebar fabrication shops. The North America ‘Business Division’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 inventory for the mini-mill operations is recycled steel scrap.

 

The mills of this business division manufacture and commercialize a wide range of steel products, including steel reinforcement bars (rebar), merchant bars, structural shapes, beams, special sections and coiled wire rod. Some of these products are used by the downstream units to make products with a higher added value, which consists of the fabrication of rebar, railroad spikes, super light beam processing, elevator guide rails, grinding balls, wire mesh and wire drawing.

 

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

 

In general, sales of finished products to U.S. and Canadian customers are centrally managed by the Tampa sales office.  There is also a sales office in Selkirk, Manitoba for managing sales of special sections and one in Texas for managing sales of structural and merchant bar products. Metallurgical service representatives at the mills provide technical support to the sales group.  Sales of the 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 Gerdau’s facilities work closely with customers to tailor product requirements, shipping schedules and prices.

 

In the North America Business Division, 2017 shipments were on the level of 6.5 million tonnes.  The increased share of imported products have continued to impact the North American market.

 

The North America Business Division accounted for 40.4% of overall Gerdau sales volumes. Gerdau’s Canadian operations sell a significant portion of their production in the United States.

 

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Table of Contents

 

South America Business Division

 

The South America Business Division comprises of five steel facilities, retail facilities, fab shops (including joint ventures and associate companies) and scrap processing facilities. The entire operation is focused on the respective domestic markets of each country, operating mini-mills facilities with annual manufacturing capacity of 2.2 million tonnes of crude steel and 1.6 million tonnes of finished steel products. The South American operation accounted for 11.5% of overall Gerdau sales volumes, representing 1.7 million tonnes in 2017, a reduction of 17.5% when compared to 2016. The countries in the South America Business Division are Argentina, Chile, Peru, Venezuela and Uruguay. Gerdau also operates in the markets of Colombia and Dominican Republic through joint ventures.

 

Special Steel Business Division

 

The Special Steel Business Division is composed of the operations in Brazil (Charqueadas, Pindamonhangaba and Mogi das Cruzes), in the United States (Fort Smith, Jackson and Monroe) and in India (Tadipatri). This operation produces engineering steel (SBQ), tool 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 high strength steels, clean steel, high temperability steels and steel with improved machining characteristics, among others.

 

The Special Steel Business Division registered a decrease of 5.9% when compared to 2016, due to the divestment of the units in Spain in 2016. Excluding this factor, shipments increased at the other operations.

 

In Brazil, Gerdau special steel operations are located in Rio Grande do Sul (Charqueadas) and in São Paulo (Pindamonhangaba and Mogi das Cruzes). The special steel units in Brazil have a combined annual capacity of 1.4 million tonnes of crude steel and 1.9 million tonnes of rolled products. The operation in Brazil has more than 300 customers located mainly in Brazil, although its products are also exported to South America, North America and Europe.

 

In North America, Gerdau maintains a presence in United States, with three mills located in Jackson (Michigan), Monroe (Michigan) and Fort Smith (Arkansas). The operation also has six downstream operations. The operation has an annual installed capacity of 1.5 million tonnes of crude steel and 1.5 million tonnes of rolled products and has more than 200 customers located mainly in the United States, Canada and Mexico.

 

In India, the Company has a plant for the production of special steel with capacity of 250 thousand tonnes of crude steel and 300 thousand tonnes of rolled products. The operation is constantly evolving and is achieving better results each year.

 

There are commercial and operational synergies among the units in this business division.

 

Exports

 

In 2017, the international market had two distinct moments, with the first half of the year still affected by the oversupply of steel and low prices at the close of 2016, and the second half impacted by the strong contraction of China’s presence in the international market and the consequent increase in prices.

 

The difference between the scenarios in the first and second halves of the year is clearly seen when we calculate the volumes exported by China during the year. Chinese exports of finished goods in 2017 decreased 30.5% to 75 million tonnes, based on information from specialized publications. In 2016, exports of finished products amounted to 109 million tonnes. Comparing the month of December of each year, in 2017, Chinese exports amounted to 5.7 million tonnes, compared to 7.8 million tonnes in 2016.

 

In addition to the contraction in China’s presence in the international market, 2017 was marked by higher production costs, which in turn supported higher prices. The global shortage in electrodes and in the raw material used to make them, needle coke, interruptions in the supply of metallurgical coal and iron ore in Australia due to adverse weather conditions, reductions in obsolete production capacity in China (induction furnaces) and the recent focus on electric furnaces (pressuring scrap prices) were the main factors explaining the increase in costs. Despite the significant increase in costs, the new price levels reached as from the second half ensured historically high spreads and consequently good profitability for mills around the world, especially in China.

 

In 2017, Gerdau’s Brazilian exports continued to focus on South America, which accounted for 42% of exports, leveraged by supply from the group’s companies. The share of exports destined for Africa and the Middle East increased significantly due to the growth in billet exports to these region.

 

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The following table presents Gerdau’s exports by destination for selected periods:

 

Consolidated Exports of Gerdau Steel in

 

Fiscal Year ended December 31st,

 

Brazil, by Destination (%)

 

2017

 

2016

 

2015

 

Total including shipments to subsidiaries (1,000 tonnes)

 

1.991

 

2.360

 

2.173

 

Africa

 

6

%

3

%

14

%

Central America

 

21

%

27

%

11

%

North America

 

11

%

22

%

22

%

South America

 

42

%

31

%

26

%

Asia

 

6

%

5

%

6

%

Europe

 

11

%

12

%

15

%

Middle East

 

2

%

1

%

7

%

 

Gerdau continues to consolidate its client base around the world, which is essential for expanding its exports portfolio and overcoming the challenges in 2018.

 

Products

 

The Company supplies its customers with a wide range of products, including steel products and iron ore:

 

Semi-finished products (Billets, Blooms and Slabs)

 

The semi-finished 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 represent an important part of the products from the Ouro Branco mill. 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, and mainly used to produce hot and cold rolled coils, heavy slabs, profiles and heavy plates.

 

The semi-finished products are produced using continuous casting and, in the case of blooms and billets there is subsequent rolling process.

 

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, wire rods, merchant bars, light shapes 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.

 

Special Steel Products

 

Special steel requires advanced manufacturing processes because they have specific physical and metallurgical characteristics for applications with high mechanical demands. This steel is a key product for the automotive industry, as it is used in auto parts, light and heavy vehicles and agricultural machinery. Special steels also serve other relevant markets, such as oil and gas, wind energy, machinery and equipment, mining and rail, among others.

 

Flat Products

 

The Ouro Branco mill produces hot rolled coils and heavy plate, which are sold in the domestic and export markets. The Company distributes these products through its distribution channel and direct sales, and also resells flat steel products manufactured by other Brazilian steel producers to which it adds further value through additional processing at its flat steel service centers.

 

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Table of Contents

 

Iron Ore

 

Gerdau operates three mines producing iron ore, all located in the Brazilian state of Minas Gereais (Várzea do Lopes, Miguel Burnier and Gongo Soco). The mines produce the following: sinter feed (featuring low content of contaminants and good metallurgical properties, enabling its use as a base material); pellet feed/concentrated (superior quality enabling its use as a chemical balancer in the synthetizing process, while being also adequate for pelletizing, blast furnace quality - low loss by calcination — PPC); hematite fines (small scale production, used as input in Gerdau’s furnaces); and granulated (high quality, used chiefly for own consumption at the Ouro Branco Mill).

 

The following table presents the main products and the contributions to net revenue and net income by Business Division for the periods shown:

 

 

 

Brazil(1)

 

North America

 

South America

 

Special Steel

 

Eliminations and
Adjustments

 

Products

 

Rebars, merchant bars, beams, drawn
products, billets, blooms, slabs, wire
rod, structural shapes, hot rolled coil,
heavy plate and iron ore.

 

Rebars, merchant bars, wire rod, light
and heavy structural shapes.

 

Rebar, merchant bars and drawn
products.

 

Stainless steel, special profiles
and wire rod.

 

 

 

 

 

 

Year

 

2017

 

2016

 

2015

 

2017

 

2016

 

2015

 

2017

 

2016

 

2015

 

2017

 

2016

 

2015

 

2017

 

2016

 

2015

 

Net Sales (R$ million)

 

12,562.7

 

11,634.9

 

12,977.3

 

15,433.4

 

15,430.8

 

17,312.2

 

4,025.7

 

4,775.6

 

5,477.2

 

6,228.5

 

6,884.7

 

8,882.1

 

(1,332.8

)

(1,074.3

)

(1,067.6

)

% of Consolidated Net Sales

 

34.0

%

30.9

%

29.8

%

41.8

%

41.0

%

39.7

%

10.9

%

12.7

%

12.6

%

16.9

%

18.3

%

20.4

%

-3.6

%

-2.9

%

-2.4

%

Net (Loss) Income (R$ million)

 

302.3

 

(36.7

)

(671.7

)

(956.3

)

(2,591.9

)

(1,468.1

)

154.4

 

134.2

 

(154.2

)

475.4

 

162.5

 

(2,297.3

)

(314.5

)

(554.1

)

(4.7

)

% of Consolidated Net (Loss) Income

 

-89.3

%

1.3

%

14.6

%

282.4

%

89.8

%

31.9

%

-45.6

%

-4.7

%

3.4

%

-140.4

%

-5.6

%

50.0

%

92.9

%

19.2

%

0.1

%

 

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 39 mini-mills worldwide. Mini-mills are equipped primarily with electric arc furnaces that can melt steel scrap and produce steel product at the required specifications requested by customers. 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 five integrated mills, of which three are located in Brazil, one in Peru and one in India. The Ouro Branco mill 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 semi-finished products (billets, blooms and slabs). In the primary stage of steel making, sinter (a mixture of iron ore and fluxes), coke and other raw materials are consumed in the blast furnace to produce pig iron.

 

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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 and scrap 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 and degassing processes.

 

The liquid steel is then sent to the continuous casting equipment, which are solidified in the form of billets, blooms or slabs. These products can be sold directly to customers, be transferred for processing into other Gerdau units or be transformed into rolled finished products in the Company´s own integrated units. Gerdau integrated units in Brazil have rebar, bars and rods, wire rods, structural steel, hot rolled coils and heavy plate rolling mills.

 

Logistics

 

Gerdau sells its products through independent distributors, direct sales from the mills and its retail network.

 

Logistics costs are an important component of most steel businesses and represent a significant factor in maintaining competitive prices in the domestic and export markets. The Gerdau mills are strategically located in various different geographic regions. The Company believes that the proximity of its mills to raw material sources and important consumer markets gives it a competitive advantage in serving customers and obtaining raw materials at competitive costs. This represents an important competitive advantage in inbound and outbound logistics.

 

To adequate and reduce logistic costs, Gerdau uses specific solutions, directed to different types of transportation modes (road, rail, sea and cabotage), terminals, technology and equipment. Gerdau continuously seeks to improve its performance to receive raw materials, and to deliver products to its customers or ports of destination. Accordingly, Gerdau develops and maintain long-term relationships with logistic suppliers specialized in delivering raw materials and steel products.

 

In 1996 Gerdau acquired an interest in MRS Logística, one of the most important rail companies in Brazil, which operates connecting the states of São Paulo, Rio de Janeiro and Minas Gerais, which are Brazil’s main economic centers, and also reaches the main ports of the country in this region. These shares provide the guarantee of using this mode to transport raw materials (scrap and pig iron) as well as final products.

 

Gerdau uses a variety of ports to deliver products from the entire Brazilian coastline. The majority of exports are shipped from the Praia Mole Private Steel Terminal in Vitoria, Espírito Santo.

 

Overseas, Gerdau owns a private port terminal in Chimbote (Peru), where the Company has a steel mill, used to deliver inputs, raw material and products for the operation.

 

Competition

 

The steel market is divided into manufacturers of long steel products, flat steel products and special 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 and wire rod fabrication facilities.

 

The Company operates in the flat steel market through its Ouro Branco mill that produces slabs, which are used to roll flat products such as hot and cold rolled steel coils and heavy plates. Gerdau also produces hot-rolled coils, which are sold in the domestic and export markets. The Company distributes these hot-rolled coils and also resells flat steel products manufactured by other Brazilian steel producers to which it adds further value through additional processing at its flat steel service centers.

 

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Table of Contents

 

The Company produces special 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 special steel units in Brazil, United States and India.

 

Competitive Position — Brazil

 

The Brazilian steel market is very competitive. In the year ended December 31, 2017, ArcelorMittal Brasil and the Company were the two largest Brazilian crude steel producers, according to the Brazilian Steel Institute (IABr - Instituto Aço Brasil).

 

World common long rolled steel demand is met principally by steel mini-mills and, to a much lesser extent, by integrated steel producers. In the Brazilian market, no single company competes against the Company across its entire product range. The Company has been facing some competition from long steel products imports, mainly coming from Turkey, with more extension from 2010. The Company believes that the diversification of its products, the solution developed by its fab shops units and the decentralization of its business provide a competitive edge over its major competitors.

 

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 ArcelorMittal in the slab and wire rod markets. With respect to the rebar market, competition in the Brazilian domestic market has increased in recent years due to two new entrants (Simec and Silat) and Companhia Siderurgica Nacional (CSN), which started rebar production.

 

Competitive Position — Outside Brazil

 

Outside Brazil, notably in North America, the Company has increased its market share through acquisitions, and believes to be the second largest mini-mill steel producer in North America, with annual nominal capacity of 9.3 million tonnes of crude steel and 6.9 million tonnes of rolled products.

 

Gerdau’s geographic market in North America encompasses primarily the United States and Canada. The Company faces substantial competition in the sale of each of its products from numerous competitors in its markets. 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 non-regional producers is somewhat limited. Proximity of product inventories to customers, combined 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 the Selkirk, Midlothian, Jacksonville, Jackson, Cartersville and Petersburg mini-mills are shipped greater distances, including overseas.

 

The Company’s principal competitors include Commercial Metals Company (CMC), Nucor Corporation, Steel Dynamics Inc., and ArcelorMittal Inc.

 

In South 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 70% of shipments from Gerdau’s South American Operation originate from Chile, Peru and Colombia. In this market, the main barriers faced by Gerdau sales are freight and transportation costs and the availability of imports. The main products sold in the South American market are the constructions, mechanic, agriculture and mining markets.

 

Currently, the Company believes the special steel operations in United States are approximately 19.5% of the special steel market; in Brazil, Gerdau’s special steel units are combined the biggest player in that market, with a stake of approximately 60.4%; and, in India the production and commercialization of rolled products began in 2013, and continue to ramp up, providing gradual access in the Indian market.

 

Business Cyclicality and Seasonality

 

The steel industry is highly cyclical. Consequently, the Company is exposed to fluctuations in the demand for steel goods that in turn cause fluctuations in the prices of these goods. Furthermore, since the production capacity of Brazil’s steel industry exceeds its demand, it is dependent on export markets. The demand for steel goods and consequently the financial conditions and results of operations of steel producers, including the Company, are generally affected by fluctuations in the world economy and in particular the performance of the manufacturing, construction and automotive industries. Since 2003, the good performance of the world economy, especially in developing economies, such as China, has led to strong demand for steel goods, which contributed to historically high prices for Gerdau’s steel goods. However, with the financial crisis that emerged in mid-2008, these prices have become unsupportable, especially given the expansion in world installed production capacity and the recent softening of demand. In

 

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Table of Contents

 

the second quarter of 2008 and especially in early 2009, the United States and other European economies showed strong signs of a slowdown, which in turn affected many other countries. Over the past few years, developing economies have shown signs of a gradual recovery, while developed economies still present a challenging demand scenario. The Company believes that, in 2018, the steel industry will remain challenging and continue to present volatility, but the projection is that steel consumption will grow 1.6% compared to 2017.

 

In Gerdau’s Brazilian and South 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 Gerdau’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 shipments.

 

Information on the Extent of the Company’s Dependence

 

The Company is not dependent on industrial, commercial or financial agreements (including agreements with clients and suppliers) or on new production processes that are material to its business or profitability. The Company also has a policy of diversifying its suppliers, which enables it to replace suppliers without affecting its operations in the event of failure to comply with the agreements, except in the case of its energy and natural gas supply.

 

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

 

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. Some Gerdau small plants may choose, as an alternative, to use generators to compensate for the energy shortage. Moreover, the Ouro Branco mill generates 70% of its power needs internally using gases generated in the steel-making process.

 

In case of a lack of natural gas, the equipment could be adjusted to use diesel and LPG.

 

Gerdau’s operations are spread across various geographic regions, which provides a risk diversification of any electricity or natural gas supply problems in Brazil.

 

The distribution of electric power and natural gas is a regulated monopoly in most countries, which leads the distributor to be the only supplier in each geographic region. In some countries, regulations allow for a choice of electrical power or natural gas commodity supplier, allowing Gerdau to diversify its supply agreement portfolio.

 

Production Inputs

 

Price volatility

 

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 ferroalloys are also important.

 

Although international ferrous scrap prices suffer high influence 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.

 

Brazil and Special Steel Business Division — 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 contracts with scrap generators, especially scrap from industrial sources, 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.

 

Due to its size, the Ouro Branco mill has developed over the last few years a strategy to diversify its raw materials, which are supplied through various types of contracts and from multiple sources, which include: (i) coking coals imported from Colombia, United States, Canada, Russia, Australia, Peru, among other origins with lower expression in volumes, as well as petroleum coke purchased from Petrobrás and charcoal chaff also acquired from other domestic suppliers; (ii) ferroalloys, of which 76% are purchased

 

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Table of Contents

 

in the domestic market; and (iii) iron ore, which is mainly produced from its own mines and partially supplied by mining companies, most of them strategically located close to the plant.

 

North America Business Division — The main input used by the Company’s mills in North America is ferrous scrap, and has consistently obtained adequate supplies of raw materials, not depending on a smaller number of suppliers. Due to the fact that the United States are one of the largest scrap exporters in the world, the prices of this raw-material, in this country, may fluctuate according to supply and demand in the world’s scrap market.

 

South America Business Division — The main input used by the Company’s mills in South America is ferrous scrap. This 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 cans to car bodies and white goods; and (ii) industrial scrap, which is composed of scrap from manufacturing processes, essentially steel bushings and flashings, steel turnings and even scrap generated by production processes at steel producers, such as Gerdau. In Brazil, the use of scrap in electric arc furnaces varies between scrap from obsolescence and industrial scrap. Special Steel mills mainly use industrial scrap.

 

In 2017, Gerdau consumed more than 12 million tonnes of scrap, which accounted for significant gains from increasingly competitive operating costs.

 

Because ferrous scrap is one of its main raw materials in steel production, Gerdau is dedicated to improving its supply chain in various countries, aiming to develop and integrate micro and small suppliers into the Company’s business. In Brazil, the main part of the scrap consumed by the Company comes from small scrap collectors who sell all their material to Gerdau, which provides a direct supply at more competitive costs for the Company. In North America, although smaller, the number is still significant, ensuring the competitiveness of the business in the region.

 

Brazil and Special Steel Business Divisions — The price of steel scrap in Brazil varies by region and reflects local supply, demand and transportation costs. The Southeast is the country’s most industrialized region and generates the highest volume of scrap. Due to the high concentration of players in this region, competition is more intense. Gerdau has six scrap shredders, including a mega-shredder at the Cosigua mill in Rio de Janeiro, with capacity to process scrap in volumes superior to 200 carcasses of vehicles per hour.

 

North America Business Division — Ferrous scrap is the primary raw material. The availability of the scrap varies in accordance with the level of economic activity, the season of the year and export levels, leading to price fluctuations. Some mills in the North America Business Division have on-site dedicated scrap processing facilities, including shredder operations that supply a significant portion of their scrap requirements. Given that not all of the scrap it consumes is sourced from its own scrap yards, it purchases residual requirements in the market either directly or through dealers that source and prepare scrap.

 

In North America, all production units are semi-integrated mills or mini-mills, in which results of operations are closely related to the cost of ferrous scrap and its substitutes, which are the main input of mini-mills. Ferrous scrap prices are relatively higher during the winter months in the north hemisphere due to the impact of climate on collection and supply. Prices of ferrous scrap are subject to market forces beyond the Company’s control, including demand from the United States and international steel producers, freight costs and speculation.

 

South America Business Division — The price of scrap in South America varies widely from country to country in accordance with supply, demand and transportation cost.

 

Pig Iron and Sponge Iron

 

Brazil Business Division — Brazil is an exporter of pig iron. Most of Brazil’s pig iron is produced in the state of Minas Gerais by a number of small producers. Pig iron is a drop-in substitute for scrap and in Brazil it is an important component of the metal mix used to make steel in the mills. The price of pig iron follows domestic and international demand, and its cost production is basically composed by reducers and minerals.

 

North America Business Division — Scrap availability imprints a unique characteristic on the use of pig iron and sponge iron, which are used in limited amounts only to produce steels with particular characteristics.

 

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Iron Ore

 

Iron ore is the main input used to produce pig iron at Gerdau’s blast furnace mills located in the state of Minas Gerais, southeastern Brazil. The pig iron is used in the melt shops together with scrap, to produce steel.

 

Iron ore is purchased in its natural form as lump ore, pellet feed or sinter feed, or agglomerated as pellets. The lump ore and pellets are loaded directly into the blast furnace, while the sinter feed and pellet feed need to be agglomerated in the sinter plant and then loaded into the blast furnace, to produce pig iron. The production of 1.0 tonne of pig iron requires about 1.6 tonnes of iron ore.

 

Iron ore consumption in Gerdau mills in Brazil amounted to 6.8 million tonnes in 2017, partially supplied by mining companies adjacent to the steel plants and partially supplied by Gerdau’s mines.

 

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. Additional inputs associated with the production of pig iron are thermal-reducer, which is used in blast furnace mills, and natural gas, which is used at the DRI unit.

 

The Ouro Branco mill’s significant raw materials and inputs also include solid fuels, comprising the metallurgical coal, used in the production of coke and also for the blast furnace pulverized injecting, this last one providing increase in productivity and consequently reduction in the final cost of pig iron. Besides the metallurgical coal, the Company also uses the anthracite, solid fuel used in the production of sinter. The gas resulting from the production of coke and pig iron are reused for generation of thermal energy that can be converted in electric energy for the mill.

 

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 graphite electrodes that are available in the national and international market. Gerdau North America Business Division 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 role in the production process, along with natural gas, which is used mainly in furnaces to re-heat billets in rolled steel production.

 

In Brazil, electricity 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: Usiba and Açonorte. These involve state-owned companies or holders of government concessions. In these contracts, prices are defined by the National Electric Power Agency (ANEEL).

 

·                  Contracts executed in the Free Market Environment, in which Gerdau is a “Free Consumer,” are used by the following units: Araçariguama, Charqueadas, Cosigua, Cearense, Ouro Branco, Divinópolis, Barão de Cocais, Riograndense, São José dos Campos, Cumbica, Cotia, Pindamonhangaba, Mogi das Cruzes and Miguel Burnier. The load of these units is served by a portfolio of contracts and by self-generation. The power supply contracts are entered into directly with generation and/or distributing companies at prices that are pre-defined and adjusted in accordance with conditions pre-established by the parties. The transmission and distribution rates are regulated and revised annually by ANEEL. The Ouro Branco mill generates internally approximately 70% of its energy needs, using the gases produced during the steelmaking process. This makes the plant have significantly lower exposure to the energy market than mini-mills.

 

The Company, in 2017, held the following power generation concessions in Brazil:

 

·                  Dona Francisca Energética S.A. (DFESA) operates a hydroelectric power plant with nominal capacity of 125 MW located between Nova Palma and 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 Francisca) with the state power utility Companhia Estadual de Energia Elétrica (CEEE). The

 

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shareholders of DFESA are Gerdau S.A. (51.8%), COPEL Participações S.A (23.0%), Celesc (23.0%), and Statkraft (2.1%).

 

·                  Caçu and Barra dos Coqueiros hydroelectric power plants, located in the state of Goiás (Brazil), with total installed capacity of 155MW and started its operations in 2010, with all power made available to the units located in Brazil’s Southeast.

 

·                  Gerdau also holds the concession to implement São João — Cachoeirinha Hydroelectric Plant Complex located in Paraná state. The complex will have a total installed capacity of 105 MW. It is currently waiting for the granting of the environmental licenses.

 

The terms of the aforementioned generation concession agreements are for 35 years as of the signature of the agreement. As such: UHE Dona Francisca expires in 2033 and UHEs Caçu and Barra dos Coqueiros and UHEs São João - Cachoeirinha expire in 2037.

 

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.

 

In the United States, there are essentially two types of electricity markets: regulated and deregulated. In the regulated market, contracts are approved by Public Utility commissions and are subject to an approved rate of return.  These regulated tariffs are specific to local distributors and generally reflect the average fuel costs of the distributor. In deregulated markets, the price of electricity is set by the marginal resource and fluctuates with demand. Natural gas in the United States is completely deregulated. The U.S. energy market is benefiting from the increased exploration of shale gas, which is driving down prices of both electricity and natural gas.

 

In Uruguay, electricity is purchased under agreements that are renewed automatically on an annual basis from the state-owned utility UTE.  Natural gas is purchased from Montevideo Gas with prices set by the Argentinean export tariff agreement (fuel oil as substitute). During 2017, the plant operated mostly on fuel oil, due to competitive reasons.

 

In Peru, the Company has a current electricity contract until December 2025. The plant receives CNG (Compressed Natural Gas) by trucks and then is decompressed and distributed through internal pipeline to production processes.

 

Argentina uses natural gas (liquefied petroleum gas) as a substitute. The natural gas purchase agreement was renewed for another year. In 2008, Gerdau Sipar entered into a long-term agreement to supply the new mill’s power requirements.

 

In Mexico, electricity is purchased under agreements regulated by the state-owned utility Companía Federal de Electricidad (CFE) and bilateral contracts with private companies. The natural gas agreements are annually and automatically renewed. Electricity and natural gas prices are indexed and adjusted monthly based on the NYMEX prices indices.

 

Technology and Quality Management

 

All Gerdau mills have a Quality Management System 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 methods for improving the assessment of process variables, and the concept of “Quality Function Deployment”, a methodology through which technicians can identify and implement the customer requirements.

 

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

 

Gerdau 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 manufactured product high standards of quality. Gerdau’s technical specialists conduct planned visits, some are randomly selected and some are scheduled visits, to its customers to check on the quality of the delivered products in order to guarantee the final user satisfaction for products purchased indirectly.

 

Due to the specialized nature of its business, the Gerdau special 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 (Research and Development) responsible for new products and the optimization of existing processes.

 

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International machinery manufacturers and steel technology companies supply most of the sophisticated production equipment that Gerdau 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. Gerdau has technology transfer and benchmarking agreements with worldwide recognized performance companies.

 

As is common with mini-mill steelmakers, Gerdau usually acquires technology in the market rather than develop new technology through intensive process 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 Dependence” for further details.

 

Sales Terms and Credit Policy

 

The Company’s Brazilian sales are usually made on a 21/28-day settlement CIF (Cost, Insurance and Freight) basis. Comercial Gerdau, the retail arm of Gerdau in Brazil, sells on an approximately 34 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 (ECC 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 includes 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. Gerdau 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 North American credit terms to customers are generally based on customary market conditions and practices. The Company´s North American 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.

 

The Company´s Special Steel operations in the United States and Brazil have their own credit departments for custumer’ credit analyses.

 

The Company’s provision for doubtful accounts has been at low levels. On December 31, 2017, provision for doubtful accounts was 4.7% based on gross account receivables per Note 5 to the Consolidated Financial Statements, compared to 5.3% on December 31, 2016 and 4.0% on December 31, 2015. Gerdau has improved its credit approval controls and enhanced the reliability of its sales process through the use of risk indicators and internal controls.

 

Insurance

 

The Company maintains insurance coverage in amounts that it believes suitable to cover the main risks of its operating activities. The Company has purchased insurance for its integrated mill Ouro Branco to insure against operating losses, which covers amounts up to approximately US$4.9 billion (R$16 billion as of April 30, 2017), including material damage to installations (US$4.5 billion) and losses of gross revenues (US$432 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, 2018. The Company’s mini-mills are also covered under insurance policies which insure against certain operational losses resulting from business interruptions.

 

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.

 

Material effects of government regulation on the Company’s activities

 

The Company’s steel production activities are not subject to special authorizations other than the licenses and permits typical to the industry. The Company maintains a good relationship with the government agencies responsible for issuing common authorizations and does not have any history of problems in obtaining them.

 

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Gerdau Aços Longos S.A. holds the concession for the Caçú and Barra dos Coqueiros hydroelectric plants, which have aggregate installed capacity of 155MW and are located in the southeastern region of the State of Goias between the cities of Caçu and Cachoeira Alta, as per concession contract number 089/2002.

 

Chopim Energia S.A. (50% direct and 50% through Itaguaí Comércio, Importação e Exportação Ltda.) holds the concession for the São João and Cachoeirinha Energy Complex, which corresponds to the São João and Cachoeirinha hydroelectric plants, which have aggregate installed capacity of 105 MW and are located in the southeastern region of the State of Paraná between the cities of Honório Serpa and Clevelândia, as per concession contract number 016/2002.

 

Gerdau S.A. holds an interest of 51.82% in the company Dona Francisca Energética S.A. DFESA, which, in consortium with Companhia Estadual de Energia Elétrica — CEEE, holds the concession for the Dona Francisca Hydroelectric Plant located between the cities of Agudo and Nova Palma in the State of Rio Grande do Sul, which has installed capacity of 125 MW, as per concession contract 188/1998.

 

Gerdau Açominas S.A. is authorized to operate the Açominas Thermo Electric Power Plant (103 MW) located in its industrial complex in the city of Ouro Branco, as authorized by Administrative Rule (Portaria) 275/MME of February 23, 1984 and subsequent resolutions.

 

Activities involving the generation of electric power are subject to the rules and regulations of the National Electric Power Agency (ANEEL) and to oversight by the agency.  Operating licenses, which are issued by the respective state environmental departments or agencies, are required to operate the hydroelectric plants, which must also comply with the obligations of the respective concession contracts. All projects in which the Company participates are working properly, with valid licenses and no objections to their operations.  The exception is Chopim, whose construction has yet to begin.

 

The commercial operation of ports is subject to authorization by the federal government, as regulated by Federal Law 12,815 of June 5, 2013. Gerdau has two private port terminals outside of Organized Port areas located in Vitória, ES and Salvador, BA, which are known, respectively, as the Praia Mole Private Port and Mixed Use Terminal and the Gerdau Maritime Terminal.  The former, with Adhesion Contract 112/2016, was signed on June 30, 2016, with duration of 25 years, with extended successively for equal periods, as provided for by law. There is no specific description of cargoes, with authorization for the handling and/or storage in the TERMINAL of own and third-party cargo destined or originating from water transportation. The latter, with Adhesion Contract 11/2017, was signed on December 7, 2017, with duration of 25 years, with extended successively for equal periods, as provided for by law,  authorized to move and store solid bulk and own and third general cargo.

 

This authorization is subject to oversight by the National Water Transportation Agency (ANTAQ) and, alternatively, by the Special Department of Ports (SEP).

 

Gerdau’s mining explorations in Brazil are subject to the prevailing rules established by the Brazilian Mining Code (Decreto-Lei nº 227, de 28 de fevereiro de 1967) and non codified mining legislation, with mining exploration substantiated by mining property rights and titles.

 

Gerdau acquired the surface of the areas corresponding to the respective mining rights, as well as all other mining property rights and titles, through an Asset Sale and Rights Assignment Agreement entered into between Gerdau Açominas S.A. and Companhia Paraibunas de Metais, Siderúrgica Barra Mansa S.A., Votorantim Metais Ltda. and Votorantim International Holding N.V. on May 19, 2004.

 

The Company’s mining explorations are subject to the limitations imposed by Brazil’s Federal Constitution and Mining Code and by the laws and regulations pertaining to exploration activities, which include requirements concerning, among other things, how the mineral deposits are used, workplace health and safety, environmental protection and restoration, pollution prevention and health and safety of local communities where the mines are located.  The Brazilian Mining Code also establishes certain requirements for sending notifications and information.

 

On December 26, 2017, Federal Law 13,575 was sanctioned, which created the National Mining Agency (ANM), eliminated the National Department of Mineral Production (DNPM), amended federal laws 11,046 of December 27, 2004, and 10,826 of December 22, 2003, and revoked Federal Law 8,876 of May 2, 1994, and the provisions of Decree-Law 227 of February 28, 1967 (Mining code). This law derives from Provisional Presidential Decree 791/2017 issued by the Ministry of Mines and Energy (MME) and submitted to the joint commission of the Senate in mid-2017 for approval. The wording of the Federal Law was published in the federal register Diário Oficial da União (DOU) on December 27, 2017, Issue: 247, Section 1, Pages 1 to 4.

 

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The new law eliminates the National Department of Mineral Production (DNPM) and creates the National Mining Agency (ANM), a government agency linked to the Ministry of Mines and Energy responsible for promoting mineral exploration and developing the industry.

 

Gerdau holds environmental licenses for commercial operation of the mines located in the cities of Miguel Burnier, Várzea do Lopes and Gongo Soco in the Brazilian state of Minas Gerais.

 

The mineral rights held by Gerdau cover a total of 8,837.19 ha and the period of concessions is until the exhaustion of the deposits, on the condition that we perform legal requirements annually.  The table below shows the DNPM processes held by Gerdau:

 

Mining Rigth DNPM

 

City

 

Location

 

State

1.978/1935

 

BARÃO DE COCAIS

 

GONGO SOCO

 

MG

724/1942

 

OURO PRETO / OURO BRANCO

 

MORRO GABRIEL

 

MG

4.575/1935

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

3.613/1948

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

5.303/1948

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

5.514/1956

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

5.975/1956

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

6.549/1950

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

930.600/2009

 

OURO  PRETO

 

GM MIGUEL BURNIER

 

MG

3.583/1957

 

ITABIRITO / MOEDA

 

VÁRZEA DO LOPES

 

MG

3.584/1957

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

3.585/1957

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

8.141/1958

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

6.255/1960

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

317/1961

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

5.945/1961

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

932.705/2011