U.S. 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, 2006

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)

Federative Republic of Brazil
(Jurisdiction of Incorporation or Organization)

N/A
(Translation of Registrant’s name into English)

Av. Farrapos 1811
Porto Alegre, Rio Grande do Sul - Brazil CEP 90220-005
(Address of principal executive offices) (Zip code)

Securities registered pursuant to Section 12(b) of the Act:

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
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, 2006 was:

231,607,008 Common Shares, no par value per share
435,986,042 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.

Yes  x  No  o

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 1034.

Yes  o  No  o

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer  x

 

Accelerated filer

 

o

 

Non-accelerated filer  o

 

Indicate by check mark which financial statement item the Registrant has elected to follow Item 17  o Item 18  x

 




TABLE OF CONTENTS

 

 

INTRODUCTION

 

 

 

 

 

PART I

 

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

 

ITEM 3. KEY INFORMATION

 

 

ITEM 4. INFORMATION ON THE COMPANY

 

 

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 ABOUT MARKET RISK

 

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

 

ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES

 

 

 

 

 

PART II

 

 

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

 

 

ITEM 15. CONTROLS AND PROCEDURES

 

 

ITEM 16. AUDIT COMMITTEE FINANCIAL EXPERT

 

 

 

 

 

PART III

 

 

ITEM 17. FINANCIAL STATEMENTS.

 

 

ITEM 18. FINANCIAL STATEMENTS.

 

 

ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS

 

 

 

3




INTRODUCTION

Unless otherwise indicated, all references herein to:

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

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

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

(iv)                              “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$” are to the Brazilian real, the official currency of Brazil. All references to (i) “U.S.”, “dollars”, “U.S.$” or “$” are to United States dollars, (ii) “Canadian dollars” or “Cdn$” are to Canadian dollars (iii) “billions” are to thousands of millions, (iv) “km” are to kilometers, and (v) “tonnes” are to metric tonnes.

The Company has prepared the consolidated financial statements included herein in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The investments in Gallatin Steel Co. (“Gallatin”), Bradley Steel Processor and MRM Guide Rail, all in North America, of which Gerdau Ameristeel holds 50% of the total capital, the investments in Armacero Industrial y Comercial Limitada, in Chile, in which the Company holds a 50% stake and the investment in Dona Francisca Energética S.A, in Brazil, in which the Company holds a 51.82% stake, are accounted for using the equity accounting method.

Unless otherwise indicated, all information in this Annual Report is stated for December 31, 2006.  Subsequent developments are discussed in Item 8 - Financial Information - Significant Changes.

CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING STATEMENTS

Statements made in this Annual Report with respect to the Company’s current plans, estimates, strategies, beliefs and other statements that are not historical facts are forward-looking statements about the Company’s future performance. Forward-looking statements include but are not limited to those using words such as “believe”, “expect”, “plans”, “strategy”, “prospects”, “forecast”, “estimate”, “project”, “anticipate”, “may” or “might” and words of similar meaning in connection with a discussion of future operations or financial performance. From time to time, oral or written forward-looking statements may also be included in other materials released to the public. These statements are based on management’s assumptions and beliefs in the light of the information currently available to it. The Company cautions potential investors that a number of important risks and uncertainties could cause actual results to differ materially from those discussed in the forward-looking statements. Investors should not thus place undue reliance on the forward-looking statements. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company’s expectations or to reflect any change in events, conditions or circumstances on which any such forward-looking statements is based, in whole or in part. Risks and uncertainties that might affect the Company include, but are not limited to: (i) general economic conditions in the Company’s markets, particularly levels of spending; (ii) exchange rates, particularly between the real and the U.S. dollar, and other currencies in which the Company realizes significant sales or in which its assets and liabilities are denominated; and (iii) the outcome of contingencies.

4




PART I

ITEM 1.           IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

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

ITEM 2.           OFFER STATISTICS AND EXPECTED TIMETABLE

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

ITEM 3.           KEY INFORMATION

A.              SELECTED FINANCIAL DATA

The selected financial information for the Company included in the following table should be read in conjunction with, and is qualified in its entirety by, the U.S. GAAP financial statements of the Company and “Operating and Financial Review and Prospects” appearing elsewhere in this Annual Report. The consolidated financial data for the Company on December 31, 2006, 2005, 2004, 2003, and 2002 are derived from the financial statements prepared in accordance with U.S. GAAP.

 

 

(Expressed in thousands of U.S. dollars except quantity of shares and amounts per share)

 

Income Statement

 

2006

 

2005

 

2004

 

2003

 

2002

 

Net sales

 

11,844,230

 

8,894,432

 

6,952,149

 

4,530,969

 

3,264,926

 

Cost of sales

 

(8,777,827

)

(6,564,245

)

(4,838,949

)

(3,445,564

)

(2,349,636

)

Gross profit

 

3,066,403

 

2,330,187

 

2,113,200

 

1,085,405

 

915,290

 

Sales and marketing expenses

 

(256,064

)

(203,244

)

(154,558

)

(146,388

)

(112,645

)

General and administrative expenses

 

(821,497

)

(466,034

)

(359,102

)

(241,854

)

(221,895

)

Other operating income (expenses), net

 

107,395

 

(8,246

)

28,710

 

(824

)

(18,187

)

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

2,096,237

 

1,652,663

 

1,628,250

 

696,339

 

562,572

 

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

 

(311,396

)

(191,897

)

(132,409

)

(254,763

)

(424,147

)

Interest income

 

458,812

 

204,483

 

81,592

 

62,036

 

100,350

 

Equity in earnings (losses) of unconsolidated companies, net

 

118,074

 

96,476

 

141,890

 

22,062

 

(10,057

)

Gain on Gerdau Ameristeel investment

 

 

 

2,742

 

 

 

Income before income taxes and minority interest

 

2,361,727

 

1,761,725

 

1,722,065

 

525,674

 

228,718

 

Income taxes benefit (expense)

 

 

 

 

 

 

 

 

 

 

 

Current

 

(442,016

)

(347,545

)

(329,229

)

(87,812

)

(27,065

)

Deferred

 

3,115

 

(117,750

)

(77,451

)

121,925

 

20,507

 

Income before minority interest

 

1,922,826

 

1,296,430

 

1,315,385

 

559,787

 

222,160

 

Minority interest

 

(409,018

)

(178,909

)

(157,027

)

(49,623

)

9,667

 

Net income available to common and preferred shareholders

 

1,513,808

 

1,117,521

 

1,158,358

 

510,164

 

231,827

 

Basic income per share (i) – in US$

 

 

 

 

 

 

 

 

 

 

 

Common

 

2.28

 

1.68

 

1.74

 

0.76

 

0.35

 

Preferred

 

2.28

 

1.68

 

1.74

 

0.76

 

0.35

 

Diluted income per share (i) – in US$

 

 

 

 

 

 

 

 

 

 

 

Common

 

2,26

 

1.67

 

1.74

 

0.76

 

0.35

 

Preferred

 

2,26

 

1.67

 

1.74

 

0.76

 

0.35

 

Cash dividends declared per share (i) – in US$

 

 

 

 

 

 

 

 

 

 

 

Common

 

0.59

 

0.55

 

0.29

 

0.18

 

0.12

 

Preferred

 

0.59

 

0.55

 

0.29

 

0.18

 

0.12

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average Common Shares outstanding during the year(i)

 

231,607,008

 

231,607,008

 

231,607,008

 

231,607,008

 

231,607,008

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighetd average Preferred Shares outstanding during the year (i)

 

432,238,895

 

432,165,971

 

432,564,935

 

435,921,354

 

434,941,321

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of Common Shares outstanding at year end (ii)

 

231,607,008

 

231,607,008

 

231,607,008

 

231,607,008

 

231,607,008

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of Preferred Shares outstanding at year end (ii)

 

430,882,697

 

431,417,499

 

432,446,342

 

434,433,541

 

435,986,042

 

 

5




(i)                                     Per share information has been retroactively restated for all periods to reflect the effect of:  (a) the stock bonus of  ten shares for three shares held, approved in April 2003, (b) the reverse stock split of one share for 1,000 shares held, approved in April 2003, (c) the stock bonus of one share for every share held approved in April 2004, (d) the stock bonus of one share for two shares held approved in March 2005 and (e) the stock bonus of one share for two shares held approved in March 2006. Earnings per share has been computed on weighted average share outstanding during each year.

(ii)                                  The information on the numbers of shares presented above relates to the end of each year, and is retroactively restated to reflect changes in numbers of shares due to the transactions described in (i) above.

 

 

On December 31,

 

 

 

(expressed in thousands of U.S. dollars)

 

Balance sheet selected information

 

2006

 

2005

 

2004

 

2003

 

2002

 

Cash and cash equivalents

 

485,498

 

532,375

 

248,954

 

92,504

 

40,457

 

Restricted cash

 

13,512

 

9,617

 

6,603

 

1,935

 

15,001

 

Short-term investments (1)

 

2,483,052

 

1,761,421

 

404,512

 

236,137

 

367,748

 

Net working capital (2)

 

4,160,127

 

3,372,531

 

1,610,722

 

300,670

 

(63,579

)

Property, plant and equipment

 

5,990,629

 

3,517,962

 

2,790,201

 

2,304,158

 

2,084,895

 

Total assets

 

14,488,865

 

9,301,742

 

6,852,249

 

4,770,834

 

4,000,301

 

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

 

1,065,120

 

566,562

 

673,204

 

798,496

 

1,104,793

 

Long term debt, less current portion

 

3,128,868

 

2,233,031

 

1,280,516

 

1,132,429

 

794,571

 

Debentures – short term

 

1,371

 

1,162

 

1,125

 

1,048

 

 

Debentures – long term

 

443,280

 

414,209

 

344,743

 

155,420

 

200,766

 

Shareholders’ equity

 

4,930,641

 

3,621,530

 

2,522,585

 

1,403,063

 

865,010

 

Capital stock

 

3,432,613

 

2,212,382

 

1,539,204

 

982,601

 

843,959

 

 


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

(2) Total current assets less total current liabilities

Dividends

The Company’s total authorized capital stock is composed of common and preferred shares. As of April 30, 2007, the Company had 231,607,008 common shares and 430,955,233 non-voting preferred shares outstanding (excluding treasury stock).

The following table details dividends paid to holders of common shares and preferred shares since 2002. The figures are expressed in Brazilian reais and converted into U.S. dollars on the date of resolution of the dividend. Dividend per share figures have been retroactively adjusted for all periods to reflect: (a) the stock bonus of ten shares for three shares held, approved in April 2003, (b) the reverse stock split of one share for 1,000 shares held, approved in April 2003, (c) the stock bonus of one share for every share held approved in April 2004, (d) the stock bonus of one for two shares held approved in March 2005 and (e) a stock bonus of one share for two shares approved in March 2006.

 Dividend per share information has been computed by dividing dividends and interest on capital stock by the quantity of shares outstanding, which excludes treasury stock.

 

 

 

 

R$ per Share (3)

 

R$ per Share (3)

 

$ per Share (3)

 

$ per Share (3)

 

Period

 

Date of
Resolution

 

Common 
Shares

 

Preferred 
Shares

 

Common 
Shares

 

Preferred 
Shares

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Semester 2002 (1)

 

06/28/2002

 

0.1197

 

0.1197

 

0.0421

 

0.0421

 

2nd Semester 2002 (1)

 

12/30/2002

 

0.2786

 

0.2786

 

0.0789

 

0.0789

 

1st Quarter 2003 (1)

 

03/31/2003

 

0.1111

 

0.1111

 

0.0331

 

0.0331

 

2nd Quarter 2003 (1)

 

06/30/2003

 

0.0756

 

0.0756

 

0.0263

 

0.0263

 

3rd Quarter 2003 (1)

 

09/30/2003

 

0.1133

 

0.1133

 

0.0388

 

0.0388

 

4th Quarter 2003 (1)

 

12/30/2003

 

0.2267

 

0.2267

 

0.0785

 

0.0785

 

1st Quarter 2004 (1)

 

03/30/2004

 

0.1422

 

0.1422

 

0.0487

 

0.0487

 

2nd Quarter 2004 (2)

 

06/30/2004

 

0.2889

 

0.2889

 

0.0930

 

0.0930

 

3rd Quarter 2004 (1)

 

07/31/2004

 

0.2044

 

0.2044

 

0.0671

 

0.0671

 

3rd Quarter 2004

 

11/03/2004

 

0.2356

 

0.2356

 

0.0832

 

0.0832

 

 

6




 

4th Quarter 2004

 

02/01/2005

 

0.4222

 

0.4222

 

0.1616

 

0.1616

 

1st Quarter 2005

 

05/03/2005

 

0.3000

 

0.3000

 

0.1200

 

0.1200

 

2nd Quarter 2005

 

08/03/2005

 

0.3200

 

0.3200

 

0.1382

 

0.1382

 

3rd Quarter 2005

 

11/08/2005

 

0.3000

 

0.3000

 

0.1362

 

0.1362

 

4th Quarter 2005

 

02/08/2006

 

0.2800

 

0.2800

 

0.1275

 

0.1275

 

1st Quarter 2006

 

05/03/2006

 

0.3000

 

0.3000

 

0.1449

 

0.1449

 

2nd Quarter 2006

 

08/02/2006

 

0.3500

 

0.3500

 

0.1604

 

0.1604

 

3rd Quarter 2006

 

11/07/2006

 

0.3500

 

0.3500

 

0.1639

 

0.1639

 

4th Quarter 2006

 

02/07/2007

 

0.3500

 

0.3500

 

0.1678

 

0.1678

 

1st Quarter 2007 (1)

 

05/03/2007

 

0.3400

 

0.3400

 

0.1680

 

0.1680

 

 


(1) Payment of interest on capital stock.

(2) Payment of both dividends and interest on capital stock.

(3) As of April 2003 and as result of the reverse stock split of one share for 1,000 shares held approved in this same month, dividends are paid on a per share basis (rather than a per thousand shares basis, as was the case prior to this date).

Law 9,249, of December 1995, states that a company may, at its sole discretion, pay interest on capital stock in addition to or instead of dividends (See Item 8 — Financial Information - Interest on Capital Stock). A Brazilian corporation is entitled to pay its shareholders (considering such payment as part of the mandatory dividend required by Brazilian Corporate Law for each fiscal year) interest on capital stock up to the limit calculated as the TJLP rate (Long-Term Interest Rate) on its shareholders’ equity or 50% of the income for the fiscal year, whichever is the greater. The payment of interest on capital stock as described herein is subject to a 15% withholding income tax. See Item 10. Additional Information - Taxation.

B. CAPITALIZATION AND INDEBTEDNESS

Not required.

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

Not required.

D. RISK FACTORS

·          Risks Relating to Brazil

Brazilian Political and Economic Conditions, and the Brazilian Government’s Economic and Other Policies May Negatively Affect Demand for the Company’s Products as Well as Net Sales and Overall Financial Performance.

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

The Company’s operational results and financial condition may be adversely affected by the following factors and governmental reaction to them:

·                  fluctuations in exchange rates;

·                  interest rates;

·                  inflation;

·                  tax policies;

·                  exchange controls;

·                  energy shortages;

·                  liquidity of domestic capital and lending markets; and

7




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

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

Inflation and Government Actions to Combat Inflation May Contribute Significantly to Economic Uncertainty in Brazil and Could Adversely Affect the Company’s Business.

Brazil has, in the past, experienced high rates of inflation. The annual rates of inflation, as measured by the National Wide Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo, or IPCA), have decreased from 2,477.15% in 1993 to 916.46% in 1994 and to 5.97% in 2000. The same index was 7.60% in 2004, 5.69% in 2005 and 3.14% in 2006. If Brazil experiences high levels of inflation in the future, the rate of growth of the economy may be slowed, which would lead to reduced 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, and, as a consequence, the costs of servicing its real-denominated debt may increase. Inflation may, in addition, hinder its access to capital markets, which could adversely affect its ability to refinance its indebtedness. Inflationary pressures may also lead to the imposition of government policies to combat inflation that could adversely affect its business.

Foreign Exchange Variations Between the U.S. Dollar and the Currencies of the Countries in Which the Company Operates May Raise the Cost of Servicing Its Foreign Currency-Denominated Debt and Adversely Affect Its Overall Financial Performance.

The Company’s operating results are affected by foreign exchange-rate fluctuations between the U.S. dollar, the currency in which the Company prepares its financial statements, and the currencies of the countries in which it operates.

For example, Gerdau Ameristeel reports results in U.S. dollars, while a portion of its net sales and operating costs are in Canadian dollars. As a result, fluctuations in the exchange rate between these two currencies may affect operating results. The same happens with all the other businesses located outside the United States with respect to the exchange rate between the local currency of the respective subsidiary and the U.S. dollar.

The real appreciated 8.1% in 2004, 11.8% in 2005 and 8.7% in 2006 against the U.S. dollar. On April 30 2007, the U.S. dollar/real exchange rate was US$1.00 per R$2.0339.

Devaluation of the real relative to the U.S. dollar also could result in additional inflationary pressures in Brazil by generally increasing the price of imported products and services and requiring recessionary government policies to curb demand. In addition, a devaluation of the real could weaken investor confidence in Brazil. On the other hand, appreciation of the real against the U.S. dollar may lead to a deterioration of the country’s current account and the balance of payments and may dampen export-driven growth.

The Company had total foreign currency-denominated debt obligations in an aggregate amount of $3,306.6 million at December 31 2006, representing 71.3% of its indebtedness on a consolidated basis. On December 31, 2006, the Company had $950.9 million in U.S. dollar-denominated cash equivalents and short-term investments. A significant devaluation of the real in relation to the U.S. dollar or other currencies could reduce the Company’s ability to meet debt service requirements of foreign currency-denominated obligations, particularly as a significant part of net sales revenue is denominated in reais.

Export revenues and margins are also affected by the real’s fluctuations in relation to the U.S. dollar. The Company’s production costs are denominated in local currency but its export sales are denominated in U.S. dollars.  Financial revenues generated by exports are reduced when they are translated to reais in the periods in which the Brazilian currency appreciates in relation to the U.S. currency. On the other hand, when the real depreciates the translation impact is favorable and the same amount of dollars translates to a greater amount of reais.

Developments in Other Emerging Markets May Adversely Affect The Company’s Operating Results.

Political, economic, social and other developments in other countries, particularly Latin America and emerging-market countries, may have an adverse effect on the market value of the Company. Although conditions in these countries may be quite different from those in Brazil, investors’ reactions to developments in these countries

8




may affect the Brazilian securities markets and reduce investor interest in securities of Brazilian issuers. Brazil has experienced periods with a significant outflow of U.S dollars, and Brazilian companies have faced higher costs for raising funds, both domestically and abroad and have been impeded from accessing international capital markets. The Company cannot assure that international capital markets will remain open to Brazilian companies or that prevailing interest rates in these markets will be advantageous to the Company, which may limit the ability to refinance its indebtedness.

·          Risks Relating to Gerdau and the Steel Sector

The Demand for Steel Is Cyclical and a Reduction in the Prevailing World Prices for Steel Could Adversely Affect The Company’s Operating Results.

The steel industry is highly cyclical both in Brazil and abroad. Consequently, the Company is exposed to substantial swings in the demand for steel products which in turn causes volatility in the prices of its products, mainly for exports and for products that face competition from imports. Additionally, as the Brazilian steel industry produces substantially more steel than the domestic economy is able to consume, the sector is heavily dependent on export markets. The demand for steel products and, thus, the financial condition and results of operations of companies in the steel industry, including the Company itself, are generally affected by macroeconomic fluctuations in the world economy and the domestic economies of steel-producing countries, including trends in the construction sector and the automotive sector in general. Since 2003, demand for steel products from developing countries (particularly China), the strength of the Euro and overall worldwide economic growth have contributed to a historically new high level of prices for the Company’s steel products, but these relatively high prices may not endure, especially due to the worldwide expansion in installed capacity. Any material decrease in demand for steel or exporting by countries not able to consume their production could have a material adverse effect on Company’s operations and prospects.

Increases in Steel Scrap Prices or a Reduction in Supply Could Adversely Affect Production Costs and Operating Margins.

The main metallic input for the Company’s mini-mills, which corresponded to 73.4% of total crude steel output in 2006 (in volume), is steel scrap. Although international steel scrap prices are determined essentially by scrap prices in the U.S. domestic market, the United States being the main exporter of scrap, scrap prices in the Brazilian market are set by domestic supply and demand. The price of steel scrap in Brazil varies from region to region and reflects demand and transportation costs. Should scrap prices increase significantly without a commensurate increase in finished steel sale prices, the Company’s profits and margins could be reduced. An increase in steel scrap prices or shortage in the supply of scrap to its units would affect production costs and potentially reduce operating margins.

Increases in Iron Ore and Coal Prices or a Reduction in Market Supply Could Adversely Affect the Production Costs and Operating Margins of the Company’s Integrated Mills.

When the prices of raw materials that the Company needs to produce steel in its integrated facilities, particularly iron ore and coking coal, increase, the production costs in its integrated facilities also increase. The Company uses iron ore to produce liquid pig iron at its Ouro Branco mill and at its Gerdau Barão de Cocais and Gerdau Divinópolis units, in the state of Minas Gerais. Iron ore is also used to produce sponge iron at the Gerdau Usiba unit, in the state of Bahia. In 2006, these four units represented 26.6% of its consolidated crude steel output in volume.

The Ouro Branco unit is the Company’s biggest mill in Brazil, and its main metallic input for the production of steel is iron ore. This unit represents 37.1% of the total crude steel output (in volume) of its Brazilian operations. A shortage of iron ore in the domestic market would adversely affect the steel producing capacity of its Brazilian units, and an increase in iron ore prices could reduce profit margins.

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

9




The Company Operations Are Energy-Intensive, and Energy Shortages or Price Increases May Adversely Affect It.

Steel production is an energy-intensive process, especially in melt shops with electric arc furnaces. Electricity represents a significant cost component at these units, as does natural gas, to a lesser extent. Electricity cannot be replaced in the Company’s melt shops and rationing or power shortages such as those that occurred in Brazil in 2001 could adversely affect production in those units.

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

Restrictive Measures on Trade in Steel Products May Affect the Company’s Business by Increasing the Price of Its Products or Reducing Its Ability to Export.

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

Less Expensive Imports from Other Countries in North America May Adversely Affect the Company’s Business.

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

Compliance Costs Related to Environmental Regulation May Increase if Requirements Become More Stringent.  Such Increased Costs May Adversely Affect the Company’s Operating Results.

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

The Company May Not Successfully Integrate Its Businesses, Management, Operations, or Products or Realize Any of the Anticipated Benefits of Future Acquisitions.

During the last few years, the Company has expanded its operations, through significant acquisitions such as that of AmeriSteel in 1999, the stake in Açominas, the reverse takeover of Co-Steel at the end of 2002, the acquisition of the assets of North Star in 2004 and, more recently, the acquisition of the units in Colombia, the acquisition of an additional stake in Sipar, a strategic shareholding in Corporación Sidenor, the acquisition of Sheffield Steel, the acquisition of Siderperú and the acquisition of GSB Acero through Corporación Sidenor. The integration of the business and opportunities stemming from entities acquired by the Company in the future may involve risks. The Company may not successfully integrate future acquired businesses, management, operations, products, and services with its current operations. Diversion of management’s attention from its existing businesses, as well as problems that can arise in connection with the integration of the new operations, may have an impact on revenues and the results of operations. Integration of future acquisitions may result in additional expenses that could reduce profitability. The Company may not succeed in addressing these risks or any other problems encountered in connection with future acquisitions.

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ITEM 4.  COMPANY INFORMATION

A. HISTORY AND DEVELOPMENT

Gerdau S.A. is a Brazilian corporation (Sociedade Anônima) that was incorporated on November 20, 1961. Its main registered office is located at Av. Farrapos, 1811, Porto Alegre RS – Brazil. Its telephone number is + 55 (51) 3323 2000.

Gerdau began operating in 1901 as the Pontas de Paris nail factory in Porto Alegre, Brazil. In 1969, the Company changed its name to Metalúrgica Gerdau S.A., today a holding company that controls Gerdau S.A. In 106 years of activity, the Gerdau Group has made a seminal contribution to the Brazilian industry.

Important Events in the Development of the Company’s Business

At the end of World War II, Gerdau acquired Siderúrgica Riograndense S.A.(“Riograndense”), a steel mill also located in Porto Alegre, for mitigating possible raw material shortages. In February 1948, Gerdau initiated its steel operations, foreshadowing the successful mini-mill model of producing steel in electric arc furnaces (EAF), using steel scrap as the main raw material. The Company also adopted a regional sales strategy to ensure more competitive operating costs. Growth resulted in the Company installing a second Riograndense unit in the city of Sapucaia do Sul (state of Rio Grande do Sul) in 1957, consolidating the Group’s vocation as a steel producer. In 1962, the steady growth in the production of nails led to the construction of a larger and more advanced factory in Passo Fundo (state of Rio Grande do Sul). Although the factory in Passo Fundo is no longer in operation, Gerdau still produces nails at some of its existing mills and has more than 1,000 items available to customers from 100,000 sales outlets.

In 1967, the Company expanded into the state of São Paulo, in the Southeast region of Brazil, by purchasing Fábrica de Arames São Judas Tadeu, a producer of nails and wires. It was later renamed Comercial Gerdau and became the Brazilian distribution channel for the Company’s steel products, with 68 branches and 6 flat steel service centers strategically located throughout the country.

In June 1969, Gerdau expanded into the Northeast of Brazil, producing steel at Siderúrgica Açonorte in the state of Pernambuco. In 1971, Gerdau began the construction of the Cosigua mill in Rio de Janeiro, initially as a joint venture with the German group, August Thyssen Huette. Eight years later, Gerdau became the majority shareholder of Cosigua, which currently operates the largest mini-mill in Latin America. In December 1971, Gerdau acquired the control of Siderúrgica Guaíra, a pioneer steel producer in the state of Paraná. Since then, Gerdau has expanded throughout Brazil with a series of acquisitions and new operations, currently owning 11 steel mills in the country.

In 1980, Gerdau began to expand internationally first with the acquisition of Gerdau Laisa in Uruguay, followed in 1989 with the purchase of the Canadian company, Gerdau Ameristeel Cambridge, located in Cambridge, Ontario. In 1992, Gerdau acquired control of Gerdau AZA, Chile. Over time, Gerdau increased its international presence by acquiring a minority interest in units in Argentina, and most notably, in North America where it acquired interests in Gerdau Ameristeel MRM Special Sections and the former Ameristeel Corp. In October 2002, Gerdau carried out a reverse takeover, merging its North American assets with those of the Canadian company Co-Steel to create Gerdau Ameristeel, currently the second largest long steel producer in North America. Through its Gerdau Ameristeel subsidiary, Gerdau acquired the assets of North Star Steel in November 2004.

In 1995, Gerdau began a corporate restructuring - completed in 1997 - whereby the 28 Gerdau group companies were merged with the Company’s six listed companies, consolidating them into two: Gerdau S.A. and Metalúrgica Gerdau S.A., resulting in improved corporate governance and financial disclosure.

On November 28, 2003, Gerdau S.A. transferred its directly and indirectly controlled operations in Brazil to Açominas, which was renamed Gerdau Açominas S.A., while remaining headquartered in Ouro Branco (in the state of Minas Gerais).

On December 3 2004, the Board of Directors of Gerdau S.A. approved the proposal that led to the implementation of the corporate reorganization of the Gerdau companies in Brazil and in other countries in South America.

On December 29 2004, the first step in this process was taken with the capitalization of the holding company Gerdau Participações S.A. with stock from Gerdau Açominas S.A. and 22% of the capital of Gerdau Internacional Empreendimentos Ltda., owned by Gerdau S.A.

To complete a sequence of corporate operations, on July 20 2005, the shareholders of Gerdau Açominas approved the spin-off of the net assets of Gerdau Açominas into the following companies: Gerdau Aços Longos S.A.,

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Gerdau Aços Especiais S.A. and Gerdau Comercial de Aços S.A. These companies produce common long steels, specialty long steel and selling steel products in general, respectively. Gerdau Açominas S.A., headquartered in Ouro Branco, Minas Gerais, remains focused mainly on the production of slab, blooms and billets for export. Additionally, Gerdau América do Sul Participações S.A. was created as a holding company for the investments in the other South American operations (except for Brazil).

The shareholders of the companies listed in Brazil and abroad were not affected by the July 2005 reorganization. The shareholders continue to maintain their existing positions in the respective companies, and all their rights have been preserved.

In September of 2005, Gerdau acquired 35.98% of shares issued by Sipar Aceros S.A., a long steel rolling mill located in the Province of Santa Fé, Argentina. This stake added to the 38.46% already owned by Gerdau, and represents 74.44% of the capital stock of Sipar Aceros S.A. At the end of the third quarter of 2005, Gerdau concluded the acquisition of a 57.1% stake in Diaco S.A., the largest rebar manufacturer in Colombia.

On January 10 2006, through its subsidiary Gerdau Hungria Holdings Limited Liability Company, the Company acquired 40% of the capital stock of Corporación Sidenor, S.A., the largest long specialty steel producer, forged parts manufacturer and foundry in Spain and one of the major producers of forged parts using the stamping process in that country.

In March of 2006, the assets of two industrial units were acquired in the United States.  The first one was Callaway Building Products, in Knoxville, Tennessee, a supplier of civil construction cut and bent reinforcing concrete bars.  The second was Fargo Iron and Metal Company, located in Fargo, North Dakota, a storage and scrap processing facility and service provider to industries and civil construction companies.

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

In the same month, Gerdau S.A. won the bid for 50% plus one share of the capital stock of Empresa Siderúrgica Del Perú S.A.A. - Siderperú, located in the city of Chimbote (Peru). In November, Gerdau also won the bid for 324,327,847 shares issued by Siderperú, which represents 32.84% of the total capital stock. This acquisition added to the stake already acquired earlier in the year represents 83.27% of the total capital stock of Siderperú. Siderperú operates a blast furnace, a direct reduction unit, a melt shop with two electric arc furnaces and two LD converters and three rolling mills. Approximately 20% of its sales are in flat steel products and the remaining 80% are long steel products.

In November 2006, through its subsidiary Gerdau Ameristeel Corporation, Gerdau entered into a joint venture with Pacific Coast Steel, Inc. (PCS) and Bay Area Reinforcing (BAR) with Gerdau Ameristeel acquiring a controlling interest in the new joint venture, Pacific Coast Steel. This joint venture is one of the country’s largest reinforcing steel contractors, specializing in the fabrication and installation of reinforcing steel products involving a variety of construction projects throughout California and Nevada.

In December of 2006, Gerdau announced that its Spanish subsidiary Corporación Sidenor, S.A. in which it has a 40% stake, had completed the acquisition of all outstanding shares issued by GSB Acero, S.A., subsidiary of CIE Automotive. GSB Acero produces specialty steel and is located in Guipúzcoa, Spain.

In Brazil, Gerdau currently operates 11 steel units (including four integrated mills), 26 fabricated reinforcing steel facilities (branded Armafer and Prontofer), four downstream operations and 68 Comercial Gerdau’s storesand also owns three iron ore extraction areas, two solid pig iron production units and two private sea terminals. In South America, it owns 11 steel units and 11 fabricating reinforcing steel facilities. In North America, it has 16 steel units, 33 fabricating reinforcing steel facilities, 11 downstream operations, 17 scrap collection and processing units and a joint venture Gallatin Steel with Dofasco and Gerdau. In Spain, Gerdau has an associated company, Corporación Sidenor.

In November 2006, Gerdau announced a new phase in the Corporate Governance processes in order to ensure its development and continuity into the future by announcing the sucessor to the President and CEO and other senior officials . The evolution of Corporate Governance at Gerdau, begun in July 2002 when the Executive Committee was created, completed its most important phase on January 1, 2007 with the transfer of the Company’s executive leadership to the new Gerdau generation.

The structure is composed of three levels and has maintained the existing governing bodies – the Board of Directors, the Executive Committee and Business Operations Committee. As a result of these changes in Corporate

12




Governance effective January 2007, Jorge Gerdau Johannpeter has left the presidency of the companies, but continues as the Chairman of the Board. Frederico Gerdau Johannpeter and Carlos João Petry have also left their positions as Senior Vice Presidents while remaining on the Board as Vice-Presidents. André Bier Johannpeter has assumed the position of President and Chief Executive Officer and Claudio Johannpeter the position of Chief Operating Officer.

At the Board level, two additional Committees were created – Corporate Governance and Strategy Committees in addition to the already existing Compensation and Succession Committee.

Gerdau S.A. has been a listed company in Brazil since 1980, with an ADR listing on the New York Stock Exchange (NYSE) since March 1999. In June 2001, Gerdau joined the São Paulo Stock Exchange’s Corporate Governance Program (Level 1). In December 2002, it listed on the Latibex, a section of the Madrid Stock Exchange dedicated to Latin American companies with shares trading in Euros. Gerdau Ameristeel is listed in Canada on the Toronto Stock Exchange and, more recently, began trading on the New York Stock Exchange as well.

From its beginning in Brazil in 1901, Gerdau has grown steadily. In 2006, it was the 14th largest world steel producer according to Metal Bulletin (considering recent M&A activities) and the highest ranked Brazilian company.

Investment Programs 2004-2006                                                                                                                                                      

2004 – TOTAL CAPITAL EXPENDITURES: $756.7 MILLION

The Company invested $756.7 million in acquisitions of new businesses as well as new property, plant and equipment, increases in installed capacity and in technological upgrades of its units in Brazil, Canada, Chile, United States and Uruguay in 2004. The main investments during the year are described below.

Brazil

Capital expenditures amounted to $329.0 million in 2004 in Brazil. One of the major capital projects included investments of $77.9 million for the construction of the São Paulo mill melt shop as well as other improvements at the same facility. Other important expenditures during the year were $100.2 million at the Ouro Branco mill which included technological upgrades of equipment and a project to increase installed capacity by 1.5 million tonnes of liquid steel, expected to come on stream in 2007. Other amounts relate to smaller improvements and technological upgrades at various other facilities in Brazil.

South America (except Brazil)

The South American units spent $10.3 million on capital projects in 2004, compared to $6.9 million in 2003.

Canada and the United States

Gerdau Ameristeel spent $82.1 million on capital projects in 2004, compared to $55.2 million in 2003. Major capital projects in 2004 included caster upgrades of $10.0 million, mill control upgrades of $5.5 million, warehouse and material handling improvements of $16.0 million, sub-station upgrades of $3.5 million, reheat furnace improvements of $10.0 million and information system upgrades of $4.0 million.

2005 – TOTAL CAPITAL EXPENDITURES: $776.8 MILLION

The Company invested $776.8 million in the acquisition of new businesses as well as new property, plant and equipment, increases in installed capacity and in technological upgrades of its units in Argentina, Brazil, Canada, Chile, Colombia, United States and Uruguay in 2005. The main investments during the year are described below.

Brazil

Capital expenditures at the Brazilian units amounted to $527.8 million in 2005. A total of $91.2 million was invested in the completion of the São Paulo mill melt shop as well as other improvements at the same facility. The Company invested $227.0 million at the Ouro Branco mill, mainly the project to increase installed capacity by 1.5 million tonnes of liquid steel and expected to come on stream in 2007 together with technological upgrades of equipment. Another important investment of $48.0 million in the modernization of equipment was made in the Cosigua mill. Other amounts are related to smaller improvements and technological upgrades at other facilities in Brazil.

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South America (except Brazil)

The South American units spent $63.4 million on capital expenditures in 2005, compared to $10.3 million in 2004. The Company paid $13.0 million for the acquisition of Diaco and Sidelpa, in Colombia, and $16.7 million for an additional stake in Sipar, Argentina.

Canada and the United States

Gerdau Ameristeel spent $185.5 million on capital projects and acquisitions in 2005, compared to $82.1 million in 2004. Major capital investments included improved warehousing facilities at the Whitby, Ontario unit ($10.8 million), a new reheating furnace at the Sayreville, New Jersey mill ($10.0 million), and the purchase of shredders for the Jacksonville, Florida ($5.0 million) and the Jackson, Tennessee  ($6.1 million) facilities.

2006 – TOTAL CAPITAL EXPENDITURES: $1,682.9 MILLION

The Company invested $1,682.9 million in 2006 in the acquisition of new businesses as well as new property, plant and equipment, increases in installed capacity and in technological upgrades of its units in Argentina, Brazil, Canada, Chile, Colombia, Peru, Spain, United States and Uruguay. The main investments, considering the effective amount paid (cash flow), during the year are described below.

Brazil

Capital expenditures at the Brazilian units amounted to $723.7 million in 2006. A total of $77.4 million was invested in the completion of the São Paulo rolling mill that started operating in October 2006 as well as other improvements at the same facility. The Company invested $374.6 million at the Ouro Branco mill, mainly to increase installed capacity by 1.5 million tonnes of liquid steel and expected to come on stream in 2007 together with technological upgrades of equipment. Another important investment of $38.4 million was made in the modernization of equipments at the Cosigua mill. Other amounts are related to smaller improvements and technological upgrades at other facilities in Brazil.

South America (except Brazil)

The South American units spent $139.6 million on capital expenditures and acquisitions in 2006, compared to $63.4 million in 2005. The Company paid $86.9 million for the acquisition of Siderperú, in Peru, and $8.0 million for an additional stake in Sipar, Argentina. The Company invested $13.8 million in Gerdau AZA, $18.4 million in Diaco and Sidelpa, $12.4 million in Gerdau Laisa and $6.6 million in Sipar for the technological upgrades in equipment.

Canada and the United States

Gerdau Ameristeel spent $415.2 million on capital projects and acquisitions in 2006, compared to $185.5 million in 2005. The most significant projects include improvements to the bar mill finishing end at the Whitby, Ontario mill that commenced production in the fourth quarter of 2006, a new melt shop for the Jacksonville, Florida mill, scheduled for commissioning during the second quarter of 2007, a finishing end upgrade at the Cartersville, Georgia mill that started production in the second quarter of 2006, construction of a new rebar fabrication facility in King George, Virginia that began operations in the fourth quarter of 2006, and a new scrap shredder at the Jackson, Tennessee mill which is expected to begin full operation in the first quarter of 2007.

The Company paid $214.9 million for the acquisition of Sheffield Steel, Fargo Iron and Metal and Callaway Building Products in 2006.

Europe

In 2006, Gerdau invested $404.4 million in capital projects and acquisitions in Europe. The Company paid $204.0 million for the acquisition of a 40% stake in Corporación Sidenor in January of 2006 and $146.8 million for the acquisition of GSB Acero in December.

Complementary information regarding these investments is available under the following topics “Principal Capital Expenditure Currently in Progress” and “Acquisitions”.

Principal Capital Expenditure Currently in Progress

Gerdau approved, for the period between 2007 through 2009, approximately $4 billion in expansions and improvements in mills in Brazil and abroad. Of this total, 60% will be invested in mills in Brazil and the balance in mills abroad. Most of the investments will be made in the expansion of the integrated mill at Ouro Branco (Açominas), in which the installed capacity will go from 3 to 4.5 million tonnes. This increase in capacity should be available in the second half of 2007.

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The following tables contain the breakdown of investment plan in $ millions and in thousand tonnes by region:

$ millions

 

2007

 

2008

 

2009

 

TOTAL

 

BRAZIL

 

820

 

570

 

1,000

 

2,390

 

ABROAD

 

580

 

530

 

500

 

1,610

 

North America

 

260

 

360

 

315

 

935

 

Latin America

 

260

 

125

 

142

 

527

 

Europe

 

60

 

45

 

43

 

148

 

TOTAL

 

1,400

 

1,100

 

1,500

 

4,000

 

 

1,000 tonnes

 

CURRENT CAPACITY

 

2007

 

2008

 

2009

 

NEW CAPACITY

 

BRAZIL

 

 

 

 

 

 

 

 

 

 

 

Crude steel

 

9,845

 

1,290

 

50

 

 

11,185

 

Rolling products

 

6,840

 

 

 

90

 

6,930

 

NORTH AMERICA

 

 

 

 

 

 

 

 

 

 

 

Crude steel

 

7,160

 

200

 

230

 

370

 

7,960

 

Rolling products

 

7,480

 

30

 

130

 

875

 

8,515

 

LATIN AMERICA

 

 

 

 

 

 

 

 

 

 

 

Crude steel

 

1,640

 

10

 

775

 

50

 

2,475

 

Rolling products

 

2,070

 

 

270

 

425

 

2,765

 

EUROPE

 

 

 

 

 

 

 

 

 

 

 

Crude stee1

 

975

 

 

 

 

975

 

Rolling products

 

850

 

 

 

 

850

 

TOTAL

 

 

 

 

 

 

 

 

 

 

 

Crude steel

 

19,620

 

1,500

 

1,055

 

420

 

22,595

 

Rolling products

 

17,240

 

30

 

400

 

1,390

 

19,060

 

 

Acquisitions during 2006

Corporación Sidenor, S.A.

On January 10, 2006 the Company concluded the acquisition of 40% of Corporación Sidenor S.A., a Spanish steel producer with operations in Spain and Brazil. The Santander Group, a Spanish financial conglomerate, and an entity owned by executives of Sidenor contemporaneously acquired 40% and 20% of Sidenor, respectively. Purchase price for the acquisition of 100% of Sidenor consists of a fixed price of Euro 443.8 million plus a variable contingent price which is payable only by the Company, in the estimated amount of $106million. The fixed price plus tax credits paid by the Company on January 10, 2006 for its 40% interest in Sidenor amounted to Euro 168.9 million ($204.0 million).

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Corporación Sidenor, S.A. is a holding company that controls Sidenor Industrial, S.L., which is the largest manufacturer of specialty long steels as well as forged and molded parts in Spain. It is also one of the main manufacturers of forged parts by stamping in the country. Sidenor Industrial has three steel production units, located in Basauri, Vitoria, and Reinosa. Sidenor Industrial also has a subsidiary, Forjanor, S.L., a foundry for stamped parts, with plants in Madrid and Elgeta. In Brazil, Corporación Sidenor, S.A., through its subsidiary Sidenor Internacional, S.L., has an investment of 58.44% in the capital stock of Aços Villares S.A., a producer of specialty long steels and cylinders for rolling mills with industrial units in Mogi das Cruzes, Pindamonhangaba, and Sorocaba, all in the state of São Paulo.

Fargo Iron and Metal Company

In March, Gerdau Ameristeel acquired Fargo Iron and Metal Company, headquartered in Fargo, North Dakota. For more than 100 years, Fargo Iron and Metal has served the steel industry as a scrap yard and processing facility. The facility also provides a steel service center in one location for local manufacturers and construction companies.

Callaway Building Products

Gerdau Ameristeel acquired the assets of Callaway Building Products, headquartered in Knoxville, Tennessee, in March of 2006. For more than 45 years, Callaway Building Products has served the construction industry as a rebar fabricator and supplier of concrete construction products throughout East Tennessee, Eastern Kentucky, Virginia, North Carolina, and Georgia.

Sheffield Steel Corporation

Gerdau Ameristeel Corporation acquired all of the outstanding shares of Sheffield Steel Corporation of Sand Springs, Oklahoma, in June of 2006. Sheffield Steel is a mini-mill producer of long steel products, primarily rebar and merchant bars with annual shipments of approximately 550,000 tonnes of finished steel products. Sheffield operates a melt shop and rolling mill in Sand Springs, Oklahoma, a smaller rolling mill in Joliet, Illinois, and three downstream steel fabricating facilities in Kansas City and Sand Springs. The purchase price for the shares of Sheffield was $103.3 million in cash, plus the assumption of certain liabilities of the acquired company.

Empresa Siderúrgica del Perú S.A.A. - Siderperú

In June, Gerdau S.A. won the bid for 50% plus one share of the capital stock of Empresa Siderúrgica Del Perú S.A.A. - SIDERPERÚ, located in the city of Chimbote (Peru). The bid for this stake was made in a public auction promoted by the Private Investment Promotion Agency of Peru (ProInversión). The amount totaled $60.6 million, was paid in cash plus the assumption of net debt of approximately $102 million.

In November of 2006, Gerdau S.A. won the bid for 324,327,847 shares issued by SIDERPERÚ, which represents 32.84% of the total capital stock. The bid for this stake was made through a Public Offering of shares owned by Sider Corp S.A. The total price was $26.30 millions. Added to the stake already owned by Gerdau, this acquisition represents 83.27% of the total capital stock of Siderperú.

Siderperú is a long and flat steel producer with an annual installed capacity of 540 thousand tonnes of crude steel. Siderperú operates one blast furnace, a direct reduction unit and a melt shop with two electric arc furnaces (EAF), two LD converters and three rolling mills. Approximately 20% of sales are flat steel and the remaining 80% in long steel.

Pacific Coast Steel, Inc. and Bay Area Reinforcing

In November of 2006, Gerdau Ameristeel Corporation acquired a controlling interest in a newly formed joint venture with Pacific Coast Steel, Inc. and Bay Area Reinforcing. The venture, called Pacific Coast Steel, comprises one of the country’s largest reinforcing steel contractors, specializing in the fabrication and installation of reinforcing steel products across a variety of construction projects throughout California and Nevada. Additionally, the venture operates four rebar fabrication facilities in California, including San Diego, San Bernardino, Fairfield, and Napa, with a combined capacity in excess of 200,000 tonnes per year. The purchase price for the shares of PCS was $104.5 million in cash, plus the assumption of certain liabilities of the acquired company.

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GSB Acero, S.A.

In December, Gerdau acquired through the Spanish subsidiary Corporación Sidenor, S.A. in which it has a 40% stake, all outstanding shares issued by GSB Acero, S.A., subsidiary of CIE Automotive. Total price paid for this acquisition was Euro 111.5 million ($146.8 million).

Additional information regarding acquisitions during 2006 is set forth in Item 18. Financial Statements – Note 4.

B. BUSINESS OVERVIEW

Overview

Gerdau’s strategy focuses on the decentralized production of long steel using electric arc furnace (EAF) mini-mills and integrated mills with blast furnaces, and continuous casting technology being used in both processes. The Ouro Branco mill also uses the conventional casting technology. Plants are sized and located to meet the needs of local markets and provide efficient access to customers. This strategy is a response to the geographical dimensions of Brazil and the United States given both countries’ high transportation and freight costs. Gerdau is therefore able to supply its customers and source raw materials locally. From 1970 to 1990, Gerdau concentrated on building market share in Brazil by increasing its installed capacity and by acquiring existing mills, typically seeking those with management problems where the Company’s main contribution would be its management skills rather than capital. Gerdau’s Brazilian operations constitute currently the third largest crude steel producer in Brazil, according to the IBS (Brazilian Steel Institute).

Outside Brazil, and notably in North America, Gerdau Ameristeel has increased its market share by acquiring mills, which, like their Brazilian counterparts, required management restructuring rather than capital. Gerdau has progressively increased its share of the North American market and is currently the second largest North American long steel producer with an annual nominal capacity of 7.2 million tonnes of crude steel and 7.5 million tonnes of rolled products according to Company statistics. Gerdau Ameristeel’s industrial units are distributed across North America to supply local markets along the east coast of the United States and the east and central regions of Canada. Following the acquisition of Sheffield Steel’s assets, completed in June 2006, Gerdau Ameristeel has 16 long steel units and a joint venture of 50% in Gallatin.

Gerdau also owns steel units in Argentina (rolling mill), Chile, Colombia, Uruguay and recently in Peru, where it acquired a controlling shareholding in Siderperú in June and in November of 2006. The steel units have a combined annual installed capacity of 1.6 million tonnes of crude steel. These units are highly profitable and efficient and contribute 8.5% of total installed crude steel capacity to consolidated results.

In January of 2006, the Company acquired 40% of Corporación Sidenor S.A., a Spanish steel producer with operations in Spain and Brazil. In December 2006, Corporación Sidenor acquired all outstanding shares issued by GSB Acero, S.A. These represent a significant investment in the industrial segment where Gerdau has consolidated experience. These investments open the way to enter the strategic European Union market. Furthermore, these acquisitions allows the Company to open an important commercial channel with the large international carmakers as well as provides access to production, administrative, and industrial management know-how of one of the world’s largest suppliers of this sector . This initiative is consistent with the Company’s long-term growth and globalization plan.

List of Products

Gerdau produces steel products throughout its units located in Brazil, North America, South America (excluding Brazil) and Spain. Please find below the list of products:

Ancorfix e Tutor - Products for fruit crops

 

Light rails

Angles

 

Oval-shaped wire and barbed wire

Annealed wire

 

Plastic-coated galvanized wire

Billets

 

POP prefabricated light columns and meshes

Blooms

 

Prefabricated footing

Bulk nails - carpentry

 

Prefabricated warehouse

 

17




 

Bulk nails - construction

 

Ribbed reinforcing mesh

Bulk nails - packaging

 

Ribbed T profile

Cercafix post-spacing wire

 

Slabs

Channel, I-beam, T-shapes and W-beams

 

Smelter bars

Cold drawn round, square and hexagonal bars

 

Staples for fences

Cold-finished engineering steel (carbon and alloyed)

 

Star profile

Cold-finished stainless steel

 

Ssteel fence post

Complete line of wires for industrial applications, welding and wire ropes

 

Stirrups

Elevator guide rails

 

Structural shapes

Engineering steel (carbon and alloyed) with or without heat treatment

 

Superlight I-beams

Fabricated rebar

 

Transfer bars

Forged bars and blooms

 

Tribar

Galvanized wire

 

Truss reinforcing for concrete beams

Concrete reinforcing bars (rebars)

 

Welded wire fences

Grader blades

 

Wire and posts for electric fences

Grinding balls

 

Wire and wire rope for agricultural products

Gripple joiner and tensioner

 

Wire rope for corrals

Flat, round and square rolled bars

 

Wire-rod

 

Principal Markets in which the Company competes

The three main markets in which Gerdau operates are: (i) construction, to which it supplies rebars, merchant bars, nails and meshes; (ii) manufacturing, to which it supplies products for machinery and agricultural implements, tools and other industrial products; and (iii) other markets, to which it supplies wires and posts for agricultural facilities and reforestation projects. In North America, Gerdau Ameristeel Manitoba also supplies customers with special sections, including elevator guide rails and super light beams. Gerdau provides its customers with higher added value products at 56 fabricated reinforcing steel facilities – fabrication shops - (12 Armafer service centers in Brazil, 11 in South America and 33 fabrication shops in North America) plus five fab shops joint ventures (four in United States and one in Chile) and six flat steel service centers in Brazil.

Seasonality of the Company’s Main Business

The Company’s sales are subject to seasonal variation and to the economic performance of the main economic sectors to which the Company provides products which in turn are subject to variations based on changes  in the GDP of the countries in which Gerdau operates. In Brazil and in the other operations in South America, second and third quarter shipments tend to be stronger than those in the other two quarters. In North America, 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, decreased construction activity and hence lower Company sales. The third quarter in Spain is traditionally the time in which collective vacations occur reducing the quarter’s activities to only two months.

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Sources and Availability

Gerdau’s production processes are mainly based on the mini-mill concept, with mills equipped with electric arc furnaces that can melt steel scrap and produce the steel product at the required specifications. The principal raw material used at these mills is essentially steel scrap and a mixture of pig iron and steel scrap in the Brazilian mills. The component proportions of this mixture may change in line with price and availability at the time of production so as to optimize raw material costs, the ratio of steel scrap to pig iron varying from 60%-40% to 90%-10%.

The main metallic input used by the Company’s mills in the United States is steel scrap. In the event of steel scrap prices exceeding acceptable levels, 2004 being a case in point, the mills seek modify input sources accordingly.

The Company’s Brazilian mills use scrap and pig iron purchased from local suppliers. The Company believes that this strategy minimizes transportation costs. Gerdau has a network of more than 3,500 scrap suppliers that deliver their materials to its yards in Brazil. The Company believes that it is the largest buyer of scrap in Brazil. The pig iron used in the steel-making process is produced at Gerdau Contagem in the state of Minas Gerais and Margusa, in the state of Maranhão. Part of the pig iron used at Gerdau’s mills is also sourced from other companies. In 2006, 40% of Gerdau Brazil’s mini-mills solid pig iron requirements was produced internally.

Due to the nature of the raw materials employed, Gerdau does not use long-term supply contracts in its mini-mills operations in Brazil. The Company’s mini-mills purchase their scrap directly on demand using mainly obsolescence scrap. Scrap and other raw materials are priced in Brazilian reais and input prices are not therefore directly affected by currency fluctuations.

Due to its size, Ouro Branco mill employs a different strategy to acquire its raw materials: long-term contracts to guarantee supplies. The unit’s main raw materials include: (i) coal, imported from Canada, Australia and the United States; (ii) ferroalloys, of which 90% is purchased in the domestic market; and (iii) iron ore, which is supplied by large, medium and small sized mining companies, some of them strategically located close to the plant. These three items account for more than 40% of the total production costs of Gerdau Açominas in 2006.

South American units (ex-Brazil), do not maintain long-term contracts with suppliers and are thus exposed to market fluctuations.

Gerdau Ameristeel has consistently obtained adequate supplies of raw materials and is not dependent on any one supplier. It believes there are an adequate number of alternative suppliers in the marketplace should it need to replace an existing one.

Metallic Inputs

Gerdau’s main metallic input is steel scrap, which is used in electric arc furnaces. Pig iron, iron ore (used in blast furnaces and in one Direct Reduction Iron - DRI plant), and ferroalloys are also important. The Company’s Brazilian mills use a mixture of scrap and pig iron, due to the low yield of steel scrap in Brazil.

Although international steel scrap prices are determined by the U.S. domestic market (since the United States is the main scrap exporter), the price of steel scrap in Brazil varies from region to region and is influenced by demand and transportation costs. Gerdau is the largest consumer of steel scrap in Brazil with more than 3,500 scrap suppliers.

Scrap

There are two broad categories of steel scrap: (i) obsolescence scrap which is steel from various sources, ranging from tin foil cans to car bodies and white goods and (ii) industrial scrap essentially factory steel cookie cutouts, steel turnings, and even scrap generated by the Company’s production processes themselves. Gerdau uses mainly obsolescence scrap in Brazil while the North American plants use mainly industrial scrap.

In Brazil, the largest proportion of the steel scrap consumed by Gerdau is sourced in the state of São Paulo, the balance being evenly distributed among the other areas in which Gerdau has its other mills. Scrap dealers deliver obsolescence scrap directly to the mills. In regions where it does not have a steel mill, the Company has yards where scrap is collected and compacted for transportation by third parties. The price of scrap in Brazil varies by region, depending upon local supply and demand, and transportation costs. Each month, based on market conditions, the Company’s procurement officer sets the maximum price for scrap (by type of scrap and region) to be paid by Company representatives. With the large number of consumers leading to fierce competition, prices tend to be higher in the Southeast, the most industrialized region of Brazil. However, given that its facilities are evenly distributed throughout Brazil, Gerdau is able to take advantage of lower prices in other regions without incurring high transportation costs.

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Gerdau Metálicos is a division that collects and supplies scrap to the industrial units, and is the Latin American leader in steel scrap recycling. It reuses millions of tonnes of Brazilian scrap every year, accounting for significant gains through process optimization, reduced energy consumption, greater productivity and increasingly competitive operating costs. It should be noted that a tonne of steel produced from scrap requires only one third of the power needed to generate one tonne of steel from iron ore. Gerdau Metálicos purchases scrap directly from companies across Brazil, through a network of more than 3,500 suppliers that generate thousands of jobs. Gerdau Metálicos has stowage yards (collection points) for scrap in strategic locations throughout Brazil and uses several mobile presses that travel the country, preparing scrap for transportation to its mills. Every Gerdau Metálicos industrial unit has a recycling yard with state-of-the-art equipment to process scrap using presses and stationary and mobile shears. The Company also has five shredders, including a mega-shredder at Gerdau Cosigua in Rio de Janeiro, capable of processing the equivalent of 300 car bodies per hour.

The price of scrap in South America (ex-Brazil) varies according to demand, transportation costs and by region. There are more than 250 steel scrap suppliers in Chile, more than 310 suppliers in Uruguay, almost 1,800 in Colombia and 60 in Peru.

Steel scrap is Gerdau Ameristeel’s primary raw material. Scrap is a commodity, the availability of which varies with price and is a major constraint in the company’s operations. Gerdau Ameristeel’s Jackson, Jacksonville, St. Paul, Wilton and Whitby mills all have on-site dedicated scrap processing facilities, including shredder operations that supply a significant portion of their scrap requirements. Gerdau Ameristeel MRM Special Sections receives a significant amount of its scrap from Manitoba Metals Recycling and the North Dakota scrap collection and processing yards. Gerdau Ameristeel has a total of 17 scrap recycling locations, although given that not all of the scrap that it consumes is sourced from its own scrap yards, it buys residual requirements in the market either directly or through dealers that source and aggregate scrap. Gerdau Ameristeel has about 1,200 active scrap suppliers.

All of Gerdau Ameristeel’s production facilities in North America are mini-mills where operating results are closely linked to the cost of steel scrap and scrap substitutes, the primary mini-mill input. Steel scrap prices are relatively higher during winter months due to the impact of weather on collection and supply efforts. Approximately half of all steel products in North America are currently made in electric arc furnaces using steel scrap. Prices for steel scrap are subject to market forces largely beyond the Company’s control; demand by U.S. and international steel producers, freight costs and speculation among others. Increasing worldwide steel scrap consumption, especially in China, has placed significant upward pressure on the price of steel scrap. A combination of a weaker U.S. dollar, strong global demand for steel scrap and lower production of domestic steel scrap due to a weaker domestic manufacturing economy have reduced the domestic steel scrap supply resulting in prices which are currently at a ten-year high. Metal spread, the difference between mill selling prices and scrap raw material cost, is also currently well above previous ten-year highs.

Corporación Sidenor does not maintain long-term contracts with scrap suppliers: it has more than 50 scrap suppliers with the mainly type of scrap used in the Spanish operations being industrial.

Pig Iron and Sponge Iron

Brazil is a net exporter of pig iron. Most Brazilian pig iron is produced in the state of Minas Gerais by a large number of small producers. Pig iron is a natural substitute for scrap, and in Brazil, mixed with scrap due to the low quality of the existing scrap supplies. Some mills in the U.S. use pig iron with steel scrap. In Brazil, the price of pig iron is related to the cost of charcoal, an important input and the most volatile cost item in the production of pig iron. When the price of charcoal is seasonally high, coking coal can be used as a substitute which, although more expensive, provides higher pig iron yields. Iron ore, the main component of pig iron, is widely available in Brazil, the country being among the world’s leading producers and exporters.

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

The Company does not have any Brazilian contracts for the supply of pig iron, negotiating amounts and delivery conditions directly on the spot market. The price of pig iron may fluctuate in line with its international market price, given that a large portion of production in Brazil is exported.

Scrap availability is a major factor in Gerdau Ameristeel’s ability to operate. Direct reduced iron, hot briquetted iron and pig iron can be a substitute for a limited portion of the steel scrap used in electric arc furnace steel production. Gerdau Ameristeel does not employ significant quantities of scrap substitutes in its mini-mills except for pig iron used for its chemical properties in the Perth Amboy rod making facility, until September 2006, and to manufacture certain special sections.

20




Gerdau also consumes pig iron from Margusa, a solid pig iron producer owned by the Company, in the Northeast of Brazil located close to the maritime port facilities, with an annual installed plant capacity of 210,000 tonnes. Gerdau uses Margusa’s output to supply its plants in the Northeast of Brazil, although a smaller quantity has been exported to some foreign Gerdau steel units.

Iron Ore

Gerdau’s Brazilian operations use iron ore to produce pig iron at its Barão de Cocais and Divinópolis mills, in the state of Minas Gerais, and sponge iron at its Gerdau Usiba mill in Bahia. Gerdau Contagem and Margusa also use iron ore in order to produce solid pig iron. The Company has acquired iron ore from MBR, Companhia Vale do Rio Doce and other smaller suppliers.

Gerdau Açominas uses fine grain quality iron ore, which is transformed into sinter in a sintering unit, as its main metallic input in the steel production. Lump ore and iron ore pellets are directly loaded into the blast furnace to increase productivity. Raw material suppliers located adjacent to the plant reduce transportation and storage costs. The molten pig iron produced in the blast furnace is the main raw material used in the melt shop. In 2006, metallic inputs were composed of 84% of molten pig iron, 12% of steel scrap and 4% of solid pig iron.

Other Inputs

In addition to scrap, pig iron, sponge iron and iron ore, Gerdau’s Brazilian operations use other inputs to produce steel such as ferroalloys, electrodes, furnace refracting materials, oxygen, nitrogen and other industrial gases and limestone, albeit in smaller amounts. All of these inputs are readily available in Brazil. Additional inputs associated with the production of pig iron are charcoal, used in blast furnace mills, and natural gas, used at the DRI unit.

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

The North American operations also use additional inputs. Various domestic and foreign companies supply other important raw materials or operating supplies required for the business, including refractory materials, ferroalloys and carbon electrodes that are readily available in the open market. Gerdau Ameristeel has obtained adequate quantities of these raw materials and supplies at competitive market prices thus permitting efficient mill operations. The Company is not dependent on any one supplier as a source for any particular material and believes there are adequate alternative suppliers available in the marketplace if the need to replace an existing one arises.

Energy

Steel production is an energy intensive process, especially in EAF mills. Power and, to a lesser extent, natural gas used in some mills are significant components of steel production costs.

In Brazil, Gerdau’s units have contracts with a series of electricity suppliers and are not dependent on any single contract. Energy is currently supplied to the Company’s industrial units under two types of contract:

I – Contracts in which the Company is a “Captive Consumer”, exist at the following units: Riograndense, Aços Especiais Piratini, Guaíra, Usiba and Açonorte. These contracts involve state-owned companies or holders of public concessions. Under these contracts, demand and consumption are defined between the parties and the tariffs are defined by ANEEL, the Brazilian Electricity Power Regulator. Captive consumers may purchase part of their energy on the free market.

II – Contracts in which Gerdau is a “Free Consumer” include Araçariguama, Cosigua, Cearense, Ouro Branco, Divinópolis and the Barão de Cocais units. These mills have the energy contracts with generators with rates defined and adjusted according to pre-established indexes. The contracts are held with transmission and distribution companies and the tariffs are revised annually by ANEEL. Ouro Branco reduces its exposure to the energy market by meeting a significant part of its energy needs through self-generation, using top-of-blast furnace-generated gases.

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In terms of natural gas, all units are supplied under long-term contracts. The Barão de Cocais and Divinópolis units do not have access to natural gas.

In Chile, Peru, Colombia and Uruguay, both energy and natural gas are provided under long-term contracts. In 2006, the energy and natural gas contracts were renewed in Colombia. In Chile, Gerdau AZA will renegotiate its energy contract in 2007 and has had to use fuel oil in place of natural gas, due to periods of rationing in Argentina (peak hours in winter).

In Spain, all large consumers are being obliged, through 2008, to migrate to the free market, where prices are higher.

In North America, there are two kinds of energy markets: regulated and deregulated. In the regulated market, the contracts are held with authorized public utilities and the tariffs are defined for each region through long-term contracts. In the deregulated market, the price of power changes every 5 minutes (spot market price) to reflect the actual cost to produce power. Although deregulation of both natural gas and wholesale electricity may provide opportunities for lower costs resulting from competitive market forces, the prices of both of these energy inputs have recently become more volatile and may remain so. The Company does not have long-term natural gas supply contracts and therefore is subject to market variables and price swings.

In all countries self-generation alternatives are being analyzed.

Information on the Extent of the Company’s Dependence

The Company is not dependent on patents or licenses, industrial, commercial or financial contracts (including contracts with customers or suppliers) or new manufacturing processes that are material to the Company’s business or profitability.

The Company has a policy of diversifying its suppliers so that it can replace them in the event of a breach of contract without affecting the Company’s operations.

Should electricity supplies be interrupted, no alternative energy options are available at most Gerdau mills due to the high volume and tension required for the operation of these plants. In such cases (as occurred in 2001, in Brazil, when the federal government set targets for reducing consumption), the events and their consequences are discussed with the respective energy concessionaires while operating capacity is kept at emergency levels to protect staff and equipment.

In the event of rationing, decisions and procedures will be implemented by the Government’s regulatory agency. These may have a materially adverse impact on the Company’s results, with a consequent reduction in production in the light of the availability of electricity and readjustments to delivery schedules. Although such problems are not common in Brazil, some small Gerdau units may choose, as an alternative, to use generators to compensate for the shortage of energy. During the 2001 period of electric power rationing, Gerdau overcame the crisis by reallocating production among its several industrial units and by rationalizing the use of electricity. These measures resulted in efficiency and productivity gains which were incorporated into the production process after the critical period ended.

In terms of natural gas, the units of Rio Grande do Sul, Paraná and São Paulo are supplied by imported natural gas, through GASBOL (Brazil-Bolivia Pipeline), whereas the other units are supplied by domestic natural gas. In the event of natural gas rationing, it would be possible to adapt the equipment for use of fuel oil and LPG (Liquefied Petroleum Gas).

Marketing Channels

The Company sells its products to various markets, including construction, manufacturing and other markets. Sales by its Brazilian operations include both domestic and exports. Most of the sales of its North and South American business operations are in their respective local markets.

Gerdau S.A. Consolidated
Shipments by Region
(1,000 tonnes)

 

2006

 

2005

 

2004

 

TOTAL

 

14,890

 

12,860

 

11,873

 

Brazil

 

6,623

 

6,404

 

6,711

 

Domestic

 

4,227

 

3,509

 

3,881

 

Exports

 

2,396

 

2,895

 

2,830

 

North America

 

6,040

 

5,727

 

4,724

 

South America (ex-Brazil)

 

1,546

 

729

 

438

 

Europe

 

681

 

 

 

 

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Gerdau S.A. Consolidated
Net Sales by Region of Origin of
Shipments
($ million)

 

2006

 

2005

 

2004

 

TOTAL

 

11,844

 

8,894

 

6,952

 

Brazil

 

5,354

 

4,484

 

3,623

 

North America

 

4,464

 

3,897

 

3,010

 

South America (ex-Brazil)

 

1,073

 

513

 

319

 

Europe

 

953

 

 

 

 

Brazilian Operations

The Company’s Brazilian operations accounted for 44.5% of overall Gerdau shipments. Brazilian sales amounted to 6.6 million tonnes, of which 4.2 million tonnes were delivered to the domestic market and 2.4 million tonnes to the export market.

The Gerdau Brazilian operations are divided into the following segments: Brazil Long Steel Products, Specialty Steel Products (which as from 2006 also includes specialty steel operations outside Brazil) and Gerdau Açominas (Ouro Branco mill).

Approximately 18% of the production sold in Brazil is distributed through Comercial Gerdau, the Company’s largest distribution channel with 68 stores throughout Brazil, servicing approximately 100,000 customers in 2006. Another important distribution channel is the network of almost 21,000 sales channels to which Gerdau sells its products, giving it a comprehensive national coverage. Sales through its distribution network and to final industrial and construction consumers are channeled through Company employees and authorized representatives working on commission.

Gerdau Brazilian operations minimize delays by delivering its products directly to customers through third-party companies, under Gerdau’s supervision. Sales trends in both the domestic and export markets are forecasted monthly based on historical data of the three preceding months. Gerdau’s Brazilian operations use their own information system to remain current on market developments so that it can respond swiftly to fluctuations in demand. Gerdau considers its flexibility in shifting between markets, and its ability to monitor and optimize inventory levels in the light of changing demand, as key to its success.

Gerdau Açominas has specific operational features. The products are usually sold to rolling mills and to companies that use slabs, billets, blooms and ingots as raw material for their finishing lines such as shipbuilding, forging and mechanical. Gerdau Açominas also produces its own finished products such as high quality wire rod and sections. These products are delivered to the customers’ port of destination or directly to the plant facilities.

Specialty steel products are sold through Gerdau Aços Especiais Piratini. This subsidiary operates in the specialty steel market and its sales force and production facilities are independent of the Brazilian long steel business unit. Gerdau Aços Especiais Piratini, in partnership with its customers, produces engineering steel, tool steel and stainless steel that is sold to almost 270 clients. About 76% of its sales go to the automotive industry. In order to meet the continuous need for innovation, Gerdau Aços Especiais Piratini is constantly developing new products, such as micro-alloyed steel for diesel engines with high power and low emissions, clean steels for application in bearings, steels with improved machining characteristics, which allow higher machining speeds and lower tooling replacement, among others. Gerdau Aços Especiais Piratini has a 40% stake in Corporación Sidenor, a Spanish specialty steel company which in turns controls Aços Villares, a brazilian specialty steel producer.

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Retail

The Gerdau Brazilian operations sell its products nationwide through the Comercial Gerdau network of 68 stores and six flat steel service centers. In addition to Gerdau products, Comercial Gerdau resells flat products produced by other companies in Brazil. In 2006, domestic market sales of flat steel products amounted to 209,272 tonnes.

Exports

Gerdau has been exporting a larger part of its production since 2003 following the consolidation of its Brazilian operations, the decline in domestic market sales and higher international prices. In 2006, exports accounted for 36.2% of the Company’s Brazilian operations total shipments. Export activities are coordinated by the sales channel responsible for selling products directly to end overseas users and indirectly through trading companies. Sales are negotiated worldwide (i) primarily CFR (Cost and Freight) and (ii) guaranteed by sight letters-of-credit issued by customers through first class European and American banks.

Gerdau’s Brazilian exports generated $1,322.7 million in revenues in 2006. Exports from Brazilian operations totaled 2.4 million tonnes, a decrease of 17.2% due to the increase of sales (20.5%) in the domestic market. The new export strategy has allowed Gerdau to develop its client base in a more evenly distributed manner throughout the world with exports going to Africa, Europe, South, Central and North America and Asia. Exports to South America were responsible for 29% of total exports in 2006, against 19% in 2005. Exports to Asia decreased from 44% in 2005 to 23% in 2006, reflecting the export strategy in reducing exposure to the volatile Asian steel market.

Exports from the Company’s Brazilian operations have become an even more significant portion of its sales. Consequently, Gerdau has been making efforts to improve its logistics strategies to overcome Brazilian infrastructure limitations. In 2006, Brazilian exports were dispatched to 60 countries aboard 482 ships using the services of 18 different ports.

Although Gerdau’s Brazilian operations deal primarily in commodities, it is aware of the importance of quality control. The Company’s technicians conduct random visits to customers to check the quality of the products that it exports to ensure user satisfaction with products purchased indirectly from Gerdau.

Foreign operations

Gerdau’s foreign operations are divided into North American and South American operations (ex-Brazil), and specialty steel in Europe.

South American units (ex-Brazil) sold 1.5 million tonnes of finished products in 2006, representing a 112.0% increase compared to 2005. This is due to the consolidation of the 100% holding in Sipar Aceros, the acquisition of Diaco and the acquisition of Siderperú.

Gerdau AZA has a 44% share of the Chilean merchant bar and rebar markets. Since the end of 2000, Gerdau AZA has had a business unit known as AZAonLine, which services customers in Chile through the Internet. This was the first e-commerce initiative in the steel sector in Chile. Customers can track their orders on the Internet, together with product inventories and credit and payment status. They can also access their purchase records as well as generate quality certificates and place orders. Gerdau AZA sells its products to more than 120 clients, which are distributors and end-users.

Gerdau Laisa has an 83% share of the long steel products market in Uruguay. There are more than 310 registered customers classified as retail, wholesale and end-consumers, which distribute its products all over the country. Uruguayan customers can also use an e-business channel.

The Sipar Aceros figures were consolidated starting in the fourth quarter of 2005 as a result of the acquisition of an additional stake. Sipar has 19% of the Argentine market and has almost 1,000 clients. The company sells its products directly to end-users (construction companies and industries) or through distributors to the domestic market.

Diaco and Sidelpa, acquired in September 2005and December 2005, respectively, have a 37% stake in the Colombian steel market. The companies sell their products through more than 330 distributors and have more than 1,200 clients (end-users) in the following markets: civil construction, industry and others.

Siderperú was acquired in June of 2006 and has a market share of 45% in the long products segment. The company sells its products to more than 250 clients from the construction, industry and mining sectors and has more than 250 distributors.

24




Gerdau’s foreign operations supply their respective domestic markets, with the exception of the Canadian operations, which sell a significant portion of their production to the United States.

Gerdau Ameristeel’s strategy is to have production facilities located in close proximity to customers’ job-sites so quick delivery times are provided to satisfy their reinforcing steel needs and construction schedules. In 2006, Gerdau Ameristeel sold products to over 1,000 customers.

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

Gerdau is present in Europe through Corporación Sidenor, which sells specialty steel to the whole continent. Corporación Sidenor has a market share of 43% in Spain and 9% in the European Union. Sidenor has more than 400 clients located mainly in Spain, France, Germany and Italy.

Terms of Sales

Gerdau 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 a 26-day settlement basis, mainly CIF.

Brazilian customers are subject to a credit approval process. The concession of credit limits is controlled by a corporate-level system (SAP R/3), which can be accessed by all sales channels. The credit and collection department is responsible for credit evaluation, definition and monitoring in accordance with the limits policy. This policy has the active participation of the client sales channels officers.

At Comercial Gerdau, in particular, the criteria for retail sales also include practices such as the use of credit cards serviced in Brazil.

Gerdau Açominas’ exports are guaranteed via letter of credit and/or pre-payment before the product is shipped. Exceptionally, exports to Gerdau’s subsidiaries may be sold on credit at ongoing market interest rates.

As a result of the implementation of these policies, the Company’s provision for doubtful accounts was an insignificant percentage of its consolidated accounts receivable (less than 0.6%) on December 31 2006. Thanks to the implementation of the Integrated Risk Management Project, Gerdau has improved its credit approval controls and enhanced the reliability of its sales process through the use of risk indicators and internal controls.

Gerdau Ameristeel’s credit terms to customers are generally based on customary market conditions and practices. Gerdau Ameristeel’s business is seasonal with orders in the second and third quarters tending to be stronger than those of the first and fourth quarters, due primarily to weather-related slowdowns in the construction industry.

Corporación Sidenor has a Risk Committee which is responsible for the customer credit analysis.

Competitive Position

Shipping, freight and demurrage costs are a major barrier to imports, and, since Gerdau operates primarily in the common long rolled product business in Brazil where profit margins are relatively small, the incentive for foreign competitors to enter the Brazilian market is low. In the Brazilian market, no single company competes against Gerdau across its entire product range. Gerdau believes that its business diversification and decentralization provide a competitive edge over its major competitors where operations are more centralized.

Gerdau is the largest Brazilian long steel producer with a 47% market share according to the IBS. Belgo Mineira, an Arcelor subsidiary, is the second largest producer in Brazil with roughly 37% of the market. Belgo Mineira was originally an integrated steel company, but now also has mini-mill plants.

In the domestic market, Gerdau Açominas is almost an exclusive supplier to well-defined and loyal customers, which have been purchasing from it regularly for more than ten years. Competition from CST (Companhia Siderúrgica de Tubarão) in the slab market is stiffer. In the international market, Gerdau Açominas faces strong competition in the commercial quality products line from Eastern Europe (CIS) and China. The main competitors in the high quality products segment are Europeans and to a less extent the Japanese. The Company is a strong player due

25




to its great experience and the high quality of its services and products. Gerdau Açominas has a diversified list of traditional customers all over the world.

In South America (ex-Brazil), the main barriers faced by the operations are freight and transportation costs and the availability of imports. The South American units are the main players in the country where they operate with the exception of Sipar Aceros, which is ranked second in the Argentine market with a 19% market share.

Gerdau Ameristeel’s geographic market encompasses the eastern two thirds of Canada and the United States, predominantly the eastern seaboard, the Southeast and the Midwest United States. Gerdau Ameristeel experiences 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 limited. Proximity of product inventories to customers, together with competitive freight costs and low-cost manufacturing processes, are key to maintaining margins on rebar and merchant bar products. Rebar deliveries are generally concentrated within a 350 mile radius of the mills and merchant bar deliveries are generally concentrated within a 500 miles. Some products, such as special sections produced by the Manitoba mill, are shipped greater distances, including overseas. Except in unusual circumstances, the customer’s delivery expense is limited to freight charges from the nearest competitive mill, and the supplier absorbs any incremental freight charges.

Principal competitors to Gerdau Ameristeel include Commercial Metals Corporation, Nucor Corporation, Steel Dynamics Inc., Mittal Inc., Bayou Steel Corporation and Ivaco, Inc.  Gallatin Steel, which produces flat rolled sheet, competes with numerous other integrated and flat rolled mini-mill steel producers.

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

All North American steel producers have experienced significant and, in some cases, unfair competition from foreign steel producers during the past several years. Due to unfavorable foreign economic conditions and global excess capacity, imports of steel bar and wire rod products into the United States’ and Canadian markets have reached historically high levels in recent years, with a corresponding negative impact on domestic prices.

In 2006, demand for both long and flat steel continued to show strength, but the high level of imports noted during 2005 continued during the year. Capacity expansion in China and other Asian countries contributed to a record level of imports into North America in 2006. During the last quarter of 2006 these imports peaked, creating excess inventory in the distribution system. Many steel producers, including Gerdau Ameristeel, reduced production in the light of softer demand.

Material Effects of Government Regulations

Besides government regulations that apply to industry in general, the Company is not subject to any specific regulation that materially affects its business.

C. ORGANIZATIONAL STRUCTURE

Gerdau Group

Gerdau S.A. is a non-operational holding company (since November, 2003 when Gerdau S.A.’s Brazilian assets were transferred to Açominas, creating Gerdau Açominas S.A.) controlled by a holding company, Metalúrgica Gerdau S.A. As of December 31 2006, Gerdau S.A. consolidates the results of 15 operating companies: Aceros Cox S.A. (Chile), Diaco S.A. (Colombia), Empresa Siderúrgica del Perú S.A.A. (Peru), Gerdau Ameristeel Corp (Canada) and its subsidiaries (United States and Canada), Gerdau Açominas S.A. (Brazil), Gerdau Aços Longos S.A. (Brazil), Gerdau Aços Especiais S.A. (Brazil), Gerdau Comercial de Aços S.A. (Brazil), Gerdau AZA S.A. (Chile), Gerdau Laisa S.A. (Uruguay), Maranhão Gusa S.A. - Margusa (Brazil), Siderúrgica Del Pacifico S.A. (Colombia), Sipar Aceros S.A. (Argentina), Corporación Sidenor S.A. and its subsidiaries (Spain) and Seiva S.A. (Brazil) which operates in the forestry business.

The Company’s investments in Gallatin, Bradley Steel Processor and MRM Guide Rail in North America, in which Gerdau Ameristeel holds a 50% stake in the total capital, the investments in Armacero Industrial y Comercial Limitada in Chile, in which the Company owns a 50% stake, and the investment in Dona Francisca Energética S.A., in

26




which the Company owns a 51.82% stake, are accounted in the Company’s financial statements using the equity method.

Significant Subsidiaries

The table below shows the main consolidated companies and investments maintained directly or indirectly by Gerdau on December 31 2006:

 

Interest (%)

 

Company

 

2006

 

2005

 

 

 

 

 

 

 

Aceros Cox S.A. (Chile)

 

98

 

98

 

Gerdau Ameristeel Corporation (Canada) and its subsidiaries:

 

65

 

65

 

Ameristeel Bright Bar Inc. (USA)

 

65

 

65

 

Gerdau Ameristeel MRM Special Sections Inc. (Canada)

 

65

 

65

 

Gerdau Ameristeel Perth Amboy Inc. (USA)

 

65

 

65

 

Gerdau Ameristeel Sayreville Inc. (USA)

 

65

 

65

 

Gerdau Ameristeel US Inc. (USA)

 

65

 

65

 

Sheffield Steel Corporation (USA)

 

65

 

 

Pacific Coast Steel Inc. - PCS (USA) *

 

36

 

 

Gerdau Açominas S.A. (Brazil)

 

89

 

89

 

Gerdau Aços Especiais S.A. (Brazil)

 

89

 

89

 

Gerdau Aços Longos S.A. (Brazil)

 

89

 

89

 

Gerdau América do Sul Participações S.A. (Brazil)

 

89

 

89

 

Gerdau Aza S.A. (Chile)

 

98

 

98

 

Gerdau Comercial de Aços S.A. (Brazil)

 

89

 

89

 

Diaco S.A. (Colômbia)

 

57

 

57

 

Gerdau Internacional Emprendimentos Ltda. (Brazil) and its wholly owned subsidiary Gerdau GTL Spain S. L. (Spain) and subsidiaries

 

98

 

98

 

Gerdau Laisa S.A. (Uruguay)

 

98

 

98

 

Maranhão Gusa S.A. – Margusa (Brazil)

 

89

 

89

 

Paraopeba - Fundo de Investimento Renda Fixa

 

95

 

97

 

Seiva S.A. – Florestas e Indústrias (Brazil)

 

97

 

97

 

Sipar Aceros S.A. (Argentina)

 

72

 

72

 

Sidelpa S.A. (Colombia)

 

95

 

95

 

Corporación Sidenor S.A. and its subsidiaries (Spain)

 

40

 

 

Sidenor Industrial S.L. (Spain)

 

40

 

 

Forjanor S.L. (Spain)

 

40

 

 

GSB Acero S.L. (Spain)

 

40

 

 

Aços Villares S.A. (Brazil)

 

23

 

 

Empresa Siderúrgica del Peru S.A.A. – “Siderperu” (Peru)

 

83

 

 

 


* Gerdau Ameristeel holds an interest of 55% in PCS, and the Company a stake of 65% in Gerdau Ameristeel, the Company’s indirect stake in PCS therefore being 36%. PCS is being consolidated by Gerdau Ameristeel which in turn is being consolidated by the Company.

The operating companies that are fully consolidated or accounted according to the equity method in the financial statements of Gerdau S.A. are described below:

Gerdau Aços Longos and Gerdau Comercial de Aços

Gerdau Aços Longos S.A. produces common long steel and Gerdau Comercial de Aços S.A sells steel products in general. Gerdau Aços Longos has nine mills distributed throughout the country and has an annual installed capacity of 5.5 million tonnes of crude steel. Gerdau Comercial de Aços is responsible for 68 distribution steel centers throughout Brazil.

27




Gerdau Aços Especiais and Corporación Sidenor

Gerdau Aços Especiais is headquartered in Charqueadas, state of Rio Grande do Sul and has a consolidated annual installed capacity of 2.4 million tonnes of crude steel, including the annual installed capacity of Corporación Sidenor, which has operations in Brazil and in Spain.

Corporación Sidenor produces specialty steel and has a market share of 43% in Spain and 9% in the European Union.

Gerdau Açominas

Gerdau acquired a stake in Açominas, together with NatSteel and the Açominas Employee’s Association in 1997. The Company increased its stake in Açominas, acquiring a controlling stake in 2001. Gerdau Açominas owns the Ouro Branco mill, located in the state of Minas Gerais. The Ouro Branco mill has an annual installed capacity of 3.0 million tonnes of crude steel and is responsible for 37.1% of Gerdau’s crude steel output in Brazil.

Gerdau Laisa

In 1980, the Company acquired the Laisa mini-mill, in Uruguay. Gerdau Laisa is the only long steel producer in Uruguay and has an annual installed capacity of 100,000 tonnes of crude steel and 80,000 tonnes of rolled products.

Gerdau AZA and Aceros Cox

In 1992, the Company acquired the AZA mini-mill in Chile with Gerdau AZA’s second mill beginning operations in January 1999. The two units, Renca and Colina, have a combined annual production capacity of 470,000 tonnes of crude steel and 490,000 tonnes of rolled steel. The difference in the output of crude steel and long rolled products is due to the fact that at the Renca industrial unit Gerdau AZA still operates old profile rolling mill equipment, which was not decommissioned following the start-up of the new plant in 1999. Although no official statistics are available in Chile, Gerdau AZA believes its share of the domestic long steel rebar market to be about 44%. Gerdau AZA also sells its products through Aceros Cox.

Sipar

Gerdau entered the Argentine market in December 1997. Following the financial and corporate restructuring of its operations in Argentina due to the prevailing economic environment, the Company currently holds a 74.4% stake in Sipar, a rolling mill with an annual installed capacity of 240,000 tonnes.

Diaco and Sidelpa

On September 30 2005, the Company concluded the acquisition of a 57.1% voting and total interest in Diaco, thus obtaining a controlling interest. Diaco is the largest producer of steel and rebar in Colombia.

On November 19 2005, the Company met all the conditions precedent related to the acquisition of a 97.0% controlling interest in Sidelpa. Sidelpa is the only producer of specialty long steel in Cali, Colombia.

Diaco and Sidelpa have a combined annual installed capacity of 530,000 tonnes of crude steel and 620,000 tonnes of rolled products.

Siderperú

Siderperú is a long and flat steel producer with annual installed capacity of 540,000 tonnes of crude steel acquired in 2006. Siderperú operates one blast furnace, a direct reduction unit and a melt shop with two electric arc furnaces (EAF), two LD converters and three rolling mills. Approximately 20% of sales are of flat steel and the remaining 80% in long steel.

Gerdau Ameristeel

In September 1999, Gerdau acquired 75% of Ameristeel from Kyoei Steel Ltd. of Japan. At that time, Ameristeel operated four mills on the East Coast: one unit in Florida, two in Tennessee, and one in North Carolina. In 2000, Gerdau acquired an additional 12% stake from Kyoei, increasing its overall stake in Ameristeel to 87%. In December 2001, Ameristeel acquired a steel mill located in Cartersville, Georgia.

In October 2002, Gerdau merged its North American assets with Co-Steel to create Gerdau Ameristeel. As a result of this merger, Gerdau’s interest in Gerdau Ameristeel was reduced to 67%.

28




Currently, Gerdau Ameristeel has a nominal annual capacity of 7.2 million tonnes of crude steel and 7.5 million tonnes of rolled products. Gerdau S.A. holds a controlling interest of 66.6% in Gerdau Ameristeel. The Company is the second largest producer of long steel in North America and is listed on the Toronto Stock Exchange and the New York Stock Exchange, under the ticker symbols GNA.TO and GNA, respectively.

Other Businesses

Dona Francisca Energética S.A.

Dona Francisca Energética S.A. (DFESA) is an operating hydroelectric power plant with a nominal capacity of 125 MW, located in Agudo, in the state of Rio Grande do Sul.

DFESA’s corporate purpose is to operate, maintain and maximize the use of the Dona Francisca Hydroelectric Plant’s energy potential.

Dona Francisca participates in a consortium (Consórcio Dona Francisca) with the state power utility Companhia Estadual de Energia Elétrica (CEEE), in accordance with contract CEEE/9700295 of March 13 1997 and its amendments. In 2003, after Gerdau S.A.’s acquisition of an additional stake, Dona Francisca Energética S.A.’s shareholders are: Gerdau S.A. (51.8%), COPEL Participações S.A (23.0%), Celesc (23.0%), and Desenvix (2.2%).

Margusa

Margusa – Maranhão Gusa S.A. has an annual installed capacity of 210,000 tonnes of pig iron. The mill is located 50 km from São Luis and 48 km from a maritime port. The acquisition is part of the Company’s strategy to ensure the supply of pig iron to its mills in the Northeast of Brazil and for exporting any excess output to the North American units. This investment has guaranteed Gerdau’s presence in the important iron ore production center of Carajás, a strategic pig iron source with excellent logistics for supplying both domestic and export markets.

Seiva

Seiva S.A. – Florestas e Indústrias is a reforestation company created in 1971. Seiva has pinus and eucalyptus forests.

D. PROPERTY, PLANT AND EQUIPMENT

Environmental Issues

Gerdau S.A believes it is currently in compliance with government environmental regulations. The Company believes that there are no environmental issues that might affect use of the fixed assets described below.

Material Tangible Fixed Assets

Gerdau’s principal properties are for the production of steel, rolled products and drawn products. The following is a list showing the location, capacity and type of installation, as well as the types of products manufactured:

Locations of plants, capacity, equipment and products

(thousand/year)

BRAZIL

 

 

INSTALLED CAPACITY

 

 

 

 

PLANTS

 

PIG IRON/
SPONGE
IRON

 

CRUDE
STEEL

 

ROLLED
PRODUCTS

 

EQUIPMENT

 

PRODUCTS

BRAZIL

 

4,010

 

9,845

 

6,840

 

 

 

 

LONG STEEL

 

 

 

 

 

 

 

 

 

 

Açonorte

 

 

280

 

250

 

EAF mini-mill, rolling mill, drawing mill, nail and clamp factory

 

Rebar, merchant bars, wire rod, drawn products and nails

Agua Funda

 

 

 

300

 

Rolling Mill

 

Rebar and merchant bars

Barão de Cocais (1)

 

330

 

350

 

200

 

Integrated/blast furnace, LD converter and rolling mill

 

Rebar and merchant bars

Cearense

 

 

170

 

160

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

 

29




 

Cosigua

 

 

1,600

 

1,400

 

EAF mini-mill, rolling mill, drawing mill, nail and clamp factory

 

Rebar, merchant bars, wire rod, drawn products and nails

Divinópolis (1)

 

430

 

600

 

530

 

Integrated/blast furnace, EOF converter and rolling mill

 

Rebar and merchant bars

Guaíra

 

 

560

 

180

 

EAF mini-mill, rolling mill

 

Billet, rebar, merchant bars

Riograndense

 

 

450

 

520

 

EAF mini-mill, rolling mill, drawing mill, nail and clamp factory

 

Rebar, merchant bars, wire rod, drawn products and nails

Usiba (1)

 

 

560

 

430

 

Integrated with DRI, EAF mini-mill, rolling mill, drawing mill

 

Rebar, merchant bars, wire rod, drawn products

São Paulo

 

 

900

 

600

 

EAF mini-mill, rolling mill

 

Billets and rebars

Contagem

 

240

 

 

 

Blast furnace

 

Pig iron

Margusa

 

210

 

 

 

Blast furnace

 

Pig iron

AÇOMINAS

 

 

 

 

 

 

 

 

 

 

Ouro Branco (1)

 

2,800

 

3,000

 

970

 

Integrated with blast furnace

 

Billets, blooms, slabs, wire rod and heavy structural shapes

SPECIALTY STEEL

 

 

 

 

 

 

 

 

 

 

Piratini

 

 

400

 

500

 

EAF mini-mill, rolling mill

 

Specialty steels

Corporación Sidenor

 

 

975

 

800

 

EAF mini-mill, rolling mill

 

Specialty steels

 

ABROAD

 

 

INSTALLED CAPACITY

 

 

 

 

PLANTS

 

PIG IRON/
SPONGE
IRON

 

CRUDE
STEEL

 

ROLLED PRODUCTS

 

EQUIPMENT

 

PRODUCTS

EUROPE

 

 

975

 

850

 

 

 

 

SPECIALTY STEEL

 

 

 

 

 

 

 

 

 

 

Corporación Sidenor

 

 

975

 

850

 

EAF mini-mill, rolling mill

 

Specialty steels

SOUTH AMERICA

 

 

1,640

 

2,070

 

 

 

 

AZA

 

 

470

 

490

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

Laisa

 

 

100

 

80

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

Diaco

 

 

530

 

620

 

EAF mini mill, rolling mill

 

Rebar and merchant bars

Sipar

 

 

 

240

 

Rolling mill

 

Rebar and merchant bars

Siderperú

 

 

540

 

640

 

EAF mini mill, rolling mill

 

Rebar, merchant bars and slabs

NORTH AMERICA

 

 

7,160

 

7,480

 

 

Whitby

 

 

870

 

730

 

EAF mini-mill, rolling mill

 

Structural shapes, rebar and merchant bars

Cambridge

 

 

330

 

290

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars and special bar quality (SBQ)

Manitoba

 

 

350

 

330

 

EAF mini-mill, rolling mill

 

Special sections, merchant bars and rebar

Cartersville

 

 

780

 

580

 

EAF mini-mill, rolling mill

 

Merchant bars, structural shapes and beams

Charlotte

 

 

420

 

320

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

Jackson

 

 

610

 

540

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

Jacksonville

 

 

580

 

580

 

EAF mini-mill, rolling mill

 

Rebar and wire rod

Knoxville

 

 

500

 

470

 

EAF mini-mill, rolling mill

 

Rebar

St. Paul

 

 

540

 

500

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars and special bar quality round bars

Calverty City

 

 

 

300

 

Rolling Mill

 

Merchant bars, medium structural channel and beams

Wilton

 

 

320

 

300

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

Beaumont

 

 

590

 

730

 

EAF mini-mill, rolling mill

 

Quality rod products

Perth Amboy

 

 

 

730

 

Rolling mill

 

Industrial quality rod products

Sayreville

 

 

730

 

540

 

EAF mini-mill, rolling mill

 

Rebar

Joliet

 

 

 

70

 

Rolling mill

 

Merchant bars, medium structural channel and beams

 

30




 

Sand Springs

 

 

540

 

470

 

 

 

 

GERDAU TOTAL

 

4,640

 

19,620

 

17,240

 

 

 


Note (1): While EAF (electric arc furnace) mills produce crude steel from raw materials such as steel scrap or pig iron, a mill with a blast furnace or DRI (direct reduction iron) produces pig iron or sponge iron for use in the production of crude steel, with iron ore and natural gas being the main raw materials.

ITEM 4A.     UNRESOLVED SEC STAFF COMMENTS

The Company has no unresolved comments from the staff of the U.S. Securities and Exchange Commission in respect of its periodic reports under the Exchange Act.

ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A. OPERATING RESULTS

Overview

In 2006, world steel output hit another record high reaching 1.2 billion tonnes, an increase of 9.1% over the output of 2005 with China contributing approximately 34.7% to this total.

China’s output grew by 18.8% in 2006, surpassing the 400 million tonnes mark. The European Union (Europe EU-15) also reported a considerable output and a significant pace of internal demand and export. The output of crude steel in these countries grew by 4.9% for the full year.

China has been growing its steel output at a higher rate than the rest of the world due to investments made in capacity expansion to cope with an ever increasing domestic demand as a result of a GDP growth of approximately 10% per annum. Simultaneously, China is consolidating its position as a net steel exporter.

Crude steel output in Brazil fell 2.2% in 2006 mainly due to the temporary stoppage of the blast furnace of a local player. Output reached 30.9 million tonnes in 2006.

In North America steel output increased 3.1% in 2006 and in South America steel output maintained the same levels of 2005.

Overall, the world market in long steel in 2006 was favorable with demand firm and prices higher.

Considering the factors mentioned above, 2006 produced excellent results for Gerdau, due a strong demand in the civil construction sector and the acquisitions during the period. Consolidated gross revenues reached $13.2 billion, 32.0% greater than in 2005. Net income was $1.5 billion, 35.5% greater than that of 2005.

Brazilian net sales increased 19.4% in 2006 against 2005, favored by the strong demand in civil construction. Net sales of North American operations rose 14.6% in the same period. These improvements are due to the acquisition of Sheffield Steel, to a positive phase in the infra-structure sector and to investments in improvements in different units.

South American net sales (excluding Brazilian sales) increased 109.0%, due to the consolidation of units acquired in the last two years and the favorable demand in the construction sector. In 2006, Sidenor net sales reached $952.8 million, mostly due to demand from the automotive sector.

Significant Factors Materially Affecting the Company’s Results

Demand

Sales in 2006 reached 14.9 million tonnes, 15.8% greater than those of 2005. This performance is due largely to the consolidation of companies acquired at the end of 2005 and during 2006.

Brazilian domestic sales for the full year increased 20.5%, favored by the strong demand in civil construction. Exports decreased by 17.2% to meet this additional domestic demand.

North American sales for the fiscal year reached 6.0 million tonnes, an increase of 5.4% compared to 2005. South American sales (excluding Brazilian sales) were 1.5 million tonnes in 2006, a year on year increase of 112.0%, Sidenor shipped 681 thousand tonnes in 2006.

The combination of sales abroad and exports from Brazil represented 71.6% of consolidated tonnage shipped in 2006.

31




Production capacity

The Company’s growth objectives are to consolidate its position as a leader in the Americas in the production of long steel and in the international specialty steel market. Recent acquisitions and agreements substantiate the Company’s faith in the growth potential of the continent’s economies and have encouraged the search for new opportunities. During 2006, the Company acquired operations in Spain, United States and Peru.

In Europe, the acquisition of a 40% stake in Corporación Sidenor represented a significant investment in the industrial segment where Gerdau has solid experience. The investment opened the way to entry into the strategic European Union market. Furthermore, the acquisition of this stake allowed the Company to open an important channel with the large international carmakers as well as access to production, administrative, and industrial management know-how of one of the largest suppliers of this sector in the world in perfect harmony with the Company’s long-term growth and globalization plans. Gerdau’s European installed capacity is 975 thousand tonnes of crude steel per annum.

In North America, Gerdau Ameristeel’s acquisition of the Sheffield Steel assets in June, 2006, made a significant contribution to the expansion of the Company’s geographical coverage, primarily rebar markets, to the Southwest United States. The North American operations have a total capacity of approximately 7.2 million tonnes of crude steel.

In South America, the acquisition of Siderperú (Peru) in June and November of 2006, ensured Gerdau’s presence in yet another country with relevant economic growth and increasing steel consumption. The South American operations (ex-Brazil) have an annual crude steel output of 1.6 million tonnes.

The production of slabs, blooms and billets rose to 15.8 million tonnes in 2006, 21.5% more than in 2005. Rolled product output, the subsequent stage in the production chain, reached 12.8 million tonnes, a growth of 27.4% compared to the volume for the previous year. As mentioned above, this performance was mostly due to the consolidation of the steel plants acquired at the end of 2005 and during 2006.

Gerdau S.A. Consolidated 
Production
(1,000 tonnes)

 


2006

 


2005

 

Variation
2006/2005

 

Slabs, blooms and billets*

 

 

 

 

 

 

 

Brazil

 

7,698.6

 

6,888.8

 

11.8

%

North America

 

6,059.2

 

5,555.7

 

9.1

%

South America (ex-Brazil)

 

1,235.2

 

534.0

 

131.3

%

Europe

 

774.0

 

 

 

Total

 

15,767.0

 

12,978.5

 

21.5

%

 

 

 

 

 

 

 

 

Rolled Products*

 

 

 

 

 

 

 

Brazil

 

4,921.4

 

4,012.5

 

22.7

%

North America

 

5,808.2

 

5,457.8

 

6.4

%

South America (ex-Brazil)

 

1,412.5

 

578.4

 

144.2

%

Europe

 

661.1

 

 

 

Total

 

12,803.2

 

10,048.7

 

27.4

%

 


* The rolling process relies on raw materials produced at the melt shops such as slabs, blooms and billets. These products are partially sold directly to external customers and the remainder used in the rolling process.

The Brazilian units produced 7.7 million tonnes of steel in 2006, a volume 11.8% greater than in 2005 and corresponding to 48.8% of the consolidated output. In North America, production was 9.1% greater, reaching 6.1 million tonnes (38.4% of the total). The South American companies (ex-Brazil) produced 1.2 million tonnes (7.8% of the total), posting a growth of 131.3% and the European operations produced 774.0 thousand tonnes in 2006.

The Gerdau companies’ production of rolled products in Brazil amounted to 4.9 million tonnes in 2006, an increase of 22.7%. In North America and South America (ex-Brazil), production grew 6.4% and 144.2%, respectively, to reach 5.8 million tonnes and 1.4 million tonnes, reflecting the consolidation of Sheffield Steel, in North America and Siderperú, in Peru.

Significant events affecting financial performance during 2006

In addition to increased sales, the results of the Company’s operations in 2006 were positively impacted by a series of events that resulted in a strong year-on-year increase in net income. Some of the most relevant events are described below:

32




·      During 2006, the Company’s consolidated results of operations has a change in mix considering its segment operations. Long brazil operating segment, which historically has been the most profitable segment of the Company, has reduced its proportion of contribution for the consolidated profits, due to the increase in other segments of the Company, most notably Specialty steel segment and North America Segment, which have comparable lower margins against Long brazil. This increase on Specialty steel and North America segments occurred due to acquisition of Corporación Sidenor, a Spanish subsidiary which operates in the specialty steel segment, and the acquisition of Sheffield Corporation and PCS Inc., companies located in the U.S. and on North America segment.

·      In 2006, the Company has recorded a gain of $54.6 million regarding the increase of the fair value of the forward commitment to acquire a minority interest in Diaco, a Colombian subsidiary of the Company. The Company has also recorded a recovery of $37.3 million of brazilian federal income taxes on a final rule of judicial decisions.

·      The effective income tax rate fall to 18.6% from 26.4% in 2005, mainly for the increase in the benefit regarding tax deductible goodwill recorded on statutory books, increase of tax benefit for the payment of interest on capital in spite of dividends and also tax credits obtained in Spanish subsidiaries, in connection with a the incorporation of a entity that occurred in the fourth quarter of 2006 in preparation for the acquisition of GSB Acero. The Company expects to use tax benefits regarding tax deductible goodwill for the next years, although tax benefit from restructuring of Spanish operations are non-recurring.

·      Gains on investments accounted for under the equity method were $118.0 million in 2006 compared to $96.5 million, arising mainly from the results of the Gallatin, Bradley Steel Processors and MRM Guide Rail joint ventures. Gallatin Steel shipments were flat for the year ended December 31 2006 compared with 2005; however, metal spreads for flat rolled steel products increased from the levels earned in 2005. This increase in metal spreads was consistent with the increase in metal spreads verified in all North American market for the year ended 2006. Gallatin paid to Gerdau cash dividends of $101.6 million in 2006 compared to $115.8 million during 2005.

Impact of Inflation and Fluctuations in Exchange Rates

Gerdau’s results and its financial position are largely dependent on the state of the Brazilian economy, notably (i) economic growth and its impact on steel demand, (ii) financing costs and the availability of financing, and (iii) the exchange rates between the real and foreign currencies.

For many years, Brazil experienced high rates of inflation that progressively eroded the purchasing power of the vast majority of the population. During periods of high inflation, effective salaries and wages tend to fall because the frequency and size of salary and wage adjustments for inflation usually do not offset the actual rate of inflation.  Since the introduction of the real in July 1994, the inflation rate in Brazil has decreased dramatically. Following the implementation of the Real Plan, the Brazilian GDP increased, rising by 1.4% in 2001, 1.5% in 2002, decreasing by 0.2% in 2003, increasing by 5.2% in 2004 and increasing again by 2.3% in 2005 and by 3.7% in 2006.

The following table presents Brazilian inflation and the performance of the real against the U.S. dollar for the periods shown.  For a discussion of the foreign exchange rate in Brazil generally, see “Item 10.D. Exchange Controls – Exchange Rates.”

 

January to
April

 

Year ended December 31

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

2002

 

Inflation (INPC base)

 

1.62

%

2.81

%

5.04

%

6.13

%

10.38

%

14.74

%

Inflation (IGP-M)

 

1.15

%

3.85

%

1.20

%

12.42

%

8.69

%

25.30

%

Appreciation (devaluation) of $versus Brazilian real

 

-4.87

%

-8.65

%

-11.85

%

-8.13

%

-18.23

%

52.27

%

 

In a positive economic environment, the real appreciated against the U.S. dollar throughout 2006 leading to a significant improvement in Brazilian country risk and a gradual reduction in interest rates.

33




A portion of Gerdau’s trade accounts receivable, trade accounts payable and debt is denominated in currencies different to the respective functional currency of each subsidiary. Brazilian operating subsidiaries’ (Gerdau Açominas, Gerdau Aços Longos, Gerdau Aços Especiais and Gerdau Comercial de Aços) functional currency is the Brazilian real. Brazilian subsidiaries have foreign currency denominated assets and liabilities, mainly in U.S. dollars, their financial position and results being affected by changes in the exchange rate of the Brazilian real in relation to the U.S. dollar. In 2006, 2005, 2004 and 2003, Gerdau’s results were affected by the appreciation of the Brazilian real against the U.S. dollar, generating losses in its U.S. dollar-denominated trade accounts receivable from exports, and generating gains in the U.S. dollar denominated trade accounts payable and also debt. The reduction of net debt balances (defined as short and long term debt less short term investments, restricted cash and cash and cash equivalents) during 2006 compared to 2005 and the appreciation of the real, together with the increase in the balance of trade accounts receivable and trade accounts payable generated a net foreign exchange gain during 2006. Gerdau’s financial statements are presented in U.S. dollars with transactions in currencies other than the U.S. dollar translated into U.S. dollars in accordance with the criteria established in SFAS No. 52 Foreign Currency Translations. Changes in the exchange rate between the functional currency of the Company’s operations, such as the Brazilian real and the U.S. dollar, affect the reported amounts of revenues and expenses in the consolidated statements presented in U.S. dollars.

Net income for the years ended December 31, 2006, 2005 and 2004

The table below contains information for various income statement items, expressed as a percentage of net sales for each of the respective years:

 

Fiscal year ending December 31,

 

 

 

2006

 

2005

 

2004

 

Net Sales

 

100.0

%

100.0

%

100.0

%

Cost of Sales

 

(74.1

)%

(73.8

)%

(69.6

)%

Gross Profit

 

25.9

%

26.2

%

30.4

%

Operating Expenses:

 

 

 

 

 

 

 

Sales and Marketing Expenses

 

(2.2

)%

(2.3

)%

(2.2

)%

General and Administrative Expenses

 

(6.9

)%

(5.2

)%

(5.2

)%

Other Operating Income (expenses), net

 

0.9

%

(0.1

)%

0.4

%

Operating Income

 

17.7

%

18.6

%

23.4

%

Financial Expenses, Financial Income, Foreign Exchange Gains and Losses, Net and Gain and Losses on Derivatives, Net

 

1.2

%

0.1

%

(0.7

)%

Equity in Earnings of Unconsolidated Companies

 

1.0

%

1.1

%

2.0

%

Gain on change in interest on Gerdau Ameristeel investment

 

 

 

0.1

%

Provision for taxes on income

 

(3.7

)%

(5.2

)%

(5.8

)%

Minority interest

 

(3.4

)%

(2.0

)%

(2.3

)%

Net Income

 

12.8

%

12.6

%

16.7

%

 

The table below contains information for various income statement items, where the years are expressed in $ millions:

 

Fiscal year ending December 31,

 

 

 

2006

 

2005

 

2004

 

Net Sales

 

11,844

 

8,894

 

6,952

 

Cost of Sales

 

(8,778

)

(6,564

)

(4,839

)

Gross Profit

 

3,066

 

2,330

 

2,113

 

Operating Expenses:

 

 

 

 

 

 

 

Sales and Marketing Expenses

 

(256

)

(203

)

(155

)

General and Administrative Expenses

 

(821

)

(466

)

(359

)

Other Operating Income (expenses), net

 

107

 

(8

)

29

 

Operating Income

 

2,096

 

1,653

 

1,628

 

Financial Expenses, Financial Income, Foreign Exchange Gains and Losses, Net and Gain and Losses on Derivatives, Net

 

148

 

13

 

(51

)

Equity in Earnings of Unconsolidated Companies

 

118

 

96

 

142

 

Gain on change in interest on Gerdau Ameristeel investment

 

 

 

3

 

Provision for taxes on income

 

(439

)

(465

)

(407

)

Minority interest

 

(409

)

(179

)

(157

)

Net Income

 

1,514

 

1,118

 

1,158

 

 

34




Year Ended December 31, 2006 Compared with Year Ended December 31, 2005

Net Sales

The Company’s net sales were $11,844.2 million in 2006, 33.2% more than 2005 ($8,894.4 million). Of this amount, 45.2% ($5,354.2 million) came from operations in Brazil, 37.7% ($4,464.2 million) from the North American units, 9.1% ($1,073.1 million) from the South American companies (ex-Brazil) and 8.0% from the European operations. This performance reflects the improvements in the several operations in the different regions in which the Company is present as well as to the consolidation of units acquired in the last two years.

Gerdau S.A. Consolidated

 

 

 

 

 

 

 

Net Sales by Geographical Region from

 

 

 

 

 

 

 

which Shipment was originated
($ millions)

 

2006

 

2005

 

Variation
2006/2005

 

 

 

 

 

 

 

 

 

Brazil

 

5,354.2

 

4,483.9

 

19.4

%

North America

 

4,464.2

 

3,897.1

 

14.6

%

South America (ex-Brazil)

 

1,073.1

 

513.4

 

109.0

%

Europe

 

952.7

 

 

 

Consolidated Total

 

11,844.2

 

8,894.4

 

33.2

%

 

The average net price of steel in 2006 was $795.5/ton, a 15.0% increase from $691.6/ton in 2005.

Cost of Sales and Gross Profit

Cost of sales increased from $6,564.2 million in 2005 to $8,777.8 million in 2006, representing an increase of 33.7%. This increase is mainly due to higher volume of shipments in 2006, the consolidation of acquired companies, as well as to the appreciation of the real against the U.S. dollar, which impacts significantly the cost of sales (as well as domestic sales) of the Brazilian subsidiaries when translated into U.S. dollars. The Company’s gross margin reached 25.9% in 2006, compared to 26.2% in 2005. This reduction is due to the increase in costs of the main raw materials used in the production process in 2006, such as iron ore, energy and others. Another factor which contributed to this reduction is the change in the mix of operating segments margins; Long Brazil, which historically has been the most profitable operating segment of the Company, has reduced its relative contribution to consolidated margin, mainly due to the increase of contribution from the North American and the Specialty Steel segments, as a result of the acquisition of business allocated to those segments during 2006. Gross profit reached $3,066.4 million in 2006, compared to $2,330.2 million in 2005, representing an increase of 31.6%, principally due to higher sales volume in 2006.

Operating Expenses

Operating expenses (sales and marketing, general and administrative, expenses) increased 61.0% in 2006, compared to 2005. The ratio of operating expenses-to-net sales was 9.1%, above the percentage of 7.5% in 2005. This increase is mainly due to the consolidation of the new companies not consolidated during the year ended December 31, 2005 (an increase of $249.7 million in 2006), to the enhanced long-term incentive program for Gerdau Ameristeel’s employees (an expense of $20.4 million in 2006 compared to an expense of $3.0 million in 2005) and to the accounting of PIS/COFINS on payments of interest on capital stock (approximately $19 million). In 2006, consolidated operating expenses were $970.2 million against $677.5 million in 2005.

Other Operating Income (Expenses), Net

Other operating income, net, amounted $107.4 million in 2006 against other operating expense, net, of $8.2 million in 2005. This positive result includes mainly the effects of recording at fair value the forward commitment to acquire a minority interest in Diaco which amounted to $54.6 million in 2006 against $7.5 million in 2005 and gains for tax credits recovered as result of non-appealable judicial decisions with respect to PIS and Cofins taxes which amounted to $37.3 million.

35




Operating Income

Operating income was $2,096.2 million in 2006, an increase of 26.8% when compared to $1,652.7 million in 2005. Operating income increased in 2006 due to the consolidation of the acquired companies and the improvement in sales.

Financial Expenses, Financial Income, Foreign Exchange Gains and Losses, Net and Gains and Losses in Derivatives, Net

In the fiscal year 2006, net financial income (which consists of financial income, financial expenses, foreign exchange gains and losses and gains and losses from derivatives) totaled $147.4 million, against net financial income of $12.6 million in the previous year. This increase in financial income is mainly due to the foreign exchange gains of $132.9 million in 2006 compared to $57.9 million in 2005 and to the greater gain over financial investments in the period, basically due to its higher volume.

Equity in Earnings (Losses) of Unconsolidated Companies, net

During 2006, equity income from unconsolidated companies amounted to $118.1 million compared to $96.5 million recorded in 2005. A greater metal spread during the year generated better results at the joint ventures in the United States (Gallatin Steel, MRM Guide Rail and Bradley Steel Processors), which account for the majority of the equity income recorded on the Company’s books. Although Gallatin shipments were essentially flat for the year ended 2006 when compared to 2005, higher metal spreads significantly increased during the year, following the general improvement in the North America steel market in 2006.

Provision for Taxes on Income

In 2006, income tax expenses were positively affected by the recognition of tax-deductible amortization of goodwill, which reduced this expense, in the amount of $128.7 million in 2006 compared to $76.7 million in 2005. The effective tax rate has been reduced from 26.41% in 2005 to 18.58% in 2006 due to the combined effects of benefit of deductible interest on equity paid to shareholders of $75.4 million, benefit regarding tax deductible goodwill in the statutory books in the amount of $128.7 million and to the non-recurrent tax credits obtained in the Spanish subsidiaries of $38.7 million. The Company expects to continue to benefits from tax-deductible amortization of goodwill over the next eight years.

Net Income

In 2006, consolidated net income amounted to $1,513.8 million, 35.5% greater than $1,117.5 million in 2005. This increase reflects the greater volume shipped and strong demand in the civil construction sector. Net margin (defined as net income divided by net sales) increased from 12.6% in 2005 to 12.8% in 2006.

Year Ended December 31, 2005 Compared with Year Ended December 31, 2004

Net Sales

The Company’s net sales were $8,894.4 million in 2005, 27.9% more than 2004 ($6,952.1 million). Of this amount, 50.4% ($4,483.9 million) came from operations in Brazil, 43.8% ($3,897.1 million) from the North American units, and 5.8% ($513.4 million) from the South American companies (ex-Brazil). The consolidation of the steel units in North and South America was the principal reason for this growth, and, to a lesser extent, the improved demand in North America and in the South American countries where the Company is present.

Gerdau S.A. Consolidated

 

 

 

 

 

 

 

Net Sales by Geographical Region

 

 

 

 

 

 

 

from which Shipment was
originated
($ millions)

 

2005

 

2004

 

Variation
2005/2004

 

 

 

 

 

 

 

 

 

Brazil

 

4,483.9

 

3,623.0

 

23.8

%

North America

 

3,897.1

 

3,009.9

 

29.5

%

South America (ex-Brazil)

 

513.4

 

319.2

 

60.8

%

Consolidated Total

 

8,894.4

 

6,952.1

 

27.9

%

 

36




The average net price of steel in 2005 was $691.6/ton, an 18.1% increase from $585.5/ton in 2004.

Cost of Sales and Gross Profit

Cost of sales increased from $4,838.9 million in 2004 to $6,564.2 million in 2005, representing an increase of 35.7%. This increase is due to higher volume of shipments in 2005, as well as to the appreciation of the real against the US dollar, which impacts significantly the cost of sales of the Brazilian subsidiaries when translated into U.S. dollars. The Company’s gross margin reached 26.2% in 2005, compared to 30.4% in 2004. This reduction is due to the increase in costs of the main raw materials used in the production process in 2005, such as coking coal, iron ore, energy and others. Gross profit reached $2,330.2 million in 2005, compared to $2,113.2 million in 2004, representing an increase of 10.3%, principally due to higher sales volume in 2005.

Operating Expenses

Operating expenses (sales and marketing, general and administrative and other expenses) increased 39.7% in 2005, compared to 2004, and against a growth of 27.9% in net sales. The ratio of operating expenses-to-net sales was 7.5%, and slightly above the percentage of 7.4% in 2004. This increase is mainly the result of expenses related to greater export volumes and the enhanced long-term incentive program for Gerdau Ameristeel’s employees. In 2005, consolidated operating expenses, excluding other operating expenses, were $669.3 million against $513.7 million in 2004.

Other Operating Income (Expenses), Net

During 2005, several non-recurring items affected operating income, such as the recognition of an impairment loss on the goodwill related to the acquisition of Margusa in the amount of $13.0 million, due to a reduction in pig iron prices and the appreciation of the real during the year, which reduced severely Margusa’s profitability. Other non-recurring items included the recognition of a provision for tax contingencies related to ICMS credits denied by the fiscal authorities and an unfavorable court ruling during the fourth quarter on this issue amounting to $12.6 million, as well as tax contingencies recorded regarding operations performed under a drawback concession which is being challenged by the fiscal authorities, and for which the Company has also had an unfavorable court ruling in the amount of $33.9 million. Nevertheless, the Company has also recorded some amounts that generated other income such as the positive fair value of the commitment to acquire 40% of Diaco shares in the amount of $7.5 million.

Operating Income

Operating income was $1,652.7 million in 2005, an increase of 1.5% when compared to $1,628.3 million in 2004. Operating income was substantially flat in 2005 because of lower gross margins. Bearing in mind that net sales were higher in 2005, the increase in the cost of goods and a reduction in other operating income almost offset the impact on operating income in 2005.

Financial Expenses, Financial Income, Foreign Exchange Gains and Losses, Net and Gains and Losses in Derivatives, Net

In the fiscal year 2005, net financial income (which consists of financial income, financial expenses, foreign exchange gains and losses and gains and losses from derivatives) totaled $12.6 million, against net financial expenses of $50.8 million in the previous year. This decrease in expenses is due mainly to the increase in financial investments, as a result of the stronger cash flow in the period, and to a reduction in the cost of debt.

With the goal of extending the average maturity of its indebtedness, financial transactions conducted throughout 2005 contributed substantially to meeting this objective. The average debt maturity more than doubled in the period increasing from 4 to 9 years, also generating lower financial expenses on the new debt contracted. Foreign exchange gains during 2005 amounted to $57.9 million against $30.8 million in 2004, but these gains were partially offset due to losses recorded with derivatives, mainly swap agreements in the amount of $22.0 million during 2005 compared to a gain of $1.2 million during 2004.

Equity in Earnings (Losses) of Unconsolidated Companies, net

During 2005, equity income from unconsolidated companies amounted to $96.5 million compared to $141.9 million recorded in 2004. Lower average selling prices for flat steel products during the year, as well as an increase in the price of scrap during the year, generated lower net income at the joint ventures in the United States (Gallatin Steel,

37




MRM Guide Rail and Bradley Steel Processors), which account for the majority of equity income recorded in the Company’s books.

Provision for Taxes on Income

In 2005, income tax expenses were positively affected by the recognition of tax-deductible amortization of goodwill, which reduced this expense, in the amount of $76.7 million. Nevertheless, the effective tax rate increased from 23.61% in 2004 to 26.41% in 2005 due to the recognition during 2004 of a reversal of valuation allowance in the amount of $120.3 million for Gerdau Açominas and $48.6 million for Gerdau Ameristeel. These events significantly reduced the effective tax rate in 2004.

Net Income

In 2005, consolidated net income amounted to $1,117.5 million, 3.5% lower than $1,158.4 million in 2004. This reduction reflects the smaller volume shipped to the domestic market and the impact of the foreign exchange rate on sales abroad, considering that the average US dollar rate for 2005 was lower than that of 2004. Net margin (defined as net income divided by net sales) decreased from 16.7% in 2004 to 12.6% in 2005.

Year Ended December 31, 2004 Compared with Year Ended December 31, 2003

Net Sales

Net sales were $6,952.1 million in 2004, 53.4% more than 2003 ($4,531.0 million).  Of this amount, 52.1% ($3,623.0 million) came from operations in Brazil, 43.3% ($3,009.9 million) from the North American units, and 4.6% ($319.2 million) from Chile and Uruguay.  This increase was driven by a better performance from operations outside Brazil, an increase in international market prices and a recovery in domestic demand, in addition to the consolidation of the North Star assets acquired in November 2004.

Gerdau S.A. Consolidated

 

 

 

 

 

 

 

Net Sales

 

 

 

 

 

Variation

 

($ millions)

 

2004

 

2003

 

2004/2003

 

 

 

 

 

 

 

 

 

Brazil

 

3,623.0

 

2,597.8

 

39.5

%

North America

 

3,009.9

 

1,811.2

 

66.2

%

South America (ex-Brazil)

 

319.2

 

122.0

 

161.6

%

Consolidated Total

 

6,952.1

 

4,531.0

 

53.4

%

 

The average net price of steel in 2004 was $585.5/ton, a 48.0% increase from $395.6/ton in 2003.

Cost of Sales and Gross Profit

Cost of sales was $4,839.0 million in the year ended December 31, 2004, an increase of 40.4% compared to the cost of sales in 2003 ($3,445.6 million). The increase was mainly due to the increases in the cost of raw materials (scrap and pig iron) caused by a greater demand from steel producers, and a 3.7% increase in sales volume in tonnes. Gross margin reached 30.4% in 2004, against 24.0% in 2003. This reflected improved margins from the Brazilian operations following adjustments in sale prices due to higher raw material costs and increased international market prices, strongly favoring exports and the North America business. Gross profit reached $2,113.2 million in 2004, against $1,085.4 million in 2003, a growth of 94.7%.

Operating Expenses

Operating expenses (sales and marketing, general and administrative) increased 32.3% in 2004, compared to 2003, against a growth of 53.4% in net sales, with the ratio of operating expenses-to-net sales falling from 8.6% to 7.4%. This reduction primarily reflects lower export volumes, which reduced freight and transportation costs, and lower expenses at Gerdau Ameristeel. In 2004, consolidated operating expenses, excluding other operating expenses, were $513.7 million against $388.2 million in 2003.

Other Operating Income (Expenses), Net

Net other operating income in 2004 totaled $28.7 million, an increase of $29.5 million compared to net other operating expenses of $0.8 million reported in 2003. The increase was principally due to an irrevocable court ruling in favor of the subsidiary, Gerdau Açominas S.A. for a lawsuit brought against the payment of social contribution taxes

38




based on the unconstitutionality of Decree-Laws 2,445/88 and 2,449/88 and totaling $43.5 million ($28.7 million net of tax).

Operating Income

Operating income in 2004 was $1,628.2 million, an increase of 133.8% compared to $696.3 million in 2003.  The increase was mainly due to an increase in gross margin on steel products throughout the year, particularly during the second half of 2004, as a result of increased prices and the gain of $43.5 million resulting from the final non-appealable court ruling in the Company’s favor in a lawsuit challenging the payment of PIS taxes.

Financial Expense, Financial Income, Foreign Exchange Gains and Losses, Net and Gains and Losses on Derivatives, Net

In the fiscal year 2004, net financial expense (which comprises financial income, financial expenses, foreign exchange gains and losses and derivative gains and losses) totaled $50.8 million, against $192.7 million in the previous year. This decrease is due mainly to the increase in financial investments, as a result of the stronger cash flow in the period, and to a reduction in the cost of debt due to a change in its debt profile, with the issuance of debt facilities such as an Euro Commercial Paper and Senior Notes by Gerdau AmeriSteel, with lower financial costs to Gerdau, and repayment of debt bearing higher interest rates. Additionally, the majority of the cross-currency rate swap contracts entered into in 2003 matured in 2004 and was not replaced, resulting in the reduction of losses on derivatives in 2004.

Equity in Earnings (Losses) of Unconsolidated Companies, Net

Equity in earnings of unconsolidated companies was $141.9 million in 2004, mainly due to positive results of the 50% joint ventures in Gallatin, Bradley Steel Processors and MRM Guide Rail and reflecting the good performance of the steel making business.

Gain on Change in Interest on Gerdau Ameristeel Investment

On October 15 2004, Gerdau Ameristeel issued 70,000 new shares, which were acquired by Gerdau and other investors in a public offering. As the new shares were issued at a price higher than the average carrying amount of the shares held by Gerdau, Gerdau recorded a gain in the amount of $2.7 million presented as “Gain on change of interest” in the consolidated income statements.

Provision for Taxes on Income

In 2004, provision for income tax and social contribution was affected by the recognition of deferred tax assets corresponding to tax loss carryforwards in the amounts of $120.3 million and $48.6 million by the Company’s  Brazilian operations and Gerdau Ameristeel, respectively. This reflects a review of the probability of realizing these tax loss carryforwards considering current levels of profitability.

Net Income

In 2004, consolidated net income was $1,158.4 million, 127.1% higher than $510.2 million in 2003, due to higher gross margins generated by an increase in world steel demand, an impact of $43.5 million related to a final court ruling regarding tax claims, an increase in earnings of unconsolidated companies accounted for under the equity income method contributing $141.9 million and also the reduction of financial expenses due to an increase in cash generated from operations permitting the paying down of debt.

B. LIQUIDITY AND CAPITAL RESOURCES

Net cash generated from operating activities amounted to $1,454.5 million, $345.1 million and $1,070.6 million for the years ended December 31, 2006, 2005 and 2004, respectively, with a cumulative total for the three years of $2,870.2 million. Net cash generated from operating activities was one of the Company’s main sources of liquidity. Cumulative short and long-term financing amounted to $5,044.3 million for the three-year period contributing $2,123.7 million in 2006, $1,630.6 million in 2005 and $1,290.0 million in 2004 towards the Company’s liquidity requirements. Disposals of fixed assets, such as obsolete machinery and scrap equipment, generated cumulative losses of $6.5 million for the years of 2006, 2005 and 2004.

39




The main uses of capital resources in 2006 were: $1,022.2 million for investment in fixed assets, $214.9 million for the acquisition of companies in North America, $8.0 million for the acquisition of Sipar Aceros, $86.9 million for the acquisition of Siderperú, $204.0 million for the acquisition of Corporación Sidenor and $146.8 million for the acquisition of GSB Acero, $445.3 million for payment of dividends and interest on capital and $1,467.1 million for the repayment of debt. In 2005 the main uses of capital resources were: $697.4 million for investment in fixed assets, $49.6 million for the acquisition of North Star in North America, $16.7 million for the acquisition of Sipar Aceros, $6.7 million for the acquisition of Diaco and $6.2 million for the acquisition of Sidelpa, $420.5 million for payment of dividends and $798.4 million for the repayment of debt. The acquisitions of Diaco and Sidelpa completed in 2005, also had a non-cash impact of $53.6 million resulting from the release of funds previously maintained in trusts. The payment of cash into the trusts was previously recognized as a use of resources during 2004 in the cash flow statement. In 2004, the main uses of capital resources were: $440.9 million for investments in fixed assets, $298.4 million for the acquisition of businesses in North America, $1,273.2 million for the repayment of maturing short and long-term debt and $275.6 million for the distribution of dividends. Resources invested in fixed assets from 2004 to 2006 ($2,160.6 million) were used to modernize the Company’s industrial plants and subsidiaries and to upgrade technology. In 2006, capital resources were primarily used for the construction of a new rolling mill in São Paulo and for the expansion of the blast furnace at the Ouro Branco mill.

The Company’s principal source of liquidity has traditionally consisted of cash generated from operating activities.

Between December 31, 2005 and December 31, 2006, net working capital (current assets less current liabilities) increased by $865.5 million, from $3,294.6 million in 2005 to $4,160.1 million in 2006. Between December 31, 2004 and December 31, 2005, net working capital increased by $1,683.9 million, from $1,610.7 million in 2004 to $3,294.6 million in 2005. The increase in 2006 was primarily due to the increase in financial investments as a result of the stronger cash flow in the period and due to the issuance of long term debt and the consolidation of assets of Corporación Sidenor, Sheffield Steel and Siderperú, acquired during 2006. The Company believes its current working capital and cash generation is sufficient to meet its capital needs. As of December 31, 2006, there were no material commitments entered into by the Company, so no sources of funds are needed or anticipated.

Debt and Financial Strategy

The Company’s debt is intended to finance investments in fixed assets, both in the modernization and technological upgrading of its plants and in the expansion of installed capacity, as well as working capital, the purchase of stakes in other companies, and, depending on market conditions, short-term financial investments.

Total debt amounted to $4,638.6 million in 2006 and $3,215.0 million in 2005. Net debt (defined as short and long-term debt plus debentures less short-term investments, restricted cash and cash and cash equivalents) increased from $911.6 million in 2005, to $1,656.6 million in 2006. This increase was due to the financial agreements signed to fund the expansion of the Ouro Branco mill and to the consolidation of the liabilities of Corporación Sidenor, Sheffield Steel and Siderperú.

In 2006, net financial income (which comprises financial income, financial expenses, foreign exchange gains and losses and gains and losses on derivatives) amounted to $147.4 million compared to $12.6 million in 2005. This improvement is due to the greater gain from financial investments in the period. Additionally, net financial income in 2006 reflected foreign exchange gains ($132.9 million) mainly due to the appreciation of the real, which impacted U.S. dollar denominated assets and liabilities, most notably trade accounts receivable and debt and trade accounts payable. Derivatives generated losses of $7.1 million in 2006 due to the appreciation of the real against the U.S. dollar.

The following table profiles the Company’s debt on December 31 2006 and 2005 (in thousands of U.S. dollars):

 

 

2006

 

2005

 

SHORT-TERM:

 

 

 

 

 

Short-term debt:

 

 

 

 

 

Debt denominated in reais

 

88,840

 

7,896

 

Debt denominated in foreign currency

 

414,459

 

303,488

 

Total short-term debt

 

503,299

 

311,384

 

Current portion of long-term debt:

 

 

 

 

 

Debt denominated in reais

 

121,562

 

39,947

 

Debt denominated in foreign currency

 

440,259

 

215,231

 

Total current portion of long-term debt

 

561,821

 

255,178

 

Debentures(a)

 

1,371

 

1,162

 

Short-term debt plus current portion of long-term debt and debentures

 

1,066,491

 

567,724

 

 

 

 

 

 

 

LONG-TERM:

 

 

 

 

 

Long-term debt, less current portion:

 

 

 

 

 

Debt denominated in reais

 

676,996

 

349,567

 

Debt denominated in foreign currency

 

2,451,872

 

1,883,464

 

Total long-term debt

 

3,128,868

 

2,233,031

 

Debentures

 

443,280

 

414,209

 

Long-term debt plus debentures

 

3,572,148

 

2,647,240

 

 

 

 

 

 

 

Total debt plus debentures, current portion of long-term debt and parent company

 

4,638,639

 

3,214,964

 

Short-term investments, restricted cash, cash and cash equivalents

 

2,982,062

 

2,303,413

 

Net debt plus debentures, current portion of long-term debt and parent company

 

1,656,577

 

911,551

 

 

40




On December 31 2006, the Company’s total debt plus debentures amounted to $4,638.6 million. Of this balance, $1,332.0 million (28.7%) was denominated in Brazilian reais and $3,306.6 million (71.3%) in foreign currency.

Short-term debt plus current portion of long-term debt and debentures

As of December 31, 2006, the Company’s short-term debt amounted to $503.3 million. Of this total, $88.8 million related to financing in reais and $414.5 million in foreign currencies. In 2006, short-term debt plus the current portion of long-term debt and debentures amounted to $1,066.5 million, representing an increase of 87.9% relative to 2005. This increase was due to the financing of the Ouro Branco mill expansion, loans obtained for the acquisition of companies and working capital obtained during the period.

Long term

Long-term debt including debentures amounted to $3,572.1 million as of December 31, 2006.  Of this total, $3,128.9 million represented loans obtained from financial institutions and from issuance of debt in the market, of which $677.0 million was denominated in reais and $2,451.9 million in foreign currency. Of total long-term debt, $443.3 million represents debentures in reais.

Approximately 72.7% of the $2,892.1 million of long-term loans denominated in foreign currency, including the current portion of long-term debt, was contracted by the Company and its Brazilian subsidiaries and 27.3% by the Company’s foreign subsidiaries.

The Company has entered into financial agreements to fund and improve its debt profile. The most significant financial agreements contracted in 2006 are described below.

On March 24 2006, Gerdau concluded negotiations and signed a $267.0 million Yen-equivalent term loan agreement to finance part of its Gerdau Açominas subsidiary’s production expansion of the Ouro Branco mill. The transaction was led by Citigroup and has NEXI credit insurance. The financial operation has a total tenor of ten years and pays semi-annual interest of Libor + 0.30 % p.a.

On November 1 2006, Gerdau concluded negotiations and signed a $400.0 million Senior Liquidity Facility in order to improve its liquidity and improve the management of its exposure to market risks. The program has an availability period of three years and a two-year payment period as of any effective disbursement. Costs are a Facility Fee of 0.27% p.a. and interest of Libor + 0.30% to 0.40% p.a. when actually withdrawn. The operation was lead jointly by ABN AMRO, Santander, Calyon and HSBC.

The Company is subject to limitations on debt levels, the granting of encumbrances on its properties and the payment of dividends under certain circumstances, in accordance with the terms of its debentures and its loans from the Brazilian National Bank for Economic and Social Development (BNDES). These limitations are applicable to the Guaranteed Perpetual Senior Securities and to the refinancing agreements for Gerdau Ameristeel (Senior Notes and Senior Secured Credit Facility) as well as trade finance lines, bank loans and suppliers’ credits. Most of the financial agreements contracted by the Company, including ECA operations, Senior Liquidity Facility and Export Receivables Notes, have covenants based on certain limits such as (i) Financial Debt divided by Earnings before Interest, Taxes,

41




Depreciation and Amortization - EBITDA (defined as gross profit minus general, sales and marketing and administrative expenses plus depreciation and amortization) of less than four times and (ii) EBITDA divided by Net Financial Expenses Excluding Monetary and Foreign Exchange Variations of higher than three times.

Under the Export Receivables Notes Program, the Company has to maintain a Consolidated Minimum Net Worth of R$3,759.2 million.

In order to protect the Company from changes in interest rates on its foreign currency debt incurred in Brazil, Gerdau entered into interest rate swap operations whereby it pays U.S. dollars, generally accruing interest at fixed rates, and receives U.S. dollars accruing interest at LIBOR rates. In some other swaps the Company has entered into, it receives fixed interest rates based on U.S. dollars, and pays a variable interest rate based on LIBOR. The Company has also entered a swap in which it receives a variable amount based on CDI rates, and pays a fixed rate based on Referential Rate (TR). Such swaps have a notional value of $444.3 million as of December 31, 2006. These derivative instruments are not contracted by the same entities, and aim to reduce each entity’s exposure to changes in interest rates, or to assure the denominations of inflows match contracted debt outflows.

The Company has also cross currency swaps in which it receives a variable amount in Japanese yen based on Japanese LIBOR, and pays a fixed interest rate in U.S. dollars. A reverse swap was entered into, in which it receives a fixed interest rate in U.S. dollars and pays a variable interest rate based on JIBOR in Japanese yen. In December 2006, the total amount swapped was $378 million (notional amount).

Also, in order to reduce its exposure to changes in the fair value of its Senior Notes, Gerdau Ameristeel entered into interest rate swaps whereby it receives a fixed interest rate and pays a variable interest rate based on LIBOR. In December 2006, the total amount swapped was $200 million. Cash flows from operations may be used to service this debt. However, there can be no assurance that cash flows from operations will be sufficient to service foreign currency debt obligations, denominated principally in U.S. dollars. It is thus possible that exchange rate fluctuations may have a material adverse effect on the Company’s business, financial condition and results of operations.  See Item 3 - Risk Factors. The maturity profile of the Company’s long-term debt with financial institutions, including debentures, is as follows:

Gerdau S.A. Consolidated
Amortization
($ million)

 

 

 

2008

 

502.7

 

2009

 

500.9

 

2010

 

504.0

 

2011

 

314.3

 

After 2011

 

1,750.3

 

Total

 

3,572.2

 

 

The amounts described above include the Aços Villares debentures that mature in 2010 ($143.4 million) and a further five Gerdau S.A. debenture issues ($299.9 million) with different maturity dates after 2010.

As of December 31, 2006, the Company was in compliance with all contract covenants.

C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENCES, ETC.

Due to the specialized nature of its business, Gerdau Aços Especiais is the only unit that has been investing uninterruptedly in technological upgrading and in research and development (R&D). This unit is active in the automotive segment and maintains an R&D department responsible for new products and the optimization of existing processes. These product development projects are headed by specialists who use quality tools such as ‘6 Sigma’, statistical procedures for improving the assessment of process variables, and ‘Quality Function Deployment’, a methodology through which the technicians are able to identify the full spread of customer requirements. In the other plants, production and quality teams are responsible for developing new products to meet customer and market needs.

As is common with mini-mill steel makers, Gerdau usually acquires technology in the market, since steel-making technology is readily available for purchase.

International machinery manufacturers and steel technology companies supply most of the sophisticated production equipment used by the Company. Such suppliers generally sign technology transfer agreements with the

42




purchaser and provide extensive technical support and staff training for the installation and commissioning of the equipment. Gerdau has technology transfer agreements with Nippon Steel, Sumitomo Steel, Thyssen, Daido Steel and BSW.

D. TREND INFORMATION

Gerdau’s business focuses on the production of long steel and the distribution of steel products in general at its operations located in Brazil, North and South America and Spain. One of the corporate’s strategies is the development of business on a regional basis aimed at servicing the Company’s raw material requirements and the selling of its production to clients mostly located close to the operating units.

Since international prices are recovering, influenced in good measure by strong demand and the increase in scrap and iron ore prices along with the reduction of Chinese supply of billets and long steel as a result of surtaxes imposed on exports from that country.

Some supplier iron ore contracts have already been negotiated at a 9.5% increase in price. On the other hand, prices for coking coal in international markets are falling approximately 20% due to the increase in supply resulting from investments in new mining sites in Canada and Australia.

Another interesting point is sea freight. Even with new tonnage available throughout 2006, freight prices are rising indicating that the economies in the different regions continue to grow and demand for steel products in international markets is strong.

Perspectives for the steel sector are positive for the year 2007. According to the IISI, apparent demand for steel products should grow 5.3% worldwide with the spotlight on China and the CIS (Commonwealth of Independent States), where demand is expected to grow at 10.4 and 9.4%, accordingly. South America is another region in which an important apparent consumption should experience significant growth of about 7%. The NAFTA countries and those of Eastern Europe should see stable demand or perhaps a slight dip.

In Brazil, the year of 2007, not considering the PAC – “Growth Acceleration Program” (a government program launched during 2007 to promote economic growth)-, is showing a quite favorable scenario for business. Volumes shipped to the domestic market should grow between 6% and 8%, influenced by the strong demand in the civil construction and the agricultural sectors. In civil construction it is worth mentioning that the decline in interest rates and the strong capitalization of construction companies will most certainly contribute to the investment in residential construction throughout this and the coming years.

As for the PAC, as announced by the Brazilian government in January, it is possible to visualize an even more intense warming up of the demand for our products. This should be felt as investments begin to be implemented.  The rough estimates indicate that direct investments in civil construction will reach R$ 27.5 billion in 2007, and R$ 78.8 billion for the period between 2008 and 2010. The investment program also envisages investments in logistics (highways, railroads and ports), along with energy and sanitation. These investments should benefit Gerdau directly and indirectly via the reduction of transportation and electricity costs, as well as with the increase in consumption of our products.

In 2007, North American demand for rebars, merchant bars and structural steel should continue strong, given that investments in infrastructure are expected to remain high. With this scenario combined with the outlook that steel imports should continue to decline and steel prices remain buoyant, the prospects of metal spread at $ 400 per short ton throughout the next several months look favorable.

The year is also expected to report good performance from the Latin American operations due to GDP driven by investments in the public sector, in infrastructure and in our ability to run the businesses recently acquired.

European demand for specialty steel should remain quite strong in 2007 due to the continued growth of the automotive sector throughout the world. Gerdau’s business in the region should present an even better performance following the acquisition of GSB, at the end of December, which added 200 thousand tonnes of long specialty steel per annum to our Spanish operation.

43




E. OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources other than the ones described below.

The Company has guaranteed 51.82% of the debt of Dona Francisca Energética S.A., an unlisted corporation that owns and operates a hydroelectric power plant, known as Usina Hidroelétrica Dona Francisca. The debt amounts to R$157.8 million (equivalent to $73.8 million at the year-end foreign exchange rate). The percentage of this guarantee corresponds to its 51.82% stake in Dona Francisca Energética. In addition, the Company has issued guarantees to Banco Gerdau S.A. for $9.3 million relating to loans by the bank to its customers for purchasing its products.

F. DISCLOSURE OF CONTRACTUAL OBLIGATIONS

 

 

Payments due by period

 

 

 

 

 

 

 

 

 

 

 

More

 

Contractual Obligations

 

 

 

Less than 

 

 

 

 

 

than 5

 

($ thousands)

 

Total

 

1 year

 

1-3 years

 

3-5 years

 

years

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-Term Debt Obligations (1)

 

3,690,689

 

561,821

 

1,003,586

 

617,075

 

1,508,207

 

Debentures (1)

 

444,651

 

1,371

 

 

143,424

 

299,856

 

Interest payments (2)

 

3,034,242

 

512,582

 

731,845

 

395,023

 

1,394,793

 

Operating Lease Obligations (3)

 

73,643

 

12,994

 

18,857

 

14,677

 

27,115

 

Capital Expenditures (4)

 

199,011

 

149,258

 

34,827