GGB

Business Context and Reporting Period

Company: GERDAU S.A.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2003
Business Overview: Gerdau is a Brazilian holding company and the 14th largest steel producer in the world. Its operations are concentrated in Brazil (via Gerdau Acominas), North America (via Gerdau Ameristeel), and South America (Chile and Uruguay). The company produces long steel products, drawn products, and specialty steel using mini-mill (electric arc furnace) and integrated processes.

Key Financial Metrics (2003)

Note: All figures are in thousands of U.S. Dollars unless otherwise noted. EPS figures are retroactively adjusted for stock splits and bonuses.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 38.8% to $4.53 billion, driven by a 125% surge in export revenues ($787.3 million) and the full-year consolidation of Gerdau Acominas and Gerdau Ameristeel (Co-Steel).
• Profitability: Net income rose 120.1% to $510.2 million. This was significantly aided by a $34.1 million income tax credit resulting from the reversal of a valuation allowance on tax losses.
• Margins: Gross margin declined to 23.9% from 28.0% due to increased costs of scrap, pig iron, electricity, and natural gas. Operating margin fell to 15.4% from 17.8%.
• Financial Expenses: Net financial expenses decreased 40.5% to $192.7 million, primarily due to a $162.2 million foreign exchange gain resulting from the appreciation of the Brazilian real against the U.S. dollar.
• Liquidity: Net working capital improved significantly to $300.7 million from a negative $63.6 million in 2002, driven by a reduction in short-term debt.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Brazil: Management expects domestic demand growth by the end of 2004, potentially reducing export volumes. Input prices (scrap, pig iron) are expected to decline due to reduced Chinese demand, though a rebound is possible.
• North America: Strong first-quarter 2004 results were driven by economic recovery and favorable prices. Capacity utilization remains above 95%.
• South America: Positive outlook with expected GDP growth in Uruguay and Chile.

Risks and Contingencies

• Raw Material Costs: Significant exposure to fluctuations in steel scrap, pig iron, and iron ore prices. Supply shortages could adversely affect margins.
• Energy Supply: Interruption or rationing of electrical power would severely impact production, particularly in electric arc furnace melt shops.
• Exchange Rates: Results are sensitive to the Brazilian real/U.S. dollar exchange rate. While the real appreciated in 2003, future devaluation could increase debt service costs.
• Legal Contingencies: Significant tax contingencies exist, including disputes over "compulsory loans" to Eletrobras ($17.5 million provision) and social contributions ($14.1 million provision). An antitrust proceeding regarding alleged cartel behavior is pending, though management believes the probability of loss is remote.
• Integration Risks: Ongoing integration of acquired assets (Co-Steel, Acominas) requires significant management attention and carries execution risks.

Investor Verification Checklist

• Export Dependency: Verify the sustainability of the 125% increase in export revenues and the impact of potential trade restrictions or tariffs.
• Tax Credit Realization: Confirm the permanence of the $34.1 million tax credit and the utilization of tax loss carryforwards.
• Debt Covenants: Review compliance with debt covenants, particularly the 13th debenture issue limiting consolidated financial debt to four times EBITDA.
• Input Cost Volatility: Monitor trends in steel scrap and energy prices, which directly impact the gross margin.
• Legal Reserves: Assess the adequacy of the $102.1 million provision for contingencies against potential adverse rulings in tax and labor disputes.