20-F 1 a19-2248_120f.htm 20-F

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

o

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

OR

 

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2018

 

 

OR

 

 

o

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

 

 

OR

 

 

o

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

 

Commission file number 1-14878

 

GERDAU S.A.

(Exact name of Registrant as specified in its charter)

 

N/A

(Translation of Registrant’s name into English)

 

Federative Republic of Brazil

(Jurisdiction of incorporation or organization)

 

Av. das Nações Unidas, 8,501 – 8° andar

São Paulo, São Paulo - Brazil CEP 05425-070

(Address of principal executive offices) (Zip code)

 

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

 

Title of each class

 

Name of each exchange in which registered

Preferred Shares, no par value per share, each represented by American Depositary Shares

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

 


Table of Contents

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

 

The total number of issued shares of each class of stock of GERDAU S.A. as of December 31, 2018 was:

 

 

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

 

1,146,031,245 Preferred Shares, no par value per share

 

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

x Yes   o No

 

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

o Yes   x No

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes   o No

 

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

x Yes   o No

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Emerging growth company o

 

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

 


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

 

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

 

U.S. GAAP o

 

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

 

Other o

 

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

o Item 17   o Item 18

 

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

o Yes   x No

 


Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

INTRODUCTION

2

 

 

 

PART I

 

4

 

 

 

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

4

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

4

ITEM 3.

KEY INFORMATION

4

ITEM 4.

COMPANY INFORMATION

21

ITEM 4A.

UNRESOLVED SEC STAFF COMMENTS

54

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

55

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

81

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED-PARTY TRANSACTIONS

93

ITEM 8.

FINANCIAL INFORMATION

96

ITEM 9.

THE OFFER AND LISTING

101

ITEM 10.

ADDITIONAL INFORMATION

104

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK

119

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

120

 

 

 

PART II

 

121

 

 

 

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

121

ITEM 14.

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

121

ITEM 15.

CONTROLS AND PROCEDURES

121

ITEM 16.

[RESERVED]

122

ITEM 16A.

AUDIT COMMITTEE FINANCIAL EXPERT

122

ITEM 16B.

CODE OF ETHICS

122

ITEM 16C.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

123

ITEM 16D.

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

123

ITEM 16E.

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

124

ITEM 16F.

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

124

ITEM 16G.

CORPORATE GOVERNANCE

124

ITEM 16H

MINE SAFETY DISCLOSURE

125

 

 

 

PART III

 

125

 

 

 

ITEM 17.

FINANCIAL STATEMENTS

125

ITEM 18.

FINANCIAL STATEMENTS

125

ITEM 19.

FINANCIAL STATEMENTS AND EXHIBITS

125

 

i


Table of Contents

 

INTRODUCTION

 

Unless otherwise indicated, all references herein to:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The Company has prepared the Consolidated Financial Statements included herein in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). The following investments are accounted following the equity method: Bradley Steel Processor and MRM Guide Rail, all in North America, of which Gerdau Ameristeel holds 50% of the total capital, the investment in the holding company Gerdau Metaldom Corp., in which the Company holds a 50% stake, in the Dominican Republic, the investment in the holding company Corsa Controladora, S.A. de C.V., in which the Company holds a 49% stake, which in turn holds the capital stock of Aceros Corsa S.A. de C.V., in Mexico, the investment in Gerdau Corsa S.A.P.I. de C.V., in Mexico, in which the Company holds a 50% stake and the investment in Dona Francisca Energética S.A, in Brazil, in which the Company holds a 51.82% stake, the investment in Diaco S.A., in Colombia, in which the Company holds a 49.87% stake, the investment in Gerdau Summit Aços Fundidos e Forjados S.A., in Brazil, in which the Company holds a 58.73% stake and the investment in Juntos Somos Mais Fidelização S.A., in Brazil, in which the Company holds a 27.50% stake.

 

Unless otherwise indicated, all information in this Annual Report is stated as of December 31, 2018.

 

2


Table of Contents

 

CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING STATEMENTS

 

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

 

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

 

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

 

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

 

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

 

·                  our ability to obtain financing on satisfactory terms;

 

·                  prices and availability of raw materials;

 

·                  changes in international trade;

 

·                  changes in laws and regulations;

 

·                  electric energy shortages and government responses to them;

 

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

 

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

 

·                  protectionist measures imposed by steel-importing countries; and

 

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

 

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

 

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

 

3


Table of Contents

 

PART I

 

ITEM 1.                                                IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

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

 

ITEM 2.                                                OFFER STATISTICS AND EXPECTED TIMETABLE

 

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

 

ITEM 3.                                                KEY INFORMATION

 

A.                                    SELECTED FINANCIAL DATA

 

The selected financial information for the Company included in the following tables should be read in conjunction with the IFRS financial statements of the Company, appearing elsewhere in this Annual Report, and section “Operating and Financial Review and Prospects”. The consolidated financial data of the Company as of and for each of the years ended on December 31, 2018, 2017, 2016, 2015 and 2014 are derived from the financial statements prepared in accordance with IFRS and presented in Brazilian Reais.

 

 

 

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

 

 

 

2018

 

2017

 

2016

 

2015

 

2014

 

NET SALES

 

46,159,478

 

36,917,619

 

37,651,667

 

43,581,241

 

42,546,339

 

Cost of sales

 

(40,010,100

)

(33,312,995

)

(34,187,941

)

(39,290,526

)

(37,406,328

)

 

 

 

 

 

 

 

 

 

 

 

 

GROSS PROFIT

 

6,149,378

 

3,604,624

 

3,463,726

 

4,290,715

 

5,140,011

 

Selling expenses

 

(570,431

)

(524,965

)

(710,766

)

(785,002

)

(691,021

)

Impairment loss on trade receivables

 

(9,914

)

 

 

 

 

General and administrative expenses

 

(1,082,449

)

(1,129,943

)

(1,528,262

)

(1,797,483

)

(2,036,926

)

Impairment of non-financial assets

 

 

(1,114,807

)

(2,917,911

)

(4,996,240

)

(339,374

)

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

 

(414,507

)

(721,682

)

(58,223

)

 

636,528

 

Other operating income

 

235,421

 

260,618

 

242,077

 

213,431

 

238,435

 

Other operating expenses

 

(270,413

)

(168,887

)

(114,230

)

(116,431

)

(150,542

)

Reversal of provision for tax liabilities, net

 

 

929,711

 

 

 

 

Equity method investees

 

10,141

 

(34,597

)

(12,771

)

(24,502

)

101,875

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

4,047,226

 

1,100,072

 

(1,636,360

)

(3,215,512

)

2,898,986

 

Financial income

 

204,000

 

226,615

 

252,045

 

378,402

 

276,249

 

Financial expenses

 

(1,579,341

)

(1,726,284

)

(2,010,005

)

(1,780,366

)

(1,397,375

)

Bond repurchases expenses

 

(223,925

)

 

 

 

 

Exchange variations, net

 

(322,621

)

(4,057

)

851,635

 

(1,564,017

)

(476,367

)

Reversal of interest on provision for tax liabilities, net

 

 

369,819

 

 

 

 

Gains and losses on derivative financial instruments, net

 

32,092

 

(9,441

)

(38,930

)

87,085

 

36,491

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) BEFORE TAXES

 

2,157,431

 

(43,276

)

(2,581,615

)

(6,094,408

)

1,337,984

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

(629,209

)

(313,758

)

(110,511

)

(158,450

)

(571,926

)

Deferred

 

798,160

 

18,367

 

(193,803

)

1,656,872

 

722,315

 

Income and social contribution taxes

 

168,951

 

(295,391

)

(304,314

)

1,498,422

 

150,389

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INCOME (LOSS)

 

2,326,382

 

(338,667

)

(2,885,929

)

(4,595,986

)

1,488,373

 

 

 

 

 

 

 

 

 

 

 

 

 

ATTRIBUTABLE TO:

 

 

 

 

 

 

 

 

 

 

 

Owners of the parent

 

2,303,868

 

(359,360

)

(2,890,811

)

(4,551,438

)

1,402,873

 

Non-controlling interests

 

22,514

 

20,693

 

4,882

 

(44,548

)

85,500

 

 

 

2,326,382

 

(338,667

)

(2,885,929

)

(4,595,986

)

1,488,373

 

 

4


Table of Contents

 

 

 

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

 

 

 

2018

 

2017

 

2016

 

2015

 

2014

 

Basic earnings (loss) per share  — in R$

 

 

 

 

 

 

 

 

 

 

 

Common

 

1.35

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

Preferred

 

1.35

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

Diluted earnings (loss) per share  — in R$

 

 

 

 

 

 

 

 

 

 

 

Common

 

1.34

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

Preferred

 

1.34

 

(0.21

)

(1.70

)

(2.69

)

0.82

 

Cash dividends declared per share  — in R$

 

 

 

 

 

 

 

 

 

 

 

Common

 

0.45

 

0.08

 

0.05

 

0.15

 

0.25

 

Preferred

 

0.45

 

0.08

 

0.05

 

0.15

 

0.25

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average Common Shares outstanding during the year (1)

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

Weighted average Preferred Shares outstanding during the year (1)

 

1,129,851,598

 

1,137,012,265

 

1,132,626,373

 

1,117,034,926

 

1,132,483,383

 

Number of Common Shares outstanding at year end (2)

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

571,929,945

 

Number of Preferred Shares outstanding at year end (2)

 

1,124,233,755

 

1,137,327,184

 

1,137,018,570

 

1,114,744,538

 

1,132,613,562

 

 


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

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

 

 

 

On December 31,

 

 

 

2018

 

2017

 

2016

 

2015

 

2014

 

 

 

(Expressed in thousands of Brazilian Reais - R$)

 

Balance sheet selected information

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

2,890,144

 

2,555,338

 

5,063,383

 

5,648,080

 

3,049,971

 

Short-term investments

 

459,470

 

821,518

 

1,024,411

 

1,270,760

 

2,798,834

 

Current assets

 

17,503,082

 

17,982,113

 

17,796,740

 

22,177,498

 

20,682,739

 

Current liabilities

 

8,504,253

 

7,714,120

 

8,621,509

 

7,863,031

 

7,772,796

 

Net working capital (1)

 

8,998,829

 

10,267,993

 

9,175,231

 

14,314,467

 

12,909,943

 

Property, plant and equipment, net

 

15,546,481

 

16,443,742

 

19,351,891

 

22,784,326

 

22,131,789

 

Net assets (2)

 

25,938,571

 

23,893,941

 

24,274,653

 

31,970,383

 

33,254,534

 

Total assets

 

51,281,029

 

50,301,761

 

54,635,141

 

70,094,709

 

63,042,330

 

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

 

1,822,183

 

2,004,341

 

4,458,220

 

2,387,237

 

2,037,869

 

Long-term debt, less current portion

 

11,545,658

 

14,457,315

 

15,959,590

 

23,826,758

 

17,148,580

 

Debentures - short term

 

2,755

 

 

 

 

 

Debentures - long term

 

1,536,118

 

47,928

 

165,423

 

246,862

 

335,036

 

Equity

 

25,938,571

 

23,893,941

 

24,274,653

 

31,970,383

 

33,254,534

 

Capital

 

19,249,181

 

19,249,181

 

19,249,181

 

19,249,181

 

19,249,181

 

 


(1)  Total current assets less total current liabilities.

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

 

5


Table of Contents

 

Dividends

 

The Company’s total authorized capital stock is composed of common and preferred shares. As of December 31, 2018, the Company had 571,929,945 common shares and 1,124,233,755 non-voting preferred shares outstanding (excluding treasury stock).

 

The following table details dividends and interest on equity paid to holders of common and preferred stock since 2014. The figures are expressed in Brazilian reais and U.S. dollars. The exchange rate used for conversion to U.S. dollars was based on the date of the resolution approving the dividend.

 

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

 

Period

 

Date of
Resolution

 

R$ per Share
Common or
Preferred Stock

 

$ per Share
Common or
Preferred
Stock

 

 

 

 

 

 

 

 

 

1st Quarter 2014 (1)

 

05/07/2014

 

0.0700

 

0.0312

 

2nd Quarter 2014

 

07/30/2014

 

0.0600

 

0.0265

 

3rd Quarter 2014 (1)

 

11/05/2014

 

0.0500

 

0.0199

 

4th Quarter 2014

 

03/04/2015

 

0.0700

 

0.0235

 

1st Quarter 2015 (1)

 

06/05/2015

 

0.0600

 

0.0197

 

2nd Quarter 2015 (1)

 

08/12/2015

 

0.0500

 

0.0144

 

3rd Quarter 2015

 

10/29/2015

 

0.0400

 

0.0102

 

2nd Quarter 2016

 

08/10/2016

 

0.0300

 

0.0096

 

3rd Quarter 2016

 

11/04/2016

 

0.0200

 

0.0062

 

2nd Quarter 2017

 

08/08/2017

 

0.0200

 

0.0064

 

3rd Quarter 2017

 

11/07/2017

 

0.0300

 

0.0092

 

4rd Quarter 2017

 

27/02/2018

 

0.0300

 

0.0092

 

1st Quarter 2018 (1)

 

08/05/2018

 

0.0800

 

0.0224

 

2nd Quarter 2018 (1)

 

07/08/2018

 

0.1400

 

0.0373

 

3rd Quarter 2018

 

06/11/2018

 

0.1300

 

0.0345

 

4th Quarter 2018

 

20/02/2019

 

0.1000

 

0.0268

 

 


(1) Payment of interest on equity.

 

6


Table of Contents

 

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

 

B.                                    CAPITALIZATION AND INDEBTEDNESS

 

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

 

C.                                    REASONS FOR THE OFFER AND USE OF PROCEEDS

 

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

 

D.                                    RISK FACTORS

 

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

 

Risks Relating to our Business and the Steel Industry

 

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

 

The steel industry is highly cyclical. Consequently, the Company is exposed to substantial swings in the demand for steel products, which in turn causes volatility in the prices of most of its products and eventually could cause write-downs of its inventories. In addition, the demand for steel products, and hence the financial condition and results of operations of companies in the steel industry, including the Company itself, are generally affected by macroeconomic changes in the world economy and in the domestic economies of steel-producing countries, including general trends in the steel, construction and automotive industries. Slow growth in steel consumption was not accompanied by a corresponding slowdown in capacity expansion over the last few years, resulting in an even greater excess of global steel capacity. Since then, the price has experienced a high volatility. A material decrease in demand for steel or exports by countries not able to consume their production could have a significant adverse effect on the Company’s financial condition and results of operations.

 

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

 

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

 

7


Table of Contents

 

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

 

·                  Decrease in international steel prices;

 

·                  Slump in international steel trading volumes;

 

·                  Crisis in automotive industry and infrastructure sectors; and

 

·                  Lack of liquidity in the international market.

 

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

 

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

 

We are subject to the risks arising from adverse changes in domestic and global economic and political conditions. Our industry is cyclical by nature and fluctuates with economic cycles, including the current global economic instability. The global financial markets experienced significant disruptions in 2008 and the United States, Europe and other economies went into recession. The recovery from the lows of 2008 and 2009 was uneven and is facing new challenges, including the uncertain effects of the United Kingdom’s decision to withdraw from the European Union (BREXIT) and increasing political uncertainty and instability in a number of countries. There continues to be considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies that have been adopted by the central banks and financial authorities of some of the world’s leading economies, including China. These policies may have a negative impact on the global and local economy, and consequently our business, financial condition and results of operations. We cannot predict if the actions taken in the United States, Europe, China and elsewhere in the world to address this situation will be successful in reducing the duration and impact of the economic instability and political uncertainty. More recently, the risk of trade protection measures in favor of local producers of competing products and the disruption in existing trade agreements or increased trade friction between countries (e.g., the U.S. and China) could have a negative effect on our business and results of operations by restricting the free flow of goods and services across borders and exacerbating global economic conditions. Global economic weakness may prompt banks to limit or deny lending to us or to our customers, which could have a material adverse effect on our liquidity, on our operations and on our ability to carry out our announced capital investment programs and may prompt our customers to slow down or reduce the purchase of our products. We may experience longer sales cycles, difficulty in collecting sales proceeds and lower prices for our products. We cannot provide any assurance that any of these events will not have a material adverse effect on market conditions, the prices of our securities, our ability to obtain financing and our results of operations and financial condition.

 

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

 

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

 

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

 

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

 

8


Table of Contents

 

An increase in China’s steelmaking capacity or a slowdown in China’s steel consumption could have a material adverse effect on domestic and global steel pricing and could result in increased steel imports into the markets in which the Company operates.

 

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

 

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

 

The main metal input for the Company’s mini-mills, which mills accounted for 78.0% of total crude steel output as of and for the year ended on December 31, 2018, is steel scrap. Although international steel scrap prices are determined essentially by scrap prices in the U.S. local market, because the United States is the main scrap exporter, scrap prices in the Brazilian market are set by domestic suppliers and demand. The price of steel scrap in Brazil varies from region to region and reflects demand and transportation costs. Should scrap prices increase significantly without a corresponding increase in finished steel selling prices, the Company’s profits and margins could be adversely affected. An increase in steel scrap prices or a shortage in the supply of scrap to its units would affect production costs and potentially reduce operating margins and revenues. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

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

 

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

 

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

 

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

 

All of the Company’s coking coal requirements for its Brazilian units are imported due to the low quality of Brazilian coal. Coking coal is the main energy input at the Ouro Branco mill and is used at the coking facility. Although this mill is not dependent on coke supplies, a contraction in the supply of coking coal could adversely affect the integrated operations at this site. The coking coal used in this mill is imported from Canada, the United States, Australia, Mozambique, Peru, Russia and Colombia. Although the market for the supply of coking coal is relatively balanced at the moment, and we have entered into long-term contracts with negotiable prices periodically to minimize the risks of shortages, a shortage of coking coal in the international market would adversely affect the steel producing capacity of the Ouro Branco mill. In addition, an increase in prices could reduce profit margins. Another related risk is the currency depreciation to which the Ouro Branco Mill is exposed, since all coking coal consumed by the operation is imported.

 

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

 

Risks Relating to our Operations

 

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

 

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

 

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

 

9


Table of Contents

 

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

 

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

 

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

 

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

 

Unexpected equipment failures may lead to production curtailments or shutdowns.

 

Unexpected interruptions in the production capabilities at Gerdau’s principal sites and installations would increase production costs, reducing shipments and earnings for the affected period. These interruptions result from: (i) unpredictable/periodic equipment failures, which are essential to the development of the production processes of Gerdau, such as steelmaking equipment, such as its electric arc furnaces, continuous casters, gas-fired reheat furnaces, rolling mills and electrical equipment, including high-output transformers; and/or (ii) unanticipated events such as fires, explosions or violent weather conditions. As a result, Gerdau has experienced and may in the future experience material plant shutdowns or periods of reduced production. Unexpected interruptions in production capabilities would adversely affect Gerdau’s productivity and results of operations. Moreover, any interruption in production capability may require Gerdau to make additions to fixed assets to remedy the problem, which would reduce the amount of cash available for operations. Gerdau’s insurance may not cover the losses. In addition, long-term business disruption could harm the Company’s reputation and result in a loss of customers, which could adversely affect the business, results of operations, cash flows and financial condition.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

A substantial number of our employees are represented by labor unions and are covered by collective bargaining or other labor agreements, which are subject to periodic negotiation. Strikes or work stoppages have occurred in the past and could reoccur in connection with negotiations of new labor agreements or during other periods for other reasons, including the risk of layoffs during a

 

10


Table of Contents

 

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

 

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

 

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

 

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

 

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

 

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

 

Our business operations rely upon secure information technology systems for data capture, processing, storage and reporting. Despite careful security and controls design, implementation, updating and independent third party verification, our information technology systems, and those of our third party providers, could become subject to employee error or malfeasance, cyber-attacks, or natural disasters. Network, system, application and data breaches could result in operational disruptions or information misappropriation. Access to internal applications required to plan our operations, source materials, manufacture and goods and account for orders could be denied or misused. Theft of intellectual property or trade secrets, and inappropriate disclosure of confidential company, employee, customer or vendor information, could stem from such incidents. Any of these operational disruptions and/or misappropriation of information could result in lost sales, business delays, negative publicity and could have a material effect on our business. We also could be required to spend significant financial and other resources to remedy the damage caused by a security breach, including to repair or replace networks and information technology systems, liability for stolen information, increased cybersecurity protection costs, litigation expense and increased insurance premiums.

 

Risks Relating to our Mining Operations

 

Estimates of Gerdau’s mineral resources are based on interpretations and assumptions and may differ substantially from the quantities that actually can be extracted.

 

Gerdau’s mineral resources refer to estimated quantities of iron ore and minerals. There are a number of uncertainties that are inherent to such estimates of resources, including many factors that are beyond our control, such as geological and technological factors. The engineering of reserves involves estimating mineral deposits that have yet to be measured accurately, and the accuracy of any reserve estimates is directly related to the quality of the data available, geological interpretations and judgments and engineering. Moreover, estimates from different engineers may vary. As a result, the volume of mineral resources available that will or may be extracted at commercially feasible rates cannot be guaranteed, which could adversely affect the operating results and financial condition of the Company.

 

Moreover, in order to determine whether a project should advance to its development stage, Gerdau relies on estimates of the mineralized material occurring on its properties. Since Gerdau may not have conducted a feasibility study demonstrating proven or probable reserves, estimates of mineralized material content are less accurate than if they had been made in accordance with the

 

11


Table of Contents

 

definition of proven and probable reserves recognized by the SEC. Furthermore, until iron ore is effectively mined and processed, any reserves and grades of mineralization must be considered mere estimates. Such estimates are inaccurate and based on geological interpretation and statistical deduction drawn from analyses of drillings and samples, which may not be reliable. We cannot guarantee that such estimates on mineralized material are accurate and that such mineralized material can be extracted or processed profitably. Therefore, any decision to advance to the development stage is inherently risky. We also cannot guarantee that any minerals recovered in small-scale testing can be replicated in large-scale testing under actual conditions or on a production scale. Any material changes in the estimates of mineralized material will affect the financial feasibility of making a property productive, as well as the return on capital of such property.

 

Gerdau does not have any proven or probable mineral reserves, and Gerdau’s decision to start industrial production to supply its steelmaking activities and sell the surplus is not based on studies demonstrating the economic recovery of any mineral reserves, and therefore is inherently risky. Any resources employed in exploration or development may not be recovered.

 

Gerdau has not established any proven or probable mineral reserve on any of its properties. All exploration activities are based on mineral resources classified as mineralized materials, since they do not comply with the SEC definitions of proven or probable reserves. Gerdau is conducting comprehensive exploration studies to determine, in accordance with SEC definitions, the quantity of mineralized material that could be transformed into proven or probable reserves. Therefore, part of the volume of mineralized materials informed and discussed in this report may never make it to the development or production stage.

 

To demonstrate the existence of proven or probable reserves, it is necessary to carry out additional exploration activities to prove the existence of sufficient mineralized material, with satisfactory continuity, and to obtain a positive feasibility study demonstrating, with reasonable certainty, that the deposits can be extracted and produced profitably and legally. The absence of proven or probable reserves makes it more probable that the Company’s properties cease to be profitable and that the financial resources employed for exploration and development are never recovered, which would adversely affect the operating results and financial condition of the Company.

 

Drilling and production risks could adversely affect the mining process.

 

After the discovery of mineral deposits, it could take several years from the initial drilling phase to the feasibility of production, and during such period the economic feasibility of production could suffer changes. Substantial time and investments are necessary to:

 

·                  create mineral reserves through drilling;

 

·                  establish adequate mining and metallurgical processes to optimize the recovery of the metal contained in the ore;

 

·                  obtain environmental and other types of licenses;

 

·                  build mining and processing facilities as well as the necessary infrastructure for greenfield properties; and

 

·                  obtain ore or extract minerals from the ore.

 

If a mining project proves to be economically unfeasible when Gerdau reaches the profit-earning stage, we could incur substantial losses and be forced to write off mineral assets. Furthermore, potential changes or complications involving metallurgical or technological processes during a project cycle could cause delays and generate higher-than-expected costs, rendering the project economically unfeasible and adversely affecting the financial condition and operating results of the Company.

 

The Company has one mining dam for the disposal of tailings, and any accident or defect that affects the structural integrity of any of its dams could affect its image, operating results, cash flows and financial condition.

 

Gerdau has one mining dam for the disposal of tailings in the state of Minas Gerais, the Alemães Dam, which has been in operation since 2011 and is regularly monitored. The data from the monitoring instruments are within the safety limits, with the dam classified as Class C (low risk) in accordance with the National Mining Dam Registry available on the website of the National Mining Agency (ANM). Gerdau adopts rigorous standards for engineering control and environmental supervision and conducts a half-yearly Geotechnical Stability Audit to ensure the stability of the dam. Gerdau has Mining Dam Emergency Action Plans that are filed at the regulatory agencies, as required by applicable law.

 

The Company also has other structures that are treated as Mining Dams by the ANM: Bocaina Clarification, UTM 1 Bays, UTM 2 Bays, North Dike of Tailing Pile 01, and North and South Bays of Tailings Pile A. These are structures that receive stormwater runoff and/or effluents from drainage at the Ore Treatment Units to enable the sedimentation of solid waste before the water is returned to the environment.

 

They also undergo external audits that attest to their geotechnical stability, as well as regular inspections and monitoring.

 

12


Table of Contents

 

An accident involving any of these dams could have serious adverse consequences, including:

 

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

 

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

 

· High investments to resume operations;

 

· Payment of fines and damages;

 

· Potential environmental impacts.

 

Any of these consequences could have a material adverse impact on the Company’s operating results, cash flow and financial condition.

 

Financial Risks

 

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

 

In 2007, the international rating agencies, Fitch Ratings and Standard & Poor’s, classified the Company’s credit risk as “investment grade”, enabling the Company to access more attractive borrowing rates. During recent reviews, the Company maintained its investment grade with S&P and Fitch, with positive and stable outlook, respectively, and its Ba1 rating with Moody’s with positive outlook.

 

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

 

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

 

The Company’s degree of leverage, together with the change in rating by the credit rating agencies, could have important consequences, including the following:

 

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

 

·                  It may limit the ability to declare dividends on its shares;

 

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

 

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

 

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

 

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

 

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

 

13


Table of Contents

 

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

 

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

 

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

 

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

 

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

 

The Brazilian real appreciated against the U.S. dollar by 16.5% in 2016, depreciated by 1.5% in 2017 and depreciated by 17.1% in 2018.

 

The Company held debt denominated in foreign currency, mainly U.S. dollars, in an aggregate amount of R$11 billion at December 31, 2018, representing 73.8% of its consolidated gross debt (loans, financings, and debentures). Significant further depreciation in the Brazilian real in relation to the U.S. dollar or other currencies could reduce the Company’s ability to service its obligations denominated in foreign currencies, particularly since a significant part of its net sales revenue is denominated in Brazilian reais. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

We are subject to LIBOR-based risks.

 

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

 

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

 

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

 

The principal litigations are described more fully in “Legal Proceedings.” Among the material matters for which no provision has been established because are considered as possible contingent liabilities (possibility of any outflow in settlement is possible):

 

·                  The Company and its subsidiary Gerdau Aços Longos S.A. and Gerdau Açominas S.A., have lawsuits related to the ICMS (state VAT) which are mostly related to credit rights and rate differences, whose demands totaled R$ 613,642 thousands.

 

·                  The Company and certain of its subsidiaries in Brazil are parties to claims related to: (i) Imposto sobre Produtos Industrializados - IPI, substantially related to IPI credit on inputs, whose demands total the updated amount of R$ 341,659 thousands; (ii) PIS and COFINS, substantially related to non-approval of compensation of credits on inputs totaling R$ 968,047 thousands, (iii) social security contributions in the total of R$ 88,374 thousands and (iv) other taxes , whose updated total amount is currently R$ 641,782 thousands.

 

14


Table of Contents

 

·                  The Company and its subsidiary Gerdau Aços Longos SA are parties to three administrative proceedings related to Withholding Income Tax, levied on interest remitted abroad, linked to export financing formalized through “Prepayment of Exports Agreements “(PPE) or” Prepayment of Exports “(RAE), in the updated amount of R$ 410,893 thousands, of which: (i) R$ 125,365 thousands corresponds to a lawsuit of the subsidiary Gerdau Aços Longos, which had its Voluntary Appeal judged at the first instance of the Administrative Council of Tax Appeals (CARF), which was dismissed by the quality vote, by means of the judgment published on September 3, 2018, in the face of which the Company objected Embargoes of Declaration, which  awaits judgment;; (ii) R$ 132,643 thousands corresponds to a lawsuit filed by the subsidiary Gerdau Aços Longos, which was challenged and dismissed and filed a Voluntary Appeal at the first instance of CARF, on August 28, 2018, which is pending of judgment; and; (iii) R$ 152,885 thousands, corresponds to a lawsuit filed by the Company, which was challenged and dismissed and filed a Voluntary Appeal at the first instance of CARF, on August 31, 2018, which is pending of judgment.

 

·                  The Company (as successor of Gerdau Aços Especiais S.A.) and its subsidiary Gerdau Internacional Empreendimentos Ltda. are parties to administrative and judicial proceedings relating to IRPJ — Corporate Income Tax and CSLL — Social Contribution Tax, in the current amount of R$ 1,200,672 thousands. Such proceedings relate to profits generated abroad, of which (i) R$ 1,023,337 thousands correspond to two lawsuits of the subsidiary Gerdau Internacional Empreendimentos Ltda., of which (i.a) R$ 988,819 thousands correspond to a lawsuit whose administrative discussion has already been closed and are currently in Fiscal Execution, in relation to which the Company filed Execution Embargoes, which are pending of judgment by the first instance and (i.b) R$ 34,518 thousands are remaining from a notice originally of R$ 372,213 thousands and correspond to a suit partially provided by the Superior Court of Tax Appeals (CSRF), in a decision published on May 25, 2017 and has already become final; currently the process is awaiting proceedings by the first instance of the Administrative Council of Tax Appeals (CARF), for analysis of matters not previously analyzed, as determined by the CSRF decision; and (ii) R $ 177,335 thousands corresponds to a lawsuit filed by the Company, which had its Voluntary Appeal adjudicated by the first instance of CARF, which was dismissed, reason why a Special Appeal was filed with the Superior Court of Tax Appeals (CSRF), known in part and pending of judgment.

 

·                  The Company (as successor of Gerdau Aços Especiais S.A.) and its subsidiaries Gerdau Aços Longos S.A. and Gerdau Açominas S.A. are parties to administrative proceedings relating to the disallowance of the deductibility of goodwill generated in accordance with Article 7 and 8 of Law 9,532/97 — as a result of a corporate restructuring carried out in 2004/2005 — from the tax base of the Corporate Income tax - IRPJ and Social Contribution on Net Income - CSLL. The total updated amount of the proceedings is R$ 7,062,878 thousands, of which (i) R$ 5,128,470 thousands correspond to four proceedings involving the Company and its subsidiaries Gerdau Aços Longos S.A. and Gerdau Açominas S.A., for which administrative discussions already ended and are currently in the judicial collection stage; and the Companies obtained injunctive relief to permit it to offer a judicial guarantee using a liability insurance policy, for judicial discussions on Embargoes to Execution in the respective proceedings, and in the Embargoes to Execution filed by the Company (as successor of Gerdau Aços Especiais S.A.), on May 17, 2018, a judgment was rendered dismissing the fiscal launch, in the face of which the National Treasury filed an appeal, which is pending of judgment in the Federal Regional Court of the 4th Region; (ii) R$ 629,753 thousands correspond to a lawsuit filed by the subsidiary Gerdau Aços Longos SA, which had its Voluntary Appeal judged at the first instance of CARF on September 18, 2018, which was given partial relief and it is pending of publication of the judgment, in the light of which the Company will take the appropriate measures; (iii) R$ 255,531 thousands correspond to a lawsuit filed by the subsidiary Gerdau Aços Longos SA, which had a Voluntary Appeal rejected by the first instance of CARF, which is why a Special Appeal was filed in the CSRF, which was partially dispatched by an order of which it became aware on July 6, 2018 and in the face of which it filed Regimental Grievance, which is awaiting judgment; (iv) R$ 297,033 thousands correspond to a lawsuit filed by the subsidiary Gerdau Aços Longos SA, which had its Voluntary Appeal rejected, reason for which was filed a Special Appeal, which was given partial follow-up; currently, the company awaits judgment of its Special Appeal in so far as it is known and awaits collection of the amounts corresponding to the part in which its Special Appeal was not known, in order to adopt the appropriate judicial measures; (v) R$ 128,404 thousands correspond to a lawsuit filed by the Company (as successor to Gerdau Aços Especiais SA), which had its Voluntary Appeal rejected by the first instance of CARF, which is why a Special Appeal was filed, by an order of which it became aware on September 12, 2018 and in the face of which it filed a regimental grievance that awaits judgment; (vi) R$ 100,686 thousands corresponds to a lawsuit filed by the Company (as successor to Gerdau Aços Especiais SA), which was rejected as unfounded, by decision of which it became aware on September 17, 2018 and in the face of which it filed Voluntary Appeal in the first instance of CARF, currently pending of judgment; and (vii) R$ 522,731 thousands correspond to a lawsuit filed by the subsidiary Gerdau Aços Longos S.A., which was challenged as unfounded, by decision of which it became aware on November 27, 2018 and in the face of which it filed a Voluntary Appeal at the first instance of CARF, which is currently pending of judgment.

 

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

 

In connection with the so-called Operation Zelotes and other matters, Brazilian federal authorities and the judiciary branch are investigating certain issues relating to CARF proceedings, as well as specific political contributions made by the Company, with the purpose of determining whether the Company engaged in any illegal conduct.  The Company previously disclosed that, in addition to its interactions with Brazilian authorities, the Company was providing information requested by the U.S. Securities and Exchange Commission (“SEC”).  The Company has since been informed by the SEC’s staff that it has closed its inquiry and therefore is not seeking any further information from the Company regarding these matters.

 

The Company believes it is not possible at this time to predict the term or outcome of the proceedings in Brazil, and that there currently is not enough information to determine whether a provision for losses is required or any additional disclosures.

 

15


Table of Contents

 

Furthermore, as previously disclosed, the Company retained outside counsel, reporting to a Special Committee of the Board of Directors, to investigate certain matters relating to CARF proceedings and ultimately political donations by Company entities.  That investigation by outside counsel has now been concluded and its results have been reported to the Board of Directors and the SEC.

 

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

 

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

 

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

 

Regulatory Risks

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

16


Table of Contents

 

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

 

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

 

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

 

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

 

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

 

On February 25, 2016, the Federal Police came to Gerdau’s premises to execute court ordered searches and seizures, taking documents and data for examination. The Federal Police also interviewed certain individuals associated with Gerdau, including its Chief Executive Officer and another current Board member. On that same date, the Company filed a press release with SEC and CVM and informed Bovespa and the New York Stock Exchange (NYSE). Furthermore, as previously disclosed, the Company retained outside counsel, reporting to a Special Committee of the Board of Directors, to investigate certain matters relating to CARF proceedings and ultimately political donations by Company entities. That investigation by outside counsel has now been concluded and its results have been reported to the Board of Directors and the SEC. See Note 17 to the Consolidated Financial Statements (Tax, Civil and Labor Claims and Contingent Assets) for further information.

 

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

 

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

 

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

 

Risks Relating to Brazil

 

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

 

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

 

17


Table of Contents

 

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

 

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

 

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

 

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

 

Brazil has experienced heightened economic and political instability derived from various causes such as corruption scandals and currently ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation, known as Lava Jato.

 

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

 

After the impeachment and removal of President Dilma Rousseff in 2016, Michel Temer, the then-vice president, served the remainder of her presidential term through the end of 2018. The Temer administration was marked by significant political and economic unrest, the continued emergence of corruption accusations, political impasse, slow economic recovery, a national transportation strike, low approval ratings and foreign commercial disputes, among other factors.  Mr. Temer has himself recently been accused by the Federal Public Prosecutor of corruption charges.

 

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

 

In addition, the Brazilian economy remains subject to government policies, which may affect our operations and financial performance. Governmental policies and actions, if unsuccessful or poorly implemented, may affect our operations and financial performance. Uncertainty regarding the implementation by the new administration of promised transformational changes in monetary, fiscal and pension policies, as well as the enactment of corresponding legislation, could contribute to economic instability.

 

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

 

If Brazil experiences high levels of inflation once again, the country’s rate of economic growth could slow, which would lead to lower demand for the Company’s products in Brazil. Inflation is also likely to increase some costs and expenses which the Company may not be able to pass on to its customers and, as a result, may reduce its profit margins and net income. In addition, high inflation generally leads to higher domestic interest rates, which could lead the cost of servicing the Company’s debt denominated in Brazilian reais to increase. Inflation may also hinder its access to capital markets, which could adversely affect its ability to refinance debt. Inflationary pressures may also lead to the imposition of additional government policies to combat inflation that could adversely affect our business. As a result, the Company’s financial condition and results of operations may be adversely affected.

 

18


Table of Contents

 

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

 

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

 

The Brazilian economy is also affected by international economic and market conditions, especially economic and market conditions in the United States. Share prices on the B3, for example, have historically been sensitive to fluctuations in United States interest rates as well as movements of the major United States stocks indexes.

 

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

 

Risks Related to our Corporate Structure

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

19


Table of Contents

 

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

 

Risks Relating to Our Preferred Shares and ADSs

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

20


Table of Contents

 

ITEM 4.                                                COMPANY INFORMATION

 

A.                                    HISTORY AND DEVELOPMENT OF THE COMPANY

 

Gerdau S.A. is a Brazilian corporation (Sociedade Anônima) that was incorporated on November 20, 1961 under the laws of Brazil. Its main registered office is located at Av. das Nações Unidas, 8501 - 8º andar, São Paulo, SP, Brazil, and the telephone number is +55 (11) 3094 6300.

 

History

 

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

 

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

 

In 1967, the Company expanded into the Brazilian state of São Paulo, purchasing Fábrica de Arames São Judas Tadeu, a producer of nails and wires, which was later renamed Comercial Gerdau and ultimately became the Company’s Brazilian distribution channel for steel products. In June 1969, the Company expanded into the Northeast of Brazil, producing long steel at Siderúrgica Açonorte in the state of Pernambuco. In December 1971, the Company acquired control of Siderúrgica Guaíra, a long steel producer in the state of Paraná in Brazil’s South Region. The Company also established a new company, Seiva S.A. Florestas e Indústrias, to produce lumber on a sustainable basis for the furniture, pulp and steel industries. In 1979, the Company acquired control of the Cosigua mill in Rio de Janeiro, which currently operates the largest mini-mill in Latin America. Since then, the Company has expanded throughout Brazil with a series of acquisitions and new operations, and today owns 12 steel units in Brazil.

 

In 1980, the Company began to expand internationally with the acquisition of Gerdau Laisa S.A., the only long steel producer in Uruguay. In 1989, the Company acquired the Canadian company Gerdau Ameristeel Cambridge, a producer of common long rolled steel products located in Cambridge, Ontario. In 1992, the Company acquired control of Gerdau AZA S.A., a producer of crude steel  and long rolled products in Chile. Over time, the Company increased its international presence by acquiring a non-controlling interest in a rolling mill in Argentina, a controlling interest in Diaco S.A. in Colombia, and, most notably, additional interests in North America through the acquisition of Gerdau Ameristeel MRM Special Sections, a producer of special sections, and the former Ameristeel Corp., a producer of common long rolled products. In 2002, through a series of transactions, the Company merged its North American steel production assets with those of the Canadian company Co-Steel, a producer of long steel, to create Gerdau Ameristeel, which is currently the second largest long steel producer in North America based on steel production volume.

 

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

 

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

 

21


Table of Contents

 

In January 2006, through its subsidiary Gerdau Hungria Holdings Limited Liability Company, Gerdau acquired 40% of the capital stock of Corporación Sidenor S.A. for US$ 219.2 million (R$ 493.2 million on the acquisition date). In December 2008, Gerdau Hungria Holding Limited Liability Company acquired for US$ 288.0 million (R$ 674.0 million on the acquisition date) a 20% interest in Corporación Sidenor S.A. With this acquisition, Gerdau became the majority shareholder (60%) in Corporación Sidenor. In January 2013, as a result of the settlement of a put option held by the Santander Group, the Company acquired the remaining 40% of Corporación Sidenor S.A., for R$ 599.2 million. In May 2016, the Company closed the sale of Gerdau Holdings Europa S.A. in Spain (the subsidiary which held Corporación Sidenor S.A.). The transaction value was € 155 million (equivalent to R$ 621 million on the completion of the sale).

 

In June 2006, Gerdau won the bid for 50% plus one share of the capital stock of Empresa Siderúrgica Del Perú S.A.A. (Siderperú) located in the city of Chimbote in Peru for US$ 60.6 million (R$ 134.9 million on the acquisition date). In November 2006, Gerdau also won the bid for 324,327,847 shares issued by Siderperú, which represented 33% of the total capital stock, for US$ 40.5 million, totaling US$ 101.1 million (R$ 219.8 million on the acquisition date). This acquisition added to the interest already acquired earlier in the year, for an interest of 83% of the capital stock of Siderperú.

 

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

 

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

 

In June 2007, Gerdau acquired 100% of the capital stock of Siderúrgica Zuliana C.A., a Venezuelan company operating a steel mill in the city of Ojeda, Venezuela. The total cost of the acquisition was US$ 92.5 million (R$ 176.2 million on the acquisition date).

 

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

 

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

 

In October 2007, Gerdau executed a letter of intent for the acquisition of a 49% interest in the capital stock of the holding company Corsa Controladora, S.A. de C.V., headquartered in Mexico City, Mexico. The holding company owns 100% of the capital stock of Aceros Corsa, S.A. de C.V. and its distributors. The acquisition price was US$ 110.7 million (R$ 186.3 million on the acquisition date). In February 2008, the Company announced the conclusion of this acquisition.

 

In November 2007, Gerdau entered into a binding agreement for the acquisition of the steel company MacSteel from Quanex Corporation. MacSteel operates three mini-mills located in Jackson, Michigan; Monroe, Michigan; and Fort Smith, Arkansas. The Company also operates six downstream operations in the states of Michigan, Ohio, Indiana and Wisconsin. The purchase price for this acquisition was US$1.5 billion (R$2.4 billion on the acquisition date) in addition to the assumption of their debts and some liabilities. Gerdau concluded the acquisition in April 2008.

 

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

 

22


Table of Contents

 

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

 

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

 

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

 

On March 30, 2018, the Company concluded the sale of its wire-rod production unit located in Beaumont, Texas and of the processing units, Beaumont Wire Products and Carrollton Wire Products, to Optimus Steel LLC for US$ 99.5 million (equivalent to R$ 330.7 million). The mill has a melt shop with annual steel production capacity of approximately 700,000 short tons and has the capacity to produce wire-rods and rebar.

 

On June 29, 2018, the Company concluded the sale of 100% of the shares of Aza Participações SpA and its subsidiaries, Gerdau AZA SA, Aceros Cox SA, Armacero - Matco SA and Salomon Sack S.A. through Gerdau Chile Inversiones Limitada, an indirect subsidiary of Gerdau S.A., to a group of Chilean investors formed by Ingeniería e Inversiones Limitada, Inversiones Reyosan SpA, Los Andes S.A. de Inversiones and Matco Cables SpA. This sale included three production plants with an annual installed capacity of 520,000 tonnes of recycled long steel and its distribution network in Chile. The transaction value corresponds to US$ 154.1 million (equivalent to R$ 594.2 million on the date of the conclusion of the sale).

 

On July 31, 2018, the Company concluded the sale of its two hydropower plants in Goiás for R$ 835 million to Kinross Brasil Mineração, a wholly-owned subsidiary of the mining company Kinross Gold Corporation. The plants Caçu and Barra dos Coqueiros, inaugurated in 2010, have aggregate installed capacity of 155 MW.

 

On September 14, 2018, the Company announced to the market that the Brazilian antitrust authority known as CADE approved, without restrictions, the creation of a new company to manage and promote a loyalty program for Brazil’s retail construction industry, called Juntos Somos +, jointly with Votorantim Cimentos and Grupo Tigre. The initiative functions like a benefits program for stores and respective vendors, with the aim of improving service to end customers and to construction industry professionals. Votorantim Cimentos, founder of the program in 2015, will have a 45% stake, while Gerdau and Grupo Tigre each have 27.5%.

 

On October 31, 2018, the Company concluded the sale of its interest in Gerdau Hungria KFT Y CIA Sociedad Regular Colectiva, a subsidiary of the Company located in Spain and the holder of 98.89% of the shares of Gerdau Steel India Ltd., to Blue Coral Investment Holdings Pte. Ltd and Mountainpeak Investment Holdings Ltd. This sale comprises 100% of its operations and assets in India, including the special steels industrial unit located in Tadipatri, with annual installed capacity of 250 thousand tonnes of crude steel and 300 thousand tonnes of rolled steel. The transaction value corresponds to US$ 120 million (equivalent to R$ 490.2 million on the signing date of the agreement).

 

On November 5, 2018, the Company concluded the sale to Commercial Metals Company (CMC) of four U.S. rebar mills and rebar fabrication locations. The sale includes the steel mills in Jacksonville, FL, Knoxville, TN, Rancho Cucamonga, CA, and Sayreville, NJ, as well as all of Gerdau’s U.S. rebar fabrication facilities. The transaction value is US$ 600 million (equivalent to R$ 2,222.9 million) as well as working capital adjustments.

 

B.                                    BUSINESS OVERVIEW

 

Steel Industry

 

The world steel industry is composed of hundreds of steel producing facilities and is divided into two major categories based on the production method utilized: integrated steel mills and non-integrated steel mills, sometimes referred to as “mini-mills”. Integrated steel mills normally produce steel from iron oxide, which is extracted from iron ore melted in blast furnaces, and refine the iron into steel, mainly through the use of basic oxygen furnaces or, more rarely, electric arc furnaces. Non-integrated steel mills produce steel by melting in electric arc furnaces scrap steel, which occasionally is complemented by other metals such as direct-reduced iron or hot-compressed iron. According to World Steel, in 2017 (the most recent year for which information is available), 28.0% of the total crude steel production in the world was through mini-mill process and the remaining 72.0% was through the integrated process.

 

23


Table of Contents

 

Crude Steel Production by Process in 2017*

 

 

 

Crude Steel
Production
(in million

 

Production by Process (%)

 

Blast Furnace

 

tonnes)

 

Mini-mill

 

Integrated

 

World

 

1,688

 

28.0

 

71.5

 

China

 

832

 

9.0

 

91.0

 

Japan

 

105

 

24.2

 

75.8

 

India

 

101

 

56.8

 

43.2

 

U.S.A.

 

82

 

68.4

 

31.6

 

Russia

 

71

 

30.8

 

66.9

 

S. Korea

 

71

 

32.9

 

67.1

 

Germany

 

44

 

28.8

 

71.2

 

Turkey

 

37

 

69.2

 

30.8

 

Brazil

 

34

 

21.0

 

77.6

 

 


Source: World Steel/World Steel In Figures

*Most recent year for which information available

 

Over the past 10 years, according to World Steel, total annual crude steel production has grown from 1,343 million tonnes in 2008 to a forecast of 1,789 million tonnes in 2018, for an average annual increase of 33.17%.

 

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

 

Over the past year, total annual crude steel production increased by 4.50% from 1,712 million tonnes in 2017 to 1,789 million tonnes in 2018.

 

Crude Steel Production (in million tonnes)

 

GRAPHIC

 

Source: World Steel/Annually Statistics

 

China is rebalancing its economy to move more towards a consumer-driven economy. GDP growth was aligned with the government expectation and despite the injection of credit into the construction and infrastructure sectors, the country showed a reduction in steel consumption for the third year in a row. In 2016, China’s crude steel production was 928.2 million tonnes, an increase of 12% compared to 2017. In 2017, China’s share of world steel production was 52% of world total crude steel.

 

24


Table of Contents

 

Crude Steel Production by Country in 2018 - forecast (million tonnes)

 

GRAPHIC

 

 

Source: World Steel/Annually Statistics

 

Asia produced 1,257.9 million tonnes of crude steel in 2018, an increase of 5.5% compared to 2017, and its share of world steel production amounted to 42.3%. The EU-28 produced 168.0 million tonnes of crude steel in 2018, a reduction of 0.3% compared to 2017, representing 9.4% of the global total. In 2018, crude steel production in North America increased 4.1% when compared to 2017, a total of 120.5 million tonnes. The CIS (Commonwealth of Independent States) showed a stable crude steel production with a total of 101.0 million tonnes in 2018.

 

The Brazilian Steel Industry

 

According World Steel Association, in 2018 Brazil was the world’s 9th largest producer of crude steel, with a production of 34.7 million tonnes, a 2.0% share of the world market and 78.4% of the total steel production in South America during the year.

 

Total sales of Brazilian steel products were 34.7 million tonnes in 2018, 34.3 million tonnes in 2017 and 31.3 million tonnes in 2016, exceeding domestic demand of 20.6 million tonnes in 2018, 19.2 million tonnes in 2017 and 18.4 million tonnes in 2016. In 2018, total steel sales in the domestic market increased 8.2% from 2017, going from 16.9 million tonnes to 18.3 million tonnes.

 

In 2018, the total of Brazilian steel products sales was 32.4 million tonnes. The breakdown of total sales was 69.6% or 22.5 million tonnes of flat steel products, formed by domestic sales of 11.2 million tonnes and exports of 11.4 million tonnes. The remaining 30.4% or 9.8 million tonnes represented sales of long steel products, which consisted of domestic sales of 7.1 million tonnes and exports of 2.7 million tonnes.

 

25


Table of Contents

 

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

 

GRAPHIC

 

 

Source: Instituto Aço Brasil

 

Domestic demand — Historically, the Brazilian steel industry has been affected by significant variations in domestic steel demand. Although domestic consumption varies in accordance with Gross Domestic Product (GDP), variations in steel consumption tend to be more accentuated than changes in the level of economic growth. In 2018, the Brazilian GDP increased by 1.0% and steel consumption increased by 7.3%.

 

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

 

In 2018, Brazilian steel exports totaled 14.1 million tonnes, representing 43.5% of total sales (domestic sales plus exports). Brazil has performed an important role in the world export market, principally as an exporter of semi-finished products (slabs, blooms and billets) for industrial use or for re-rolling into finished products. Brazilian exports of semi-finished products totaled 9.6 million tonnes in 2018, 9.4 million tonnes in 2017 and 7.8 million tonnes in 2016, representing 67.8%, 64.0% and 58.1% of Brazil’s total exports of steel products, respectively.

 

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

 

GRAPHIC

 

 

Source: Instituto Aço Brasil

 

Brazil used to be a small importer of steel products. Considering the reduction in the international steel prices during 2010, the appreciation of the Brazilian real against the U.S. dollar and the decrease in demand for steel products in developed countries, the Brazilian levels of imports increased from 2.3 million tonnes in 2009 to 5.9 million tonnes in 2010 (excluding the imports made by the steel mills to avoid double counting), representing 22.0% of apparent domestic consumption. In 2015, imports were 3.2 million tonnes, decreased to 1.9 million tonnes in 2016 and increased to 2.3 million tonnes in 2017. In 2018, imports represented 12.0% of apparent domestic consumption, an increase compared to 2017, which was mainly due to higher prices in the domestic market compared to the international market.

 

26


Table of Contents

 

Raw materials — One of Brazil’s major competitive advantages is the low cost of its raw materials. Brazil has an abundance of high quality iron ore. Various integrated producers are located in the state of Minas Gerais, where some of the world’s biggest iron ore mines are located. The cost of iron ore from small miners in Brazil is very competitive if compared to the cost of iron ore in China, for example.

 

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

 

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

 

North American Steel Industry

 

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

 

Crude Steel Production by North American Countries (million tonnes)

 

GRAPHIC

 

 

Source: World Steel/Monthly Statistics

 

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

 

In response to these conditions, in March 2002, Former President George W. Bush imposed a series of tariffs and quotas on certain imported steel products under Section 201 of the Trade Act of 1974.  These measures were intended to give the domestic steel industry an opportunity to strengthen its competitive position through restructuring and consolidation.  On November 10, 2003, the World Trade Organization (“WTO”) Appellate Body issued a ruling that upheld an initial WTO panel ruling that declared the Section 201 tariffs on steel imports to be in violation of WTO rules concerning safeguard measures.  On December 4, 2003, Former President Bush signed a proclamation terminating the steel safeguard tariffs, and announced that the tariffs had achieved their purpose and changed economic circumstances indicated it was time to terminate them.  International trade negotiations, such as the ongoing Organization for Economic Cooperation and Development steel subsidy agreement negotiations and the WTO Doha Round negotiations, may affect future international trade rules with respect to trade in steel products. More recently, in a White House signing ceremony on March 8, 2018, President Donald Trump announced he was imposing import tariffs of 25% on steel and 10% on aluminum. After invoking a rarely-used Cold War-era law last year, Commerce Secretary Wilbur Ross concluded imports were a threat, and he recommended the imposition of these new restrictions covering an estimated $46.1 billion of imports, or about 2% of total U.S. goods imports in 2017.

 

27


Table of Contents

 

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

 

The steel industry demonstrated strong performance through the middle of 2006, resulting from the increased global demand for steel related products and a continuing consolidation trend among steel producers. Beginning in the fall of 2008, the steel industry began feeling the negative effects of the severe economic downturn brought on by the credit crisis.  The economic downturn continued through 2009 and has resulted in a significant reduction in the production and shipment of steel products in North America, as well as reduced exports of steel products from the United States to other parts of the world. Since the beginning of 2010, the economy in North America has been showing signs of upturn, contributing to a gradual recovery in the steel industry, with an important improvement in the non-residential and automotive sector. The Company believes that this trend should continue throughout 2019.

 

Company Profile

 

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

 

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

 

Gerdau holds significant market share in the steel industries of almost all countries where it operates and was classified by World Steel Association as the world’s 18th largest steel producer based on its consolidated crude steel production in 2017, the most recent year for which information is available.

 

Gerdau operates steel mills that produce steel by direct iron-ore reduction (DRI) in blast furnaces and in electric arc furnaces (EAF). In Brazil it operates three integrated steel mills, including its largest mill, Ouro Branco, located in the state of Minas Gerais.  Gerdau currently has a total of 39 steel producing facilities globally.

 

As of December 31, 2018, Gerdau’s total consolidated installed annual capacity, excluding investments in joint ventures and associates companies, was approximately 20.3 million tonnes of crude steel and 16.8 million tonnes of rolled steel products. The Company had total consolidated assets of R$ 51.3 billion, shareholders’ equity (including non-controlling interests) of R$ 25.9 billion, consolidated net sales of R$ 46.2 billion and a total consolidated net income (including non-controlling interests) of R$ 2,326.4 million for the period ended on December 31, 2018.

 

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

 

A significant portion of Gerdau’s steel production assets are located outside Brazil, particularly in the United States and Canada, as well as in Latin America. Gerdau currently operates 14 steel production units in the United States, Canada and Mexico, and believes that it is one of the market leaders in North America in terms of production of certain long steel products, such as rebars, wire rods, commercial bars and beams.

 

Gerdau’s operating strategy is based on the acquisition and/or construction of steel mills located close to its customers and sources of the raw materials required for steel production, such as scrap metal, pig iron and iron ore.  For this reason, most of its

 

28


Table of Contents

 

production has historically been geared toward supplying the local markets in which it has production operations.  However, Gerdau also exports a substantial portion of its production to other countries.

 

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

 

Operations

 

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

 

29


Table of Contents

 

The Company manages its Business Segments as follows:

 

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

 

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

 

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

 

·                  Special Steel Business Segment - includes the special steel operations in Brazil and the United States.

 

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

 

Shipments

 

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

 

Year ended December 31,

 

(1,000 tonnes)

 

2018

 

2017

 

2016

 

TOTAL

 

14,560

 

14,938

 

15,558

 

Brazil

 

5,535

 

5,608

 

6,067

 

North America

 

6,085

 

6,313

 

5,965

 

South America

 

1,307

 

1,723

 

2,088

 

Special Steel

 

2,111

 

1,977

 

2,102

 

Eliminations and Adjustments

 

(479

)

(683

)

(665

)

 


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

 

Net Sales

 

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

 

Year ended December 31,

 

(R$ million)

 

2018

 

2017

 

2016

 

TOTAL

 

46,159

 

36,918

 

37,652

 

Brazil

 

15,745

 

12,563

 

11,635

 

North America

 

19,927

 

15,433

 

15,431

 

South America

 

3,801

 

4,026

 

4,776

 

Special Steel

 

8,159

 

6,229

 

6,885

 

Eliminations and Adjustments

 

(1,473

)

(1,333

)

(1,075

)

 


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

 

Production

 

Gerdau S.A. Consolidated

 

Year ended December 31,

 

annual production (1) (million tonnes)

 

2018

 

2017

 

2016

 

Crude Steel Production

 

15,344

 

16,120

 

15,677

 

Rolled Steel Production

 

13,749

 

14,047

 

13,616

 

Iron Ore Production

 

7,317

 

7,265

 

8,647

 

 


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

 

30


Table of Contents

 

Brazil Business Segment

 

Steel information

 

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

 

In the Brazil Business Segment, steel shipments decreased slightly in 2018 compared to 2017, due to the decline in exports. On the other hand, shipments in the domestic market grew, driven by demand from the retail construction and manufacturing industries.

 

In 2018, around 15% of the production sold in Brazil was distributed through Gerdau’s distribution channel, with stores throughout Brazil and downstream facilities serving a significant number of customers. Another important distribution channel is the independent distributors’ network, formed by points of sales to which Gerdau sells its products, giving it comprehensive national coverage.  Sales through its distribution network and to final industrial and construction consumers are made by Gerdau employees and authorized sales representatives working on commission. This Business Segment has annual crude steel installed capacity of 8.2 million tonnes and 6.7 million tonnes of finished steel products.

 

Iron ore information

 

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

 

North America Business Segment

 

The North America Business Segment has annual production capacity of 8.1 million tonnes of crude steel and 5.9 million tonnes of finished steel products. It has a vertically integrated network of 10 steel units, scrap recycling facilities and downstream operations. North America Business Segment’s products are generally sold to steel service centers, steel fabricators or directly to original equipment manufacturers for use in a variety of industries, including construction, automotive, mining, cellular and electrical transmission, metal construction fabrication and equipment fabrication. Most of the raw material feed stock for the mini-mill operations is recycled steel scrap.

 

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

 

Sales of finished products to U.S. and Canadian customers are centrally managed by sales office in Tampa, Florida. There is also a sales office in Selkirk, Manitoba for managing sales of special sections and one in Midlothian, Texas for managing sales of structural and merchant bar products. Metallurgical service representatives at the mills provide technical support to the sales group. Sales of the super light beam products are managed by sales representatives located at their respective facilities. Elevator guide rails are generally sold through a bidding process in which employees at Gerdau’s facilities work closely with customers to tailor product requirements, shipping schedules and prices.

 

The North America Business Segment 2018 shipments were on the level of 6.1 million tonnes. The North America Segment accounted for 43.2% of overall Gerdau sales volumes.

 

31


Table of Contents

 

South America Business Segment

 

The South America Business Segment comprises of five steel facilities, retail facilities, fab shops (including joint ventures and associate companies) and scrap processing facilities. The entire operation is focused on the respective domestic markets of each country, operating mini-mills facilities with annual manufacturing capacity of 1.7 million tonnes of crude steel and 1.0 million tonnes of finished steel products. The South American Business Segment accounted for 9.0% of overall Gerdau sales volumes, representing 1.3 million tonnes in 2018, a reduction of 24.1% when compared to 2017. The countries in the South America Business Segment are Argentina, Peru, Venezuela and Uruguay. Gerdau also operates in the markets of Colombia and Dominican Republic through joint ventures.

 

Special Steel Business Segment

 

The Special Steel Business Segment consists of the operations in Brazil (Charqueadas, Pindamonhangaba and Mogi das Cruzes) and the United States (Fort Smith, Jackson and Monroe). The segment produces special steels for engineering steel, tool steel and forged bars. To meet the needs of more demanding markets, this segment is constantly developing new products, such as high-resistance steels, clean steel, high temper steel, good machinability steel, among others.

 

In Brazil, Gerdau special steel units are located in the states of Rio Grande do Sul (Charqueadas) and São Paulo (Pindamonhangaba and Mogi das Cruzes). The special steel units in Brazil have aggregate annual production capacity of 1.4 million tonnes of crude steel and 1.8 million tonnes of rolled steel. The operation has over 300 clients that are located primarily in Brazil. However, it also exports products, primarily to South America, North America and Europe.

 

In North America, the Special Steel Segment is present in the United States, with three units located in Jackson (Michigan), Monroe (Michigan) and Fort Smith (Arkansas). The company also operates a downstream unit in Huntington (Indiana). The segment has annual installed production capacity of 1.4 million tonnes of crude steel and 1.5 million tonnes of rolled steel products, with a portfolio of more than 200 clients located mainly in the United States, Canada and Mexico.

 

The plants of this business segment have commercial and operational synergies.

 

Exports

 

In 2018, two factors marked the dynamics of the international steel market: the continued reduction in Chinese supply to the international market due to its domestic demand, despite the 6% growth in annual production in 2017 and 2018 (record 928 million tonnes), and the protectionist measures in major consumer markets, whose effects on prices became clearer in the last quarter of the year.

 

In the first half of the year, prices remained healthy, as expected, with no downward pressure given China’s weak presence in the market. In the second half of the year, the intensification of world trade protectionism and the political-economic discussions between China and the United States ended up pressuring prices and sparking pessimism in the market. Chinese exports of finished goods in 2018 decreased 8.1% to 69 million tonnes, according to specialized publications. In 2017, exports of finished products amounted to 75 million tonnes.

 

In addition to the continuous reduction in China’s presence in the international market, 2018 was marked by the intensification of protectionist trade measures. Examples include the consolidation of Section 232 in the United States, the temporary protectionist measures in the European Union and, on a broader spectrum, the trade war between China and the United States, whose effects were amplified in the last quarter of 2018.

 

In 2018, Gerdau’s Brazilian exports continued to focus on South and Central Americas, which accounted for 78% of exports, leveraged by supply from the group’s companies and joint ventures.

 

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

 

32


Table of Contents

 

Consolidated Exports of Gerdau
Brazil Business Segment, by

 

Fiscal Year ended December 31,

 

Destination (%)

 

2018

 

2017

 

2016

 

2015

 

2014

 

Total including shipments to subsidiaries (1,000 tonnes)

 

1,585

 

1,991

 

2,360

 

2,173

 

1,043

 

Africa

 

 

6

%

3

%

14

%

 

Central America

 

31

%

21

%

27

%

11

%

4

%

North America

 

7

%

11

%

22

%

22

%

46

%

South America

 

47

%

42

%

31

%

26

%

37

%

Asia

 

6

%

6

%

5

%

6

%

6

%

Europe

 

9

%

11

%

12

%

15

%

6

%

Middle East

 

 

2

%

1

%

7

%

 

 

Gerdau remains focused on serving strategic markets that contribute results to its operation, analyzing the impacts and opportunities arising from the volatile international political-economic scenario and consolidating the presence of its entire product portfolio in these markets in 2019.

 

Products

 

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

 

Semi-finished products (Billets, Blooms and Slabs)

 

The semi-finished products (billets, blooms and slabs) have relatively low added value compared to other steel products. Billets are bars from square sections of long steel that serve as inputs for the production of wire rod, rebars and merchant bars. They represent an important part of the products from the Ouro Branco mill. Blooms are used to manufacture products such as springs, forged parts, heavy structural shapes and seamless tubes. Slabs are used in the steel industry for the rolling of a broad range of flat rolled products, and mainly used to produce hot and cold rolled coils, heavy slabs, profiles and heavy plates.

 

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

 

Common Long Rolled Products

 

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

 

Drawn Products

 

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

 

Special Steel Products

 

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

 

Flat Products

 

The Ouro Branco unit produces cast slabs, which are rolled into flat products, such as hot-rolled steel coils and heavy plates. Gerdau also produces hot-rolled coils, which are sold in the domestic market, and heavy plates, which are sold in the domestic and export markets. The Company, through its distribution channel and direct sales, distributes these hot-rolled coils and heavy plates and resells flat steel products manufactured by other Brazilian steel products, which adds more value through additional processing at flat steel service centers.

 

33


Table of Contents

 

Iron Ore

 

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

 

The following table presents the main products and the contributions to net revenue and net income by Business Segment for the periods shown (consolidated):

 

 

 

Brazil(1)

 

North America

 

South America

 

Special Steel

 

Eliminations and
Adjustments

 

Products

 

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

 

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

 

Rebar, merchant bars and drawn
products.

 

Stainless steel, special profiles
and wire rod.

 

-

 

Year

 

2018

 

2017

 

2016

 

2018

 

2017

 

2016

 

2018

 

2017

 

2016

 

2018

 

2017

 

2016

 

2018

 

2017

 

2016

 

Net Sales (R$ million)

 

15,745.2

 

12,562.7

 

11,634.9

 

19,927.4

 

15,433.4

 

15,430.8

 

3,801.2

 

4,025.7

 

4,775.6

 

8,158.6

 

6,228.5

 

6,884.7

 

(1,472.9

)

(1,332.8

)

(1,074.3

)

% of Consolidated Net Sales

 

34.1

%

34.0

%

30.9

%

43.2

%

41.8

%

41.0

%

8.2

%

10.9

%

12.7

%

17.7

%

16.9

%

18.3

%

-3.2

%

-3.6

%

-2.9

%

Net (Loss) Income (R$ million)

 

1,247.6

 

302.3

 

(36.7

)

834.0

 

(956.3

)

(2,591.9

)

269.8

 

154.4

 

134.2

 

630.2

 

475.4

 

162.5

 

(655.2

)

(314.5

)

(554.1

)

% of Consolidated Net (Loss) Income

 

53.6

%

-89.3

%

1.3

%

35.8

%

282.4

%

89.8

%

11.6

%

-45.6

%

-4.7

%

27.1

%

-140.4

%

-5.6

%

-28.2

%

92.9

%

19.2

%

 

Production Process

 

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

 

Semi-integrated Process (Mini-mills)

 

The Company operates 27 mini-mills worldwide. Mini-mills are equipped primarily with electric arc furnaces that can melt steel scrap and produce steel product at the required specifications requested by customers. After loading the furnace with a preset mixture of raw material (i.e., steel scrap, pig iron and sponge iron), electric power is applied in accordance with a computer controlled melting profile. The Company’s mini-mill production process generally consists of the following steps: obtaining raw material, melting, casting, rolling and drawing. The basic difference between this process and the integrated mill production process described below is in the first processing phase, i.e., the steelmaking process. Mini-mills are smaller plants than integrated facilities and the Company believes they provide certain advantages over integrated mills, including:

 

·                  lower capital costs,

 

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

 

·                  proximity of production facilities to raw-material sources,

 

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

 

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

 

Integrated Process

 

Gerdau operates four integrated mills, three of which are located in Brazil and one in Peru. The Ouro Branco Mill is the largest integrated facility operated by the Company. It produces steel from pig iron from the blast furnace and has some of the advantages of a mini-mill, since it is located near key suppliers as well as the ports from which Gerdau exports most of its production.

 

Gerdau’s steel manufacturing process at integrated units consists of four basic stages: preparation of raw materials, production of pig iron, production of steel and production of semi-finished steel products (billets, blooms and slabs). In the primary stage of steelmaking, sinter (a mixture of iron ore and limestone), coke and other raw materials are consumed in the blast furnace to produce pig iron. Coke acts as both fuel and a reducing agent in this process. Gerdau’s blast furnaces have aggregate installed capacity of approximately 5.9 million tonnes of molten pig iron per year.

 

The pig iron produced is transported by rail to the desulphurization unit to reduce the steel’s sulfur content. After the desulphurization process, the low-sulfur pig iron is transformed into steel using LD-type oxygen converters. The LD steelmaking process utilizes molten pig iron and scrap to produce steel by blowing oxygen over the metallic charge inside the converters. The process does

 

34


Table of Contents

 

not require any external source of energy, which is fully supplied by the chemical reactions occurring between oxygen and the impurities in the molten pig iron. The LD steelmaking process is currently the most widely used in the world. Some mills further refine the LD converters’ output with ladle furnaces and outgassing process.

 

Liquid steel is then sent to the continuous casting equipment, where it is solidified into billets, blooms or slabs. These products may be sold to clients directly, be transferred to other Gerdau Units for transformation or be used in the production of finished rolled steel products at the integrated units. Gerdau’s integrated units in Brazil have rolling mills for rebars, bars and profiles, wire-rod, structural shapes, hot-rolled coils and heavy plates.

 

Logistics

 

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

 

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

 

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

 

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

 

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

 

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

 

Competition

 

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

 

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

 

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

 

35


Table of Contents

 

The Company produces special and stainless steel used in tools and machinery, chains, fasteners, railroad spikes, special coil steel, grader blades, smelter bars, light rails, super light I-beams, elevator guide rails and other products that are made on demand for the Company’s customers at its special steel units in Brazil and United States.

 

Competitive Position — Brazil

 

The Brazilian steel market is very competitive. In the year ended December 31, 2018, ArcelorMittal Brasil and the Company were the two largest Brazilian crude steel producers, according to the Brazilian Steel Institute (IABr - Instituto Aço Brasil).

 

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

 

In the domestic market, Gerdau is almost an exclusive supplier of blooms and billets to well-defined and loyal customers that have been purchasing from it regularly for over 15 years. Intense competition exists between the Company and ArcelorMittal in the slab and wire rod markets. With respect to the rebar market, competition in the Brazilian domestic market has increased in recent years due to two new entrants (Simec and Silat) and Companhia Siderurgica Nacional (CSN), which started rebar production.

 

Competitive Position — Outside Brazil

 

Outside Brazil, notably in North America, the Company has increased its market share through acquisitions, and believes it is the second largest mini-mill steel producer in North America, with annual nominal capacity of 8.9 million tonnes of crude steel and 6.9 million tonnes of rolled products.

 

Gerdau’s geographic market in North America encompasses primarily the United States and Canada. The Company faces substantial competition in the sale of each of its products from numerous competitors in its markets. Rebar, merchant bars and structural shapes are commodity steel products for which pricing is the primary competitive factor. Due to the high cost of freight relative to the value of steel products, competition from non-regional producers is somewhat limited. Proximity of product inventories to customers, combined with competitive freight costs and low-cost manufacturing processes, are key to maintaining margins on rebar and merchant bar products. Rebar deliveries are generally concentrated within a 350-mile radius of the mini-mills and merchant bar deliveries are generally concentrated within a 500-mile radius. Some products produced by the Selkirk, Midlothian, Jackson, Cartersville and Petersburg mini-mills are shipped greater distances, including overseas.

 

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

 

In South America, each country has a specific competitive position that depends on conditions in their respective markets. Most compete domestically and face significant competition from imports. More than 70% of shipments from Gerdau’s South American Operation originate from Chile, Peru and Colombia. In this market, the main barriers faced by Gerdau sales are freight and transportation costs and the availability of imports. The main products sold in the South American market are the constructions, mechanic, agriculture and mining markets.

 

Currently, the Company believes the special steel operations in United States are approximately 19.8% of the special steel market; in Brazil, Gerdau’s special steel units are combined the biggest player in that market, with a stake of approximately 60.6%.

 

Business Cyclicality and Seasonality

 

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

 

36


Table of Contents

 

the second quarter of 2008 and especially in early 2009, the United States and other European economies showed strong signs of a slowdown, which in turn affected many other countries. Over the past few years, developing economies have shown signs of a gradual recovery, while developed economies still present a challenging demand scenario. The Company believes that, in 2019, the steel industry will remain challenging and continue to present volatility, but the projection is that steel consumption will grow 1.4% compared to 2018.

 

In Gerdau’s Brazilian and South American operations, shipments in the second and third quarters of the year tend to be stronger than in the first and fourth quarters, given the reduction in construction activity. In Gerdau’s North American operations, demand is influenced by winter conditions, when consumption of electricity and other energy sources (i.e., natural gas) for heating increases and may be exacerbated by adverse weather conditions, contributing to increased costs and decreased construction activity, and in turn leading to lower shipments.

 

Information on the Extent of the Company’s Dependence

 

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

 

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

 

In the case of a power outage, there are no alternative supply options available at most Gerdau mills due to the high volume and tension required for the operation of these plants. Some Gerdau small plants may choose, as an alternative, to use generators to compensate for the energy shortage. Moreover, the Ouro Branco mill generates 70% of its power needs internally using gases generated in the steel-making process.

 

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

 

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

 

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

 

Production Inputs

 

Price volatility

 

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

 

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

 

Brazil and Special Steel Business Segment — The Company’s Brazilian mills use scrap and pig iron purchased from local suppliers. Due to the nature of the raw materials used in its processes, Gerdau has contracts with scrap generators, especially scrap from industrial sources, for its mini-mills in Brazil, acquiring scrap as necessary for the mills’ needs. Scrap for the Brazilian Operation is priced in Brazilian reais, thus input prices are not directly affected by currency fluctuations.

 

Due to its size, the Ouro Branco mill has developed over the last few years a strategy to diversify its raw materials, which are supplied through various types of contracts and from multiple sources, which include: (i) coking coals imported from Colombia, United States, Canada, Russia, Australia and Peru as well as petroleum coke purchased from Petrobrás and charcoal chaff also acquired from other domestic suppliers; (ii) ferroalloys, of which 78% are purchased

 

37


Table of Contents

 

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

 

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

 

South America Business Segment — The main input used by the Company’s mills in South America is ferrous scrap. This operation is exposed to market fluctuations, varying its prices according to each local market.

 

Ferrous Scrap

 

There are two broad categories of ferrous scrap: (i) obsolete scrap, which is steel from various sources, ranging from cans to car bodies and white goods; and (ii) industrial scrap, which is composed of scrap from manufacturing processes, essentially steel bushings and flashings, steel turnings and even scrap generated by production processes at steel producers, such as Gerdau. In Brazil, the use of scrap in electric arc furnaces varies between scrap from obsolescence and industrial scrap. Special Steel mills mainly use industrial scrap.

 

In 2018, Gerdau consumed more than 12 million tonnes of scrap. Because ferrous scrap is one of its main raw materials in steel production, Gerdau is dedicated to improving its supply chain in various countries, aiming to develop and integrate micro and small suppliers into the Company’s business. In Brazil, the main part of the scrap consumed by the Company comes from small scrap collectors who sell all their material to Gerdau, which provides a direct supply at more competitive costs for the Company. In North America, although smaller, the number is still significant, ensuring the competitiveness of the business in the region.

 

Brazil and Special Steel Business Segments — The price of steel scrap in Brazil varies by region and reflects local supply, demand and transportation costs. The Southeast is the country’s most industrialized region and generates the highest volume of scrap. Due to the high concentration of players in this region, competition is more intense.

 

Gerdau has six scrap shredders, including a mega-shredder at the Cosigua mill in Rio de Janeiro, with capacity to process scrap in volumes superior to 200 carcasses of vehicles per hour.

 

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

 

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

 

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

 

Pig Iron and Sponge Iron

 

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

 

North America Business Segment The availability of scrap plays an important role for operations in North America. Sponge iron and pig iron are used in limited quantities only for the production of steels with particular characteristics.

 

38


Table of Contents

 

Iron Ore

 

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

 

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

 

Iron ore consumption in Gerdau mills in Brazil amounted to 7.8 million tonnes in 2018, partially supplied by mining companies adjacent to the steel plants and partially supplied by Gerdau’s mines.

 

Other Inputs

 

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

 

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

 

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

 

Energy Requirements

 

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

 

In Brazil, electricity is currently supplied to the Company’s industrial units under two types of contracts:

 

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

 

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

 

The Company, in 2018, held the following power generation concessions in Brazil:

 

·                  Dona Francisca Energética S.A. (DFESA) operates a hydroelectric power plant with nominal capacity of 125 MW located between Nova Palma and Agudo, Rio Grande do Sul State (Brazil). Its corporate purpose is to operate, maintain and maximize use of the energy potential of the Dona Francisca Hydroelectric Plant. DFESA participates in a consortium (Consórcio Dona Francisca) with the state power utility Companhia Estadual de Energia Elétrica (CEEE). The

 

39


Table of Contents

 

shareholders of DFESA are Gerdau S.A. (51.82%), COPEL Participações S.A (23.03%), Celesc (23.03%), and Statkraft (2.12%).

 

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

 

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

 

The supply of natural gas to all Brazilian units is regulated and performed under long-term contracts. The Barão de Cocais and Divinópolis units do not have access to natural gas supplies.

 

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

 

In Uruguay, electricity is purchased under agreements that are renewed automatically on an annual basis from the state-owned utility UTE.  Natural gas is purchased from Montevideo Gas with prices set by the Argentinean export tariff agreement (fuel oil as substitute). During 2018, the plant operated mostly on fuel oil, due to competitive reasons.

 

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

 

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

 

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

 

Technology and Quality Management

 

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

 

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

 

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

 

Due to the specialized nature of its business, the Gerdau special steel mills are constantly investing in technological upgrading and in research and development. These mills are active in the automotive segment and maintain a technology department (Research and Development) responsible for new products and the optimization of existing processes.

 

International machinery manufacturers and steel technology companies supply most of the sophisticated production equipment that Gerdau uses. These suppliers generally sign technology transfer agreements with the purchaser and provide extensive technical support and staff training for the installation and commissioning of the equipment. Gerdau has technology transfer and benchmarking agreements with worldwide recognized performance companies.

 

40


Table of Contents

 

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

 

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

 

Sales Terms and Credit Policy

 

The Company’s Brazilian sales are usually made on a 21/28-day settlement CIF (Cost, Insurance and Freight) basis. Comercial Gerdau, the retail arm of Gerdau in Brazil, sells on an approximately 34 day settlement basis, mainly CIF. Brazilian customers are subject to a credit approval process. The concession of credit limits is controlled by a corporate-level system (ECC) that can be accessed by all sales channels. The credit and collection department is responsible for evaluating, determining and monitoring credit in accordance with the credit limit policy. This policy includes the active participation of staff from the various sales channels. At Comercial Gerdau, in particular, the criteria for retail sales also include practices such as the use of credit card services. Gerdau exports are guaranteed via letters of credit and/or pre-payment before the product is shipped. Exports to Gerdau’s subsidiaries may be sold on credit at market interest rates.

 

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

 

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

 

The Company’s provision for doubtful accounts has been at low levels. On December 31, 2018, provision for doubtful accounts was 4.7% based on gross account receivables per Note 5 to the Consolidated Financial Statements, compared to 4.5% on December 31, 2017 and 5.3% on December 31, 2016. Gerdau has improved its credit approval controls and enhanced the reliability of its sales process through the use of risk indicators and internal controls.

 

Insurance

 

The Company maintains insurance coverage in amounts that it believes suitable to cover the main risks of its operating activities. The Company has purchased insurance for its integrated mill Ouro Branco to insure against operating losses, which covers assets of approximately US$ 5 billion (R$19 billion as of April 30, 2018), including material damage to installations (US$4.6 billion) and losses of gross revenues (US$471 million), such as halts in production due to business interruptions caused by accidents for a period up to twelve months. The Company’s current insurance policy relating to the Ouro Branco mill remains effective until April 30, 2019. The Company’s mini-mills are also covered under insurance policies which insure against certain operational losses resulting from business interruptions.

 

Trade Investigations and Government Protectionism

 

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

 

Material effects of government regulation on the Company’s activities

 

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

 

Gerdau’s mining operation in Brazil are subject to the rules of the Brazilian Mining Code and its regulation (Decree-Law 227, of February 28, 1967 and Decree 9,406, of June 12, 2018) and to the applicable mining legislation, with mining exploration governed by Mining Property Rights and Concessions.

 

Gerdau acquired the surface of the properties located in the polygon of the respective mining rights, as well as all other Mining Property Rights and Concessions, under an Agreement for the Sale of Assets and Assignment of Rights entered into by and between

 

41


Table of Contents

 

Gerdau Açominas S.A. and Companhia Paraibunas de Metais, Siderúrgica Barra Mansa S.A., Votorantim Metais Ltda., and Votorantim International Holding N.V., on May 19, 2004.

 

The Company’s mining exploration activities are subject to the conditions and limitations imposed by the Federal Constitution of Brazil, the Brazilian Mining Code and related laws and regulations, which include requirements connected to, among other factors, how mineral deposits are used, occupational safety and health, environmental protection and restoration, pollution prevention and the health and safety of the local communities where the mines are located. The Brazilian Mining Code also establishes some requirements for the submission of notifications and information.

 

Companies authorized to economically explore mineral resources are required to pay royalties to the Federal Government, which distributes most of them to States and Municipalities. On July 26, 2017, Provisional Presidential Decree 789/17 was published, which was later converted into Federal Law 13,540/17, amending Federal Laws 7,990/89 and 8,001/90, which provide for the Financial Compensation for Exploration of Mineral Resources (CFEM). The structure for the charging of royalties was changed to the following:

 

1) TRIGGERING EVENT: the exploration of mineral resources will trigger the payment of CFEM upon:

 

·                  the first sale of mineral asset (already mined mineral substance after its processing, if applicable);

 

·                  the sale at auction, in the case of mineral assets acquired via judicial sale;

 

·                  the first acquisition of mineral assets extracted under the system of mining permission (lavra garimpeira);

 

·                  the consumption of mineral asset (use of mineral assets in a process that entails obtaining a new type of ore or its transformation into another product type).

 

2) CALCULATION BASE

 

·                  in the case of sales, calculated based on gross sales revenue, less any taxes levied, with deductions for freight and insurance expenses prohibited;

 

·                  in the case of consumption, calculated based on the current price of the mineral asset in the market or the price reference, as defined by the regulatory agency of the mining sector. Since iron ore does not appear in the absolute list of the National Mineral Production Department (DNPM) Ordinance 239/2018, it is subject to the “current price” calculation base when transformed into another type of product, such as pig iron.

 

·                  in the case of exports, even for transactions in the free market (sales to third parties/unrelated third parties) and exports to companies not located in tax havens, the calculation base is the greater of the price reference defined by the Federal Revenue Department (PECEX method) and the export value;

 

·                  in the case of mineral assets acquired via judicial sale, calculated based on the value of the sale at auction;

 

·                  in the case of extraction under the system of mining permission (lavra garimpeira), calculated based on the value of the first acquisition of the mineral asset;

 

Financial compensation (CFEM) may or may not have to be paid on sales among companies of the same business group; Federal Law 13,540/17 does not establish any criteria for such.

 

For mineral assets shipped to another establishment of the same owner, for subsequent sale, even if subject to processing, the calculation base is the price charged in the final sale.

 

3) RATES: effective 11/1/2017

 

a) Rates of mineral substances:

 

RATE

 

MINERAL SUBSTANCE

(VETOED)

 

(VETOED)

one percent (1%)

 

Rocks, sand, gravel, red clay and other mineral substances intended for immediate use in construction; ornamental rocks; mineral and thermal water

one point five percent (1.5%)

 

Gold

two percent (2%)

 

Diamond and other mineral substances

three percent (3%)

 

Bauxite, manganese, niobium and rock salt

three point five percent (3.5%)

 

Iron, subject to letters b and c of this Appendix

 

42


Table of Contents

 

For iron ore, the rate is fixed at 3.5%, which represents an increase compared to the previous rate, which was fixed at 2%. In this case, upon a justified need, the regulatory entity of the mining sector could exceptionally reduce the iron compensation rate from 3.5% to as low as 2% in order to not adversely affect the economic feasibility of deposits with low performance and profitability due to the iron content, production scale, payment of taxes and number of employees.

 

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

 

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

 

The Rate for Inspection of Mining Activities (TFAM), which the Executive Branch intended to create along with ANM, was not approved by the National Congress.

 

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

 

The mining rights held by Gerdau cover 8,837.19 hectares, and the concessions are valid until the mining deposits are exhausted, provided the legal requirements are fulfilled annually. The table below lists the DNPM processes referring to the mining rights held by Gerdau:

 

DNPM Process

 

City

 

Location / Mine / Project

 

State

1.978/1935

 

BARÃO DE COCAIS

 

GONGO SOCO

 

MG

724/1942

 

OURO PRETO / OURO BRANCO

 

MORRO GABRIEL

 

MG

4.575/1935

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

3.613/1948

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

5.303/1948

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

5.514/1956

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

5.975/1956

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

6.549/1950

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

930.600/2009

 

OURO  PRETO

 

GM MIGUEL BURNIER

 

MG

3.583/1957

 

ITABIRITO / MOEDA

 

VÁRZEA DO LOPES

 

MG

3.584/1957

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

3.585/1957

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

8.141/1958

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

6.255/1960

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

317/1961

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

5.945/1961

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

932.705/2011

 

ITABIRITO

 

GM VÁRZEA DO LOPES

 

MG

833.209/2006

 

OURO  PRETO / OURO BRANCO

 

DOM  BOSCO

 

MG

832.090/2005

 

OURO  PRETO / OURO BRANCO

 

DOM  BOSCO

 

MG

832.044/2006

 

OURO  BRANCO

 

DOM  BOSCO

 

MG

830.158/2007

 

OURO PRETO

 

DOM  BOSCO

 

MG

830.159/2007

 

OURO PRETO

 

DOM  BOSCO

 

MG

830.160/2007

 

OURO PRETO

 

DOM  BOSCO

 

MG

831.640/2003

 

OURO PRETO

 

DOM  BOSCO

 

MG

830.475/2007

 

OURO PRETO

 

DOM  BOSCO

 

MG

832.620/2006

 

OURO  PRETO

 

MIGUEL BURNIER

 

MG

830.798/2013

 

OURO PRETO

 

MIGUEL BURNIER

 

MG

832.377/2014

 

OURO PRETO

 

MIGUEL BURNIER

 

MG

832.375/2014

 

OURO PRETO

 

MIGUEL BURNIER

 

MG

833.018/2015

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

832.625/2016

 

ITABIRITO

 

VÁRZEA DO LOPES

 

MG

 

43


Table of Contents

 

C.                                    ORGANIZATIONAL STRUCTURE

 

The Company’s operational structure (including its main operating subsidiaries engaged in steel production) on December 31, 2018 is below:

 

GRAPHIC

 

44


Table of Contents

 

The table below lists the significant consolidated subsidiaries of Gerdau on December 31, 2018, 2017 and 2016:

 

 

 

 

 

Equity Interests

 

 

 

 

 

Total capital (*)

 

Consolidated company

 

Country

 

2018

 

2017

 

2016

 

Gerdau GTL Spain S.L.

 

Spain

 

100.00

 

100.00

 

100.00

 

Gerdau Internacional Empreendimentos Ltda. - Grupo Gerdau

 

Brazil

 

100.00

 

100.00

 

100.00

 

Gerdau Ameristeel Corporation and subsidiaries (1)

 

USA/Canada

 

100.00

 

100.00

 

100.00

 

Gerdau Açominas S.A. and subsidiary (2)

 

Brazil

 

99.83

 

99.36

 

99.35

 

Gerdau Aços Longos S.A. and subsidiary (3)

 

Brazil

 

99.78

 

99.12

 

99.11

 

Gerdau Steel Inc.

 

Canada

 

100.00

 

100.00

 

100.00

 

Gerdau Holdings Inc. and subsidiary (4)

 

USA

 

100.00

 

100.00

 

100.00

 

Paraopeba - Fixed-income investment fund (5) (**)

 

Brazil

 

91.40

 

10.69

 

70.93

 

Gerdau América Latina Participações S.A.

 

Brazil

 

 

 

99.12

 

Aza Participaciones S.A.

 

Chile

 

 

100.00

 

100.00

 

Gerdau Aços Especiais S.A.

 

Brazil

 

 

 

99.55

 

Gerdau Hungria Holdings Limited Liability Company

 

Hungary

 

100.00

 

100.00

 

100.00

 

GTL Equity Investments Corp.

 

British Virgin Islands

 

100.00

 

100.00

 

100.00

 

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

 

Peru

 

90.03

 

90.03

 

90.03

 

Diaco S.A. and subsidiary (6)

 

Colombia

 

 

 

99.68

 

Gerdau GTL México, S.A. de C.V. and subsidiaries (7)

 

Mexico

 

100.00

 

100.00

 

100.00

 

Seiva S.A. - Florestas e Indústrias

 

Brazil

 

97.73

 

97.73

 

97.73

 

Itaguaí Com. Imp. e Exp. Ltda.

 

Brazil

 

 

 

100.00

 

Gerdau Laisa S.A.

 

Uruguai

 

100.00

 

100.00

 

100.00

 

Sipar Gerdau Inversiones S.A.

 

Argentina

 

99.99

 

99.99

 

99.99

 

Sipar Aceros S.A. and subsidiary (8)

 

Argentina

 

99.98

 

99.98

 

99.96

 

Sizuca - Siderúrgica Zuliana, C. A.

 

Venezuela

 

100.00

 

100.00

 

100.00

 

GTL Trade Finance Inc.

 

British Virgin Islands

 

100.00

 

100.00

 

100.00

 

Gerdau Trade Inc.

 

British Virgin Islands

 

100.00

 

100.00

 

100.00

 

Gerdau Steel India Ltd.

 

India

 

 

98.90

 

98.90

 

 


(*) The voting capital is substantially equal to the total capital. The interests reported represent the ownership percentage held directly and indirectly in the subsidiary.

(**) The percentage of participation including interest of the parent company Metalúrgica Gerdau S.A. in the investment fund is 98.60% in 2018, 51.11% in 2017 and 91.58% in 2016.

(1) Subsidiaries: Gerdau Ameristeel US Inc., Gerdau Ameristeel Sayreville Inc., Chaparral Steel Company.

(2) Subsidiary: G2L Logistica Ltda.

(3) Subsidiary: Gerdau Açominas Overseas Ltd.

(4) Subsidiary: Gerdau MacSteel Inc.

(5) Fixed-income investment fund managed by Bank JP Morgan S.A..

(6) Subsidiary: Cyrgo S.A.

(7) Subsidiary: Sidertul S.A. de C.V. and GTL Servicios Administrativos México, S.A. de C.V..

(8) Subsidiary: Siderco S.A.

 

The Company’s investments in 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 Gerdau Metaldom Corp. in the Dominican Republic in which the Company owns a 45% stake, the investment in Corsa Controladora, S.A. de C.V. in Mexico, in which Gerdau has a 49% stake, the investment in Corsa Controladora, S.A.P.I de C.V. in Mexico, in which Gerdau has a 50% stake, the investment in Dona Francisca Energética S.A, in Brazil, in which the Company holds a 51.82%, investment in Gerdau Summit Aços Fundidos e Forjados S.A., in Brazil, in which Gerdau has a 58.73% stake, the investment in Diaco S.A. in Colombia, which Gerdau has a 49.87%, and the investment in Juntos Somos Mais Fidelização S.A., in Brazil, in which Gerdau has a 27.50% stake are accounted in the Company’s financial statements using the equity method (for further information, see Note 3 — Consolidated Financial Statements).

 

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:

 

45


Table of Contents

 

Gerdau Aços Longos S.A. — This company produces common long steel and has nine mills distributed throughout Brazil and an annual installed capacity of 4.7 million tonnes of crude steel. This company also sells general steel products and has steel distribution centers located throughout Brazil.

 

Gerdau Açominas S.A. — Gerdau Açominas owns the mill located in the state of Minas Gerais, Brazil. The Ouro Branco mill is Gerdau’s largest unit, with an annual installed capacity of 4.5 million tonnes of crude steel, accounting for 48.8% of Gerdau’s crude steel output in the Brazil Business Segment.

 

Gerdau Ameristeel Corporation — Gerdau Ameristeel has an annual capacity of 7.4 million tonnes of crude steel and 5.3 million tonnes of rolled products. The Company is one of the largest producers of long steel in North America.

 

Gerdau MacSteel Inc. — This company is the largest special steel producer in U.S., has three units and a combined annual production capacity of 1.5 million tonnes of crude steel and 1.5 million tonnes of rolled products.

 

Gerdau Laisa S.A. — In 1980, the Company acquired the Laisa mini-mill in Uruguay. Gerdau Laisa is the one of largest long steel producers in Uruguay and has annual installed capacity of 100,000 tonnes of crude steel and 90,000 tonnes of rolled products.

 

Sipar Gerdau Inversiones S.A. — Sipar Gerdau Inversiones, through its operational subsidiary Sipar Aceros S.A., entered the Argentinean market in December 1997 and has annual installed capacity of 650,000 tonnes of crude steel and 263,000 tonnes of rolled products.

 

Empresa Siderúrgica del Perú S.A.A. — Acquired in 2006, this company is a long steel producer with annual installed capacity of 720,000 tonnes of crude steel and 573,000 tonnes of rolled steel.

 

Gerdau GTL México, S.A. de C.V. — The subsidiary of this company is a long steel producer located in the metropolitan area of Mexico City with annual installed capacity of 500,000 tonnes of crude steel and 400,000 tonnes of rolled products.

 

Sizuca - Siderúrgica Zuliana, C. A. — In June 2007, Gerdau acquired Sizuca - Siderúrgica Zuliana, which is located in Ciudad Ojeda, Venezuela. Sizuca owns a mini-mill that produces concrete reinforcement bars. Sizuca has an annual installed capacity of 250,000 tonnes of crude steel and 170,000 tonnes of rolled products.

 

Corsa Controladora, S.A. de C.V. In 2008, the Company acquired a 49% stake in Corsa Controladora, S.A. de C.V. (Mexico). Corsa Controladora owns 100% of the capital of Aceros Corsa, S.A. de C.V. and its distributors. Located in the metropolitan area of Mexico City, Corsa is a mini-mill that produces long steel (light merchant bars).

 

Multisteel Business Holdings In 2014, the Company completed the merger of its associate Multisteel Business Holdings Corp. with the Dominican company Metaldom, originating the joint venture Gerdau Metaldom Corp., which will produce long and flat steel for the areas of civil construction, industrial and agricultural, and also scrap processing operations and PVC pipes, with over one million tons/year of installed capacity. As a result of the merger, the Company has contributed its interest of 79.97% on the associate Multisteel Business Holdings Corp. into the newly formed entity Gerdau Metaldom, in exchange of 50% interest on Gerdau Metaldom Corp. This transaction was recorded on fair value basis, which was substantially equivalent to the book value of the previous investment.

 

Gerdau Summit Aços Fundidos e Forjados S.A. - Gerdau Summit Aços Fundidos e Forjados S.A. - On January 5, 2017, the Gerdau S.A. subscribed capital stock in Gerdau Summit Aços Fundidos e Forjados S.A. through the contribution of some of its assests and liabilities, which were valued by specialized independent evaluation firm. Gerdau Summit Aços Fundidos e Forjados S.A. have accounting treatment of a joint venture in the Financial Statements of Gerdau S.A., with a 58.73% interest.

 

Diaco S.A. - On June 30, 2017, the Company concluded the operation to create a joint venture, based on the sale of 50% interest in Diaco S.A., in Colombia, to Putney Capital Management. The new company’s assets are Gerdau’s long-steel industrial units in

 

46


Table of Contents

 

Colombia, with an annual installed steel capacity of 674 thousand tons. Due to this transaction, Diaco started to have accounting treatment of joint venture in Consolidated Financial Statements with a 49.87% interest.

 

D.            PROPERTY, PLANT AND EQUIPMENT

 

Facilities

 

Gerdau’s principal properties are for the production of steel, rolled products and drawn products. The following is a list of the locations, capacities and types of facilities, as well as the types of products manufactured at December 31, 2018:

 

 

 

LOCATION

 

INSTALLED CAPACITY
(1,000 tonnes)

 

 

 

 

PLANTS

 

COUNTRY

 

STATE

 

PIG
IRON/
SPONGE
IRON

 

CRUDE
STEEL

 

ROLLED
PRODUCTS

 

EQUIPMENT

 

PRODUCTS

BRAZIL OPERATION

 

 

 

 

 

5,252

 

9,229

 

7,090

 

 

 

 

Açonorte

 

Brazil

 

PE

 

 

265

 

242

 

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

 

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

Barão de Cocais

 

Brazil

 

MG

 

330

 

330

 

196

 

Integrated/blast furnace, LD converter and rolling mill

 

Merchant bars

Cearense

 

Brazil

 

CE

 

 

198

 

161

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

Cosigua

 

Brazil

 

RJ

 

 

932

 

1,414

 

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

 

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

Divinópolis

 

Brazil

 

MG

 

430

 

570

 

460

 

Integrated/blast furnace, EOF converter and rolling mill

 

Rebar and merchant bars

Guaíra

 

Brazil

 

PR

 

 

540*

 

 

EAF mini-mill

 

Billet

Riograndense

 

Brazil

 

RS

 

 

450

 

495

 

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

 

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

Usiba

 

Brazil

 

BA

 

 

495*

 

397*

 

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

 

Rebar, merchant bars, wire rod and drawn products

São Paulo

 

Brazil

 

SP

 

 

950

 

600

 

EAF mini-mill, rolling mill

 

Billets, rebars and coil rebar

Contagem

 

Brazil

 

MG

 

 

 

 

Blast furnace

 

Pig iron

Sete Lagoas

 

Brazil

 

MG

 

132

 

 

 

Blast furnace

 

Pig iron

Ouro Branco

 

Brazil

 

MG

 

4,360

 

4,500

 

3,126

 

Integrated with blast furnace, LD converter and rolling mills

 

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

NORTH AMERICA OPERATION

 

 

 

 

 

 

7,872

 

5,733

 

 

 

 

Mexico

 

Mexico

 

 

 

500

 

400

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars and beams

Cambridge

 

Canada

 

ON

 

 

330*

 

278

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars

Cartersville

 

USA

 

GA

 

 

925

 

610

 

EAF mini-mill, rolling mill

 

Merchant bars, structural shapes, beams

Charlotte

 

USA

 

NC

 

 

468

 

316

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars

 

47


Table of Contents

 

 

 

LOCATION

 

INSTALLED CAPACITY
(1,000 tonnes)

 

 

 

 

PLANTS

 

COUNTRY

 

STATE

 

PIG
IRON/
SPONGE
IRON

 

CRUDE
STEEL

 

ROLLED
PRODUCTS

 

EQUIPMENT

 

PRODUCTS

Jackson

 

USA

 

TN

 

 

764

 

496

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars

Manitoba - MRM

 

Canada

 

MB

 

 

394

 

271

 

EAF mini-mill, rolling mill

 

Special sections, merchant bars, rebar

St. Paul

 

USA

 

MN

 

 

502

 

455

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars, special bars (SBQ) and round bars

Whitby

 

Canada

 

ON

 

 

949

 

775

 

EAF mini-mill, rolling mill

 

Structural shapes, rebar, merchant bars

Wilton

 

USA

 

IA

 

 

322

 

245

 

EAF mini-mill, rolling mill

 

Rebar and merchant bars

Midlothian

 

USA

 

TX

 

 

1,753

 

1,411

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars and beams

Petersburg

 

USA

 

VA

 

 

965

 

476

 

EAF mini-mill, rolling mill

 

Merchant bars and beams

SOUTH AMERICA OPERATION

 

 

 

 

 

400

 

1,720

 

1,096

 

 

 

 

Uruguay

 

Uruguay

 

 

 

100

 

90

 

EAF mini-mill, rolling mill

 

Rebar, merchant bars and mesh

Argentina

 

Argentina

 

 

 

650

 

263

 

EAF mini-mill, rolling mill, drawing mill

 

Rebar, merchant bars and mesh

Peru

 

Peru

 

 

400

 

720

 

573

 

Blast Furnace, EAF mini-mill, rolling mill

 

Rebar and merchant bars

Venezuela

 

Venezuela

 

 

 

250

 

170

 

EAF mini-mill, rolling mill

 

Rebar

SPECIAL STEEL OPERATION

 

 

 

 

 

 

 

2,875