*In this report, “Gerdau Ameristeel” and “Company” refer toGerdau Ameristeel Corporation and its subsidiaries and 50% owned jointventures. This report contains forward-looking information with respect to ouroperations and future financial results. Actual results may differ fromexpected results for a variety of reasons including the factors discussed inthe Management’s Discussion and Analysis section of Gerdau Ameristeel’s 2002Annual Report. The following discussion and analysis should be read inconjunction with the consolidated statements and the accompanying notescontained in that report.*
**MANAGEMENT’S DISCUSSION AND ANALYSIS**
Gerdau Ameristeel’s financial results are presented in United States dollarsand in accordance with Canadian generally accepted accounting principles(“GAAP”). Management believes EBITDA (earnings before interest, taxes,depreciation and amortization), a non-GAAP measure, is a useful supplementalmeasure of cash available prior to debt service, capital expenditures andincome tax. EBITDA is calculated by adding income before tax and interestexpense, depreciation and amortization. Investors are cautioned that EBITDAshould not be construed as an alternative to net income determined inaccordance with GAAP as a performance indicator or to cash flows fromoperations as a measure of liquidity and cash flows.
On October 23, 2002, Gerdau S.A. combined its North American operations,referred to as Gerdau North America, with Co-Steel Inc. to form GerdauAmeristeel Corporation. The accounting treatment for this combination is thereverse-takeover method of purchase accounting. This method is appropriatebecause the controlling shareholder of Gerdau North America became the owner ofmore than 50% of the voting shares of the combined entity, Co-Steel, renamedGerdau Ameristeel, on a fully-diluted basis following the transaction.
Our financial results for the three and nine months ended September 30, 2002are the financial results for Gerdau North America, the predecessor company foraccounting purposes. Also included in this report is pro forma informationfor the three and nine months ended September 30, 2002 which was prepared as ifthe combination with Co-Steel had taken place on January 1, 2002, adjusted forthe impact of purchase price allocations and resulting acquisition accountingadjustments. Management believes this information is informative disclosurewith respect to our operations. However, this pro forma information does notpurport to represent what actual operating results would have been during thoseperiods or to project what future results will be in any future periods.
**RESULTS OF OPERATIONS**
***Three months ended September 30, 2003 compared to three months ended September 30, 2002***
The following table summarizes the results of Gerdau Ameristeel for the threemonths ended September 30, 2003 and for the three months ended September 30,2002 on a pro forma and historical basis.                     **For the three months ended**          **September 30, 2003** **September 30, 2002** **September 30, 2002**     ** ** **Pro Forma** **Historical**       Shipments (Tons)              Rebar  383,853   307,876   178,660   Merchants/Structuals/Specials  536,206   463,309   351,573   Rod  155,131   167,932   16,567   Flat Rolled  173,398   183,861   —            Total Mill Finished Steel  1,248,588   1,122,978   546,800  Fabricated Steel  161,121   173,337   149,635              Total  1,409,709   1,296,315   696,435 Weighted Average Selling Price ($/ton)             Mill external shipments $311.61  $297.22  $290.82  Fabricated steel shipments  439.96   433.48   440.33  Scrap charged — $/ton $115.36  $95.91  $96.34 
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                 **For the three months ended**      **September 30, 2003** **September 30, 2002** **September 30, 2002**   ** ** **Pro Forma** **Historical**     Income Statement (US $000s except EPS)             Net Sales $485,323  $442,164  $234,523  Income (loss) from operations  (3,538)  27,425   11,559  Net (Loss) Income  (8,709)  14,380   2,511  EBITDA(1)  16,254   47,918   24,915  EPS — Basic  (0.05)  0.07   0.02  EPS — Diluted  (0.05)  0.07   0.02 
Notes: (1) EBITDA is earnings before interest, taxes, depreciation and amortization
*Net sales:*Finished tons shipped for the three months ended September 30, 2003were 1,409,709 tons compared to 1,296,315 tons shipped for the three monthsended September 30, 2002 on a pro forma basis, an increase of 113,394 tons, or8.75%. Net sales for the three months ended September 30, 2003 were $485.3million compared to $234.5 million on a historical basis and $442.2 million ona pro forma basis for the three months ended September 30, 2002, an increase of$250.8 million or 107.0% and $43.1 million or 9.8%, respectively. Compared tolast year’s historical results, the October 2002 merger with Co-Steelcontributed additional net sales of $191.4 million for the three months endedSeptember 30, 2003.
Average mill finished goods selling prices were $312 per ton for the threemonths ended September 30, 2003, up by approximately $14 per ton or 4.8% fromthe average pro forma selling prices for the same period in 2002. However,selling price increases were more than offset by scrap raw material costs thatincreased $19 per ton, or 20.3% to $115 per ton for the three months endedSeptember 30, 2003 compared to $96 per ton on a pro forma basis, for the sameperiod last year.
*Cost of sales:*Cost of sales as a percentage of net sales increased to 92.1%for the three months ended September 30, 2003 compared to 82.9% for the threemonths ended September 30, 2002 on a historical basis and 84.5% on a pro formabasis. Cost of sales for the three months ended September 30, 2003 was $447.1million compared to $373.51 million on a pro forma basis, an increase of $73.5million, or 19.7%.
Higher cost of goods sold reflects a sharp increase in scrap raw material andmill manufacturing costs. Scrap costs typically account for approximately 35%to 45% of our mill production costs. In the three months ended September 30,2003, average scrap costs were approximately $19 per ton higher than in thethree months ended September 30, 2002 on a pro forma basis. Scrap costsrepresented approximately 45% of mill production costs in the three monthsended September 30, 2003, compared to approximately 41% for the same period in2002. Mill manufacturing costs were also higher in the current quarterprimarily due to scheduled maintenance shutdowns and higher energy costs.
*Selling and administrative:*Selling and administrative expenses as a percentageof net sales for the three months ended September 30, 2003 were 4.4% comparedto 6.6% for the same period in the prior year and 4.9% on a pro forma basis.Selling and administrative expenses for the three months ended September 30,2003 were $21.2 million compared to $15.6 million for the three months endedSeptember 30, 2002 on a historical basis, and $21.6 million on a pro formabasis, an increase of $5.6 million and a decrease of $0.4 million,respectively. Included in selling and administrative expenses for the threemonths ended September 30, 2003 is $1.6 million expense for Stock AppreciationRights (SARs) held by employees. The SARs are tied to Gerdau Ameristeel’sstock price and the Company records expense based on the closing price of thestock at the end of each quarter. Excluding the SARs expense, selling andadministrative expenses declined $2.1 million when compared to pro formaresults for last year. The saving reflects the elimination of redundantoverhead and economies of scale of the merged company.
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*Depreciation:*Depreciation for the three months ended September 30, 2003 was$20.5 million compared to $12.8 million for the three months ended September30, 2002 on a historical basis, and $21.6 million on a pro forma basis, anincrease of $7.8 million and a decrease of $1.0 million, respectively.
*Other operating expense*: Other operating expense for the three months endedSeptember 30, 2003 was approximately $0.1 million compared to $0.1 million forthe three months ended September 30, 2002.
*Interest expense and amortized deferred financing costs:*Interest expense andamortized deferred financing costs were $15.3 million for the three monthsended September 30, 2003 compared to $8.9 million on a historical basis for thethree months ended September 30, 2002 and $10.5 million on a pro forma basisbefore giving effect of the refinancing.
*Income taxes:*The effective income tax rate in the United States (includingboth federal and state) and Canada (including federal and provincial) wasapproximately 40% and 35%, respectively, for the three months ended September30, 2003 and 2002. The Company has tax credits that offset income tax expenseby approximately $2.5 million per quarter.
***Nine months ended September 30, 2003 compared to nine months ended September 30, 2002***
The following table summarizes the results of Gerdau Ameristeel for the ninemonths ended September 30, 2003 and for the nine months ended September 30,2002 on a pro forma and historical basis.                     **For the nine months ended**          **September 30, 2003** **September 30, 2002** **September 30, 2002**     ** ** **Pro Forma** **Historical**       Shipments (Tons)              Rebar  1,173,781   939,639   567,819   Merchants/Structurals/Specials  1,521,308   1,440,005   1,035,678   Rod  453,221   551,510   62,127   Flat Rolled  538,612   547,601   —            Total Mill Finished Steel  3,686,922   3,478,755   1,665,624  Fabricated Steel  479,051   513,372   437,617              Total  4,165,973   3,992,127   2,103,241 Weighted Average Selling Price ($/ton)             Mill external shipments $302.74  $279.48  $289.03  Fabricated steel shipments  433.37   434.88   442.48  Scrap charged — $/ton $110.37  $87.84  $87.28 Income Statement (US $000s except EPS)              Net Sales $1,401,270   1,285,360   697,622   Income (loss) from operations  (2,569)  77,916   41,428   Net (Loss) Income  (15,290)  31,155   7,606   EBITDA(1)  57,712   140,557   79,562   EPS — Basic  (0.09)  0.14   0.06   EPS — Diluted  (0.09)  0.15   0.06 
Notes:  EBITDA is earnings before interest, taxes, depreciation and amortization
*Net sales:*Finished tons shipped for the nine months ended September 30, 2003were 4,165,973 tons compared to 3,992,127 tons for the nine months endedSeptember 30, 2002 on a pro forma basis, an increase of 4.4%. Net sales forthe nine months ended September 30, 2003 were $1,401.3 million compared to$697.6 million on a historical basis and $1,285.4 million on a pro forma basisfor the nine months ended September 30, 2002, an increase of $703.7 million, or100.9%, and $116.0 million,
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or 9.0%, respectively. Compared to last year’s historical results, the October2002 merger with Co-Steel contributed additional net sales of $575.0 millionfor the nine months ended September 30, 2003.
Average mill finished goods selling prices were $303 per ton for the ninemonths ended September 30, 2003, up by approximately $23 per ton, or 8.3%, fromthe average pro forma selling prices for the same period in 2002. However,selling price increases were more than offset by scrap raw material costs thatalso increased $23 per ton, or 25.6% to $110 per ton for the nine months endedSeptember 30, 2003 compared to $88 per ton on a pro forma basis, for the sameperiod last year.
*Cost of sales:*Cost of sales as a percentage of net sales increased to 91.6%for the nine months ended September 30, 2003 compared to 81.9% for the ninemonths ended September 30, 2002 on a historical basis and 84.9% on a pro formabasis. Cost of sales for the nine months ended September 30, 2003 was $1,283.9million compared to $1,090.6 million for the nine months ended September 30,2002 on a pro forma basis, an increase of $119.8 million, or 17.7%.
Higher cost of goods sold reflects a sharp increase in scrap raw material andenergy costs. Scrap costs typically account for approximately 35% to 45% ofmill production costs. In the nine months ended September 30, 2003, averagescrap costs were approximately $23 per ton higher than in the nine months endedSeptember 30, 2002 on a pro forma basis and represented approximately 44% ofmill production costs in the nine months ended September 30, 2003, compared toapproximately 41% for the same period in 2002. For the first nine months of2003, energy costs averaged $37 per ton of steel produced, an increase ofapproximately 23% compared to the same period last year.
*Selling and administrative:*Selling and administrative expenses as a percentageof net sales for the nine months ended September 30, 2003 were 4.2% compared to6.5% for the same period in the prior year and 4.9% on a pro forma basis.Selling and administrative expenses for the nine months ended September 30,2003 were $59.3 million compared to $45.4 million for the nine months endedSeptember 30, 2002 on a historical basis, and $62.6 million on a pro formabasis for that period, an increase of $13.9 million and a decrease of $3.3million, respectively. Compared to pro forma results for last year, the $3.3million saving reflects the elimination of redundant overhead and economies ofscale of the merged company.
*Depreciation:*Depreciation for the nine months ended September 30, 2003 was$60.5 million compared to $38.5 million for the nine months ended September 30,2002 on a historical basis, and $57.2 million on a pro forma basis, an increaseof $22.0 million and $3.3 million, respectively.
*Other operating expense:*Other operating expense for the nine months endedSeptember 30, 2003 was approximately $0.1 million. This includes a $1.8million charge from a settlement of environmental warranties from the May 2000sale of Co-Steel’s Mayer Parry Recycling unit in England, asset write-downs of$0.8 million, $0.5 million charge relating to start-up costs associated withnew process automation controls at the Knoxville rolling mill and fabricatingplant shutdown expenses of $0.3 million. The charges were offset by income of$3.5 million in electric power rebates from the Province of Ontario. Otheroperating expense for the nine months ended September 30, 2002 was $1.0 millionrelating to the closing of certain of the Company’s fabricating plants.
*Interest expense and amortized deferred financing costs:*Interest expense andamortized deferred financing costs were $34.3 million for the nine months endedSeptember 30, 2003 compared to $31.4 million on a historical basis for the ninemonths ended September 30, 2002 and $32.1 million on a pro forma basis beforegiving effect to the refinancing. Included in deferred finance costs for thenine months ended September 30, 2003 was a charge of $2.1 million relating tothe write-off of unamortized costs relating to debt extinguished in the Junerefinancing. The remaining decrease of $0.8 million on a historical basis isdue primarily to the conversion of related party debt to equity in September2002 in connection with the combination with Co-Steel ($12.3 million), offsetby the interest expense on the assumed debt of Co-Steel ($6.7 million) andincreased amortization expense in 2003 on the debt refinancing that occurred onJune 27, 2003.
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*Income taxes:*Our effective income tax rate in the United States (includingboth federal and state) and Canada (including federal and provincial) wasapproximately 40% and 35%, respectively, for the nine months ended September30, 2003 and 2002. The Company has tax credits that offset income tax expenseby approximately $2.5 million per quarter.
**LIQUIDITY AND CAPITAL RESOURCES**
*Cash Flows*
*Operating activities:*Net cash provided by operations for the nine monthsended September 30, 2003 was $3.2 million compared to net cash provided byoperations of $9.5 million for the nine months ended September 30, 2002. Thechange in fiscal 2003 is the result of increased working capital, primarilyincreased accounts receivable.
*Investing activities:*Net cash used in investing activities was $40.4 millionin the nine months ended September 30, 2003 compared to $30.0 million in thenine months ended September 30, 2002, an increase of $10.4 million. For thenine months ended September 30, 2003, capital expenditures totalled $40.5million. Capital projects included a new warehouse at the Cartersville mill, arolling mill electrical control system upgrade at the Charlotte mill, a casterupgrade at the Jackson mill and a new pollution control system at the Cambridgemill. In June 2002, the Company spent $8.4 million to acquire the assets ofour Cartersville, Georgia cold drawn plant.
*Financing activities:*Net cash provided by financing activities was $41.3million in the nine months ended September 30, 2003 compared to cash providedby financing activities of $23.9 million in the nine months ended September 30,2002. The increase in debt is primarily to support increasing accountsreceivable and capital expenditures made in fiscal 2003.
*Credit facilities and indebtedness*
On June 27, 2003, the Company refinanced most of its outstanding debt byissuing $405.0 million of 10 3/8% Senior Notes due 2011 and entered into a$350.0 million Senior Secured Credit Facility with a syndicate of lenders. Theproceeds were used to repay existing indebtedness under several lendingarrangements and to pay costs associated with the refinancing. Following therefinancing, the principal sources of liquidity will be cash flow generatedfrom operations and borrowings under the new Senior Secured Credit Facility.The principal liquidity requirements are working capital, capital expendituresand debt service. The Company does not have any off-balance sheet financingarrangements or relationships with unconsolidated special purpose entities.
The following is a summary of existing credit facilities and other long termdebt:
*Senior Secured Credit Facility:*The Senior Secured Credit Facility providescommitments of up to $350.0 million. The Company will be able to borrow underthe Senior Secured Credit Facility the lesser of (i) the committed amount, and(ii) the borrowing base (which is based upon a portion of the inventory andaccounts receivable held by most of the Company’s operating units less certainreserves), minus outstanding loans, letter of credit obligations and otherobligations owed under the Senior Secured Credit Facility. Since the borrowingbase under the Senior Secured Credit Facility will be based on actual inventoryand accounts receivable levels, available borrowings under the facility willfluctuate. The borrowings under the Senior Secured Credit Facility are securedby the Company’s inventory and accounts receivable. At September 30, 2003,approximately $103.5 million was available under the Senior Secured CreditFacility.
Loans under the Senior Secured Credit Facility bear interest at a per annumrate equal to one of several rate options (LIBOR, federal funds rate, bankers’acceptance or prime rate) based on the facility chosen at the time of borrowingplus an applicable margin determined by excess availability from time to time.Borrowings under the Senior Secured Credit Facility may be made in U.S. dollarsor Canadian dollars, at the option of the Company. Our Senior Secured CreditFacility contains restrictive covenants that limit our ability to engage inspecified types of transactions without the
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consent of the lenders. These covenants limit our ability to, among otherthings: incur additional debt, issue redeemable stock and preferred stock, paydividends on our common shares, sell or otherwise dispose of certain assets andenter into mergers or consolidations.
*Senior Notes*: On June 27, 2003, the Company issued $405.0 million of 10 3/8%Senior Notes, of which $35.0 million were sold to an indirect wholly-ownedsubsidiary of the Company’s parent, Gerdau S.A. The notes mature on July 15,2011. The notes were issued at 98% of face value. The notes are unsecured,are effectively junior to secured debt to the extent of the value of the assetssecuring such debt, rank equally with all existing and future unsecuredunsubordinated debt, and are senior to any future senior subordinated orsubordinated debt. Interest on the notes accrues at 10 3/8% per annum (10.75%effective rate) and is payable semi-annually on July 15 and January 15. At anytime prior to July 15, 2006, the Company may redeem up to 35% of the originalprincipal amount of the notes with the proceeds of one or more equity offeringsof common shares at a redemption price of 110.75% of the principal amount ofthe notes, together with accrued and unpaid interest, if any, to the date ofredemption. The indenture governing the notes permits the Company and itsrestricted subsidiaries to incur additional indebtedness, including securedindebtedness, subject to certain limitations.
*AmeriSteel Bright Bar, Inc. Term Loan:*As of September 30, 2003, AmeriSteelBright Bar, Inc. had a $3.5 million term loan outstanding. The loan bearsinterest at a fixed rate of 6% and matures in September 2011.
*Industrial revenue bonds:*The Company had $36.8 million of industrial revenuebonds outstanding as of September 30, 2003. $33.2 million of the bonds wereissued by Gerdau Ameristeel US Inc. in prior years to construct facilities inJackson, Tennessee; Charlotte, North Carolina; Jacksonville, Florida; and PlantCity, Florida. The Company assumed an industrial revenue bond in the amount of$3.6 million with the acquisition of the Cartersville cold drawn facility inSeptember 2002. The interest rates on these bonds range from 50% to 75% of theprime rate. The industrial revenue bonds mature on November 1, 2003 andDecember 15, 2003 and in 2014, 2017 and 2018. These bonds are secured byletters of credit issued under the Senior Secured Credit Facility.
*Joint venture facility:*The Company’s joint venture, Gallatin Steel, has a$40.0 million revolving credit facility with $5.9 million outstanding as ofSeptember 30, 2003. Under Canadian GAAP, 50% of the indebtedness is reflectedon Gerdau Ameristeel’s consolidated balance sheet.
*Related party loans:*In the first quarter of 2003, a subsidiary of Gerdau S.A.made loans totaling $30.0 million to the Company to increase liquidity withinthe group. These loans were used for working capital purposes, bore interestat the rate of 6.5% and were repaid in the second quarter using proceeds fromthe refinancing.
*Convertible debentures:*The Company has unsecured, subordinated convertibledebentures in the principal amount of Cdn$125.0 million, which bear interest at6.5% per annum, mature on April 30, 2007, and, at the holders’ option, areconvertible into our common shares at a conversion price of Cdn$26.25 pershare. Under the terms of the trust indenture for the convertible debentures,no adjustment to the conversion price is required if the Company issues commonshares in a customary offering. The debentures are redeemable, at theCompany’s option, at par plus accrued interest and the Company has the right tosettle the principal amount by the issuance of common shares based on theirmarket value at the time of redemption. Since the convertible debentures canbe redeemed by the issuance of common shares, the debenture obligations areclassified as shareholders’ equity. Interest on the shareholders’ equitycomponent, net of related income taxes, is charged to reinvested earnings, andis deducted from the net earnings or added to net loss in calculating basicearnings per share.
*Capital leases:*Gerdau Ameristeel has $1.0 million of capital leases,including the Company’s 50% share of the Gallatin capital leases.
*Capital expenditures*: Gerdau Ameristeel spent $40.5 million on capital projectsin the nine months ended September 30, 2003 compared to $21.8 million in thesame period in 2002.
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**Outlook**
Relative to volume trends in steel demand, the order inquiries for quotationsreflect an increased level of activity for our steel mills and for our primaryservice center customers of merchant products. Seasonal efforts to completepending construction projects have also sustained customer activity levels forconcrete reinforcing steel products. Considering the late season timing ofthis trend, the short term outlook for the winter is relatively upbeat comparedto the past two years. A secondary bullish factor is the relatively low levelsof finished inventory within our ten bar mills and production schedulinglimitations over the holiday season. This favorable volume climate for end usecustomers and overall steel supply/demand will be subjected to several externalinfluences that could impact the balance of steel supply and market pricing.
The key issues for the approaching winter season encompass potential weatherimpacts on energy costs, political decisions on the retention of importsafeguard tariffs, global steel trading patterns and currency exchange ratefluctuations. The upcoming Presidential directive on the future of safeguardtariffs and the Canadian CITT decision not to impose parallel safeguardrestrictions could increase the level of steel import activity and marketsupply. Global steel trading in scrap raw materials and finished steelproducts will be a function of continued strong demand from China and therelative valuation of the US dollar versus the currencies of Europe, Japan,Canada and other major steel trading countries. The weakening valuation trendfor the dollar is favorable relative to import pricing of finished steelproducts but increases the attractiveness of scrap material exports.
In the September 2003 quarter, escalating prices for scrap and energy have beenthe driving forces behind recent market price increases for steel products. Theconsolidation of industry competitors has also improved the market disciplinein recovering these rising cost elements. Cash flow liquidity and earningspressure have contributed to the structural change in market discipline withinthe industry. The key question is whether this competitive stability willwithstand the adversity of import surges or harsh winter impacts on steeldemand until the spring season emerges. A secondary concern is the stress ofrising steel prices on downstream customers that are struggling to pass onthese final product costs in a slow economic environment. This downstreammargin compression is clearly evident in Gerdau Ameristeel’s rebar fabricationand other downstream business.
In the December 2003 quarter, we have scheduled outages for the Jackson andCharlotte mills to complete equipment upgrades and to complete annualmaintenance projects. Production and shipments are expected to trend downwardin the December quarter reflecting the normal seasonality of our business.Prices are expected to be firm or up for all our products and we would expectimproved margins in the December quarter.