Samarco Mineração S.A.

Transcription

1 (A free translation of the original in Portuguese) Samarco Mineração S.A. Annual Management Report on the Financial Statements as of December 31, 2003 and 2002 SAMARCO311203E02DFSFT.DOC F:\USERS\AUDIT\DFS

2 (A free translation of the original in Portuguese) Annual Management Report To our Shareholders, We submit this report and the financial statements of Samarco Mineração S.A. as of and for the year ended December 31, 2003, prepared in conformity with accounting practices adopted in Brazil and audited by PricewaterhouseCoopers Auditores Independentes, for your perusal. Scenario in 2003 The year 2003 began tainted by the uncertainties of a possible conflict in the Persian Gulf, which became reality in March. The world also witnessed the breakout and growth of the SARS epidemic, which began in China, over the first several months of the year. Consequently, expectations with respect to the effects that the above-mentioned conflict and epidemic could have on the world reinforced the downturn in the global economy then occurring. However, the conflict did not last and ended around the middle of 2003, which allowed the U.S. economy to breathe more peacefully and show strong growth in the last quarter of the year. The SARS epidemic did not reach alarming portions, allowing the Chinese economy to continue as the engine of growth for international trade. With the withering of these risks, 2003 ended with a tenuous equilibrium and expectations for sustainable growth of the world economy in The steel industry started the year 2003 in a dynamic mode with steel prices at levels not seen in over twenty years. After a small decrease over the first few months of the year, prices ended 2003 higher than those in place at the start of the year. Production of raw steel continued to be strong, growing 6.7% in relation to China was responsible for 64% of this grow, surpassing the mark of 220 million metric tons produced. Added to net imports of 30 million tons, apparent steel consumption reached 250 million tons in This situation is reflected in the expectations of iron ore producers and has generated announcements for several expansion projects that are intended to meet this strong market demand. The year 2003 will also be remembered as a year in which rates for maritime shipping reached levels until now unheard of, resulting in higher costs, lower margins, and consequent increase in prices for final products. Effects in Brazil The instability of the Brazilian economy in the first several months of 2003 inevitably placed pressure on the exchange rate and sovereign risk. This process continued through the middle of the second half when the market gained confidence and reacted positively, reaching a level of stability necessary for sustained economic growth in the future. 2

3 The year ended with important triumphs in the macroeconomic area, especially international trade accounts. As a result of its efforts to adjust its accounts, the current administration was able to obtain an expressive primary surplus and international accounts recorded the largest surplus in Brazil s history. The exchange rate gradually returned to relative stability, appreciating over the year to arrive at a yearend exchange rate of US$ 1.00 = R$ This allowed the administration to adopt a policy that gradually lowered interest rates, increasing the availability of credit and creating an economic environment with expectations for low interest rates. The benchmark (SELIC) interest rate, which started the year at 25% p.a., ended 2003 at 16.5% p.a. Country risk abated and the stock market set records. The process for the reform of social security and the tax system advanced. However, since this did not occur to the extent required, conditions for modernization of the economy and sustained business development are still awaited. The mining industry s market was dominated by strong demand for iron ore in 2003, which was mainly driven by continued growth in the Chinese economy. Effects on Samarco Despite the initial economic tremors, Samarco is one of the exporting companies that benefited from the general optimism of business in The year was an exceptional one for Brazilian international commerce, which was mainly attributable to higher prices for various commodities, among them iron ore, the demand for which was for the most part propelled by the strong demand from China. Samarco took advantage of the positive moment and surpassed records reached in prior years, producing 13.3 million tons of pellets and 2.0 million tons of fines in This performance represented a total sales volume of 16.4 million tons of iron ore, a new benchmark for the company. As a consequence, the company presented the best financial performance of its history in 2003, attaining total revenues of over US$ 500 million for the first time (R$ 1.5 billion). In 2003, the company surpassed its previous record set in 2002, presenting new annual production records for concentrate, volume transported by slurry pipeline, as well as production and shipment of pellets and pellet-feed. The company ended the year with income of R$ million, compared to R$ million in 2002 (US$ million compared to US$ 96.4 million in the prior year). This result already includes expenses of R$ 70 million (US$ 23 million) related to a negotiated settlement between the company and the government of the state of Minas Gerais to end litigation in which the company challenged certain value added taxes (ICMS) that the state sought to collect. A settlement was finally reached and both parts waived all rights to further litigation. 3

4 Strong demand for iron ore pellets culminated in a price increase of approximately 10% in 2003 compared to the prior year. Samarco negotiated the price for the pellet market in 2003, following the example already set in 1999 and making it the benchmark for this segment. Prior to this, Samarco had already been the worldwide point of reference for pellet prices once before, which occurred in the eighties. As a result of the relative stability of the exchange rate throughout the year, the reduction in country risk, and a liquid market for credit, the company decided to pay down its debt by US$ 16 million (from US$ 208 million in 2002 to US$ 192 million). This permitted the company to reduce interest expenses during Samarco contributed to Brazil s international accounts, generating net foreign exchange of US$ million in 2003 (US$ million in 2002), an increase of 38%. By transcending the challenges faced in 2003, the company was able to present the best production, sales, and financial performances of it history, consolidating its position among the 25 largest exporters in Brazil. Market, production, and sales Expectations at the beginning of 2003 indicated strong demand for iron ore and pellets. Production reached 13.3 metric tons for pellets and 2.0 metric tons of fines. Notwithstanding. previously existing inventories allowed the company to sell 13.7 million tons of pellets and 2.7 million tons of fines. These volumes were 11.0% and 8.1% superior to results for 2002, respectively. Total sales of 16.4 million tons (WMT) represented one more record eclipsed by the company. 4

5 Production TMS 000 s Sales TMN 000 s Pellets Fines China s performance in 2003 surpassed 2002 in all areas, presenting growth in steel production of 21.2% that was mainly based on ore imports with high iron content and gains in productivity. China s iron ore imports reached 145 million tons (32% more than in 2002) compared to domestic production of approximately 250 million tons. Considering the difference in iron content between Chinese and imported ore, it can be inferred that a large part of China s steel production depends on imported ore. This explains the interest of Chinese companies in entering into long-term supply contracts for iron ore in Some have even joined projects involving joint investments with large world producers of iron ore in order to assure supply of this primary raw material. Sales Destinations in 2003 (% Market Share (% Europ 16 Asia Other 15 N. 9 Africa Middl Eas Chin

6 Samarco s operations Samarco obtained the best operating results of its history in The Germano Unit surpassed a record performance in 2002, producing million tons of concentrate, 3.3% more than the previous record. The slurry pipeline pumped million tons, achieving a record for concentrate transported in the year. Total production of pellets and pellet feed at the Ponta Ubu Unit reached 15.3 million tons, 5.5% more than its best previous performance. Samarco invested approximately US$ 3.6 million (R$ 11.5 million) in 2003 to conclude its Roller Press project. The total invested, including amounts disbursed in 2002, amounted to US$ 20 million (R$ 57.7 million). Another important investment was made to implement an advanced system for control of furnaces used in pellet plants. Investments in the environmental area exceeded R$ 4.0 million (US$ 1.56 million), which was primarily applied to the dust suppression system project at the Ubu Unit, which is intended to reduce particle emissions for pellet operations. A new record was reached for product shipments, which totaled 16.4 million tons. Pellet plant preventive maintenance and production performed very well during programmed shutdowns, as did the MTBF (Mean Time Between Failures) ratios obtained for the majority of critical equipment. These figures could only be achieved due to the excellent stability of the production process from mining to the shipment of products, as well as the efforts of the whole team at Samarco, which focused their work to achieve results and dealt with the market in a professional and determined manner. Main records for Germano: total daily production of concentrate, total monthly production of concentrate, and total annual production of concentrate. - Ponta Ubu: daily production of pellets, monthly pellet production, total annual production, and total annual shipments. Gross margin Despite the excellent results for the year, the company showed a small reduction in its gross margin in Brazilian reais (from 54.1% in 2002 to 52.3% in 2003). This was primarily attributable to increased consumption and prices for some inputs, especially those quoted in international markets. 6

7 Oppositely, the gross margin in U.S. dollars increased by approximately 7% (45.6% in 2002 compared to 48.4% in 2003). This was mainly attributable to fluctuations in the exchange rate. Workforce The company s strong operating performance was boosted by worker productivity in Accordingly, the gross annual revenue per employee increased 22% compared to the prior year (R$ 1,189 thousand in 2003 compared to R$ 975 thousand in 2002). Ongoing training programs and optimization of processes have led to continuous improvement in the company s operations. Annual Gross Revenue/Man US$000's and R$ 000's Number of Employees Management actions In 2003, the company was able to perceive the quality of and recognize the efforts made over the years in relation to management systems and capacitating of professionals, which culminated in the appointment of our new president by the shareholders. After years of contributions and work at the company, José Tadeu de Moraes (CEO), Paulo José Barros Rabelo (COO), and Roberto Lúcio Nunes de Carvalho (CCO) initiated a new management cycle at Samarco. In addition to this important change, the company is taking a fundamental step toward consolidation of its management system by implementing its ERP project (SAP R/3) beginning January 1, Among other advantages, this system will allow management to have a more agile and flexible decision process, allowing a more equitable distribution of management responsibilities among the various areas. 7

8 The company distributed R$ 454 million (R$ 95 million in 2002) in dividends to shareholders in 2003, which was equal to US$150 million and US$ 35 million, respectively. This was the largest amount ever paid to compensate the company s shareholders. The environment, occupational health, and safety The pursuit of excellence with respect to issues related to the environment, as well as occupational health and safety is a practice that is part of the Samarco s values and culture. The company is fully compliant in relation to requirements of federal, state, and municipal law as well as the regulations of environmental and occupational health and safety agencies. Moreover, Samarco renewed its operating license in the state of Espírito Santo for a four-year period. This license covers the company s slurry pipeline, pellet plants, stockyard areas, and its port terminal. The company also renewed its license to operate in the state of Minas Gerais for another fouryear period. It covered processing activities, waste disposal, and the slurry pipeline. The company s Tree Project was selected from among the environmental programs developed and implemented at Samarco and awarded first prize in the Environmental Education category by the Federation of Industries for the State of Espírito Santo (FINDES). Samarco has actively participated in the formation and work of river basin committees in the areas were it has a presence, including the Doce, Piracicaba, and Piranga rivers in Minas Gerais and the Benevente and Itapemirim rivers in Espírito Santo. The company turned in its second all time best safety record in 2003 (including employees of outsourced companies), achieving a frequency ratio for accidents with work time lost of 0.37 (ratio of 0.21 in 2001). 8

9 Financial performance Financial Highlights (In R$ Net Sales 1,423 1, Gross Margin (%) Net Income EBITDA Margin EBITDA (%) Gross Margin 0.8x 1,2x 1,8x 1,8x 2,0x Gross sales Strong international demand for pellets stimulated by a recovery in prices and demand for steel resulted in Samarco s primary product absorbing an average price increase of approximately 10% in relation to the previous year. This fact together with the excellent performance of sales and the favorable exchange rate guaranteed a historical record for the company in 2003: sales of R$ 1.5 billion compared to the R$ 1.2 billion attained in 2002 (US$ million and US$ million, respectively). Gross Sales US$ MM Gross Sales R$ MM ,800 1,600 1,400 1,200 1, ,218 1,

10 Net income Samarco s net income grew approximately 142% in 2003 compared to the prior year, reaching R$ million (R$ million in 2002). This was the company s best performance ever. Net income in U.S. dollars totaled US$ million (US$ 96.4 million in 2002). Net Income US$ MM Net Income R$ MM EBITDA The record set in 2002 was surpassed once again; EBITDA totaled R$ 724 million (US$ 242 million) in EBITDA US$ MM EBITDA R$ MM

11 Investments Samarco invested a total of US$ 23.6 million (R$ 70.7 million) in The conclusion of the Roller Press project begun in 2002 and implementation of the ERP software in the amount of US$ 3.1 million (R$ 9.3 million) both deserve note. This project involves two phases, the first of which was successfully completed as of January 1, 2004 and the second is expected to be concluded in the second half of The total estimated value of this investment is US$ 7.7 million (R$ 24.2 million). Capital Investment US$ MM Capital Investment R$ MM Debt The company continued to reduce debt in 2003 and it ended the year with gross debt of approximately US$ 192 million, which represented a decrease of 8% in relation to the prior year. The same performance was not achieved in relation to net indebtedness, due to the company s cash balance in 2002, attributable to the strategy adopted to mitigate the risks related to the lack of liquidity in credit markets last year. The company s net debt totaled US$ million (R$ million) at the end of The ratio of DEBT/EBITDA decreased from 1.2x to 0.8x at yearend. 11

12 Gross Debt US$ MM US$ MM Gross Debt R$ MM R$ MM Deb Gross Debt (US$ MM) Net Debt (US$ MM) Return on Capital Employed (ROCE) Remuneration of shareholder capital in 2003 surpassed the already excellent results achieved in 2002, reinforcing Samarco s commitment to meeting the expectations of shareholders and related parties. Return on capital employed was 32.5% in Brazilian reais and 23.1% in U.S. dollars. 12

13 ROC US$ ROC R$ Looking ahead The new year has arrived with the promise of relative stability and international liquidity, as well as perspectives for a favorable scenario in relation to the domestic economy. There is optimism that the process of economic recovery will continue to grow over the year. Except for a few points of political tension that exist around the globe, the general view is that there are no internal o external risks that could compromise the optimistic position suggested by the current scenario. The company has already scheduled investments of approximately R$ 112 million (US$ 35 million) for 2004, including the project for optimization of the production process that will be implemented in 2004 and This project will allow Samarco to increase its production volume for concentrate from it current 15.5 million to 16.5 million metric tons by expanding the capacity of the slurry pipeline and implementing the second phase of the ERP Project (SAP R/3), which should take until September With respect to the performance of the steel industry on which mining is dependent, it is expected that the present scenario of strong demand will continue, favoring prices and stimulating investment in the expansion of production on the supply side. Samarco s management, together with its employees, once again commemorate the surpassing of the noteworthy performance of 2002 and we thank all interested parties for their confidence, support, and the contributions received. These actions allowed the company to once again eclipse our past performance in 2003 and they will most certainly position us to recognize even better results in The Management 13

14 (A free translation of the original in Portuguese) Samarco Mineração S.A. Financial Statements at December 31, 2003 and 2002 and Report of Independent Auditors

15 (A free translation of the original in Portuguese) Report of Independent Auditors To the Board of Directors and Shareholders Samarco Mineração S.A. 1 We have audited the accompanying balance sheets of Samarco Mineração S.A. as of December 31, 2003 and 2002, and the related statements of income, of changes in shareholders equity and of changes in financial position for the years then ended. These financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements. 2 We conducted our audits in accordance with approved Brazilian auditing standards, which require that we perform the audit to obtain reasonable assurance about whether the financial statements are fairly presented in all material respects. Accordingly, our work included, among other procedures: (a) planning our audit taking into consideration the significance of balances, the volume of transactions and the accounting and internal control systems of the Company, (b) examining, on a test basis, evidence and records supporting the amounts and disclosures in the financial statements, and (c) assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. 3 In our opinion, the financial statements audited by us present fairly, in all material respects, the financial position of Samarco Mineração S.A. at December 31, 2003 and 2002, and the results of its operations, the changes in shareholders equity and the changes in its financial position for the years then ended, in conformity with accounting practices adopted in Brazil. Belo Horizonte, January 16, 2004 PricewaterhouseCoopers Auditores Independentes CRC 2SP000160/O-5 "F" MG Rogério Roberto Gollo Contador CRC 1RS044214/O-9 S MG 2

16 Balance Sheet at December 31 In thousands of reais Assets (A free translation of the original in Portuguese) Liabilities and shareholders equity Current assets Current liabilities Cash and banks 27, ,925 Suppliers Trade accounts receivable 239, ,213. Local 29,817 34,507 Value-added tax. Foreign 16,677 15,238 (ICMS) recoverable 4,990 2,044 Advances on exchange contracts 350, ,186 Deferred income tax 24,800 12,393 Loans and financings Social Integration Program (PIS) in foreign currency 62, ,874 recoverable 8, Loans from foreign subsidiary 69,341 84,799 Inventories 84, ,747 Financial charges 8,148 12,466 Prepaid expenses 6,461 7,969 Salaries and payroll charges 18,810 20,942 Other accounts receivable 4,054 7,017 Provision for income tax 1,550 28,919 Taxes payable 2,945 2, , ,094 Proposed dividends 85,626 Other accounts payable 11,601 23,595 Long-term receivables Court escrow deposits 22,667 13, , ,018 Deferred income tax 12,602 15,633 Long-term liabilities ICMS recoverable 38,245 Loans and financings Other accounts receivable 11,769 10,666 in foreign currency 37, ,274 Loans from foreign subsidiary 34, ,199 47,038 78,262 Deferred income tax 92,366 97,100 Provision for contingencies 88,062 76,099 Permanent assets Provision for loss on investments 20,182 50,679 Investments in subsidiary and Other accounts payable 24,147 17,978 associated companies 3,185 Property, plant and equipment 1,446,381 1,448, , ,329 Shareholders equity 1,446,381 1,451,377 Capital 297, ,025 Capital reserves 2,476 2,476 Revaluation reserve 427, ,915 Incentivated depletion reserve 1,517 1,517 Revenue reserves 295, ,453 1,024, ,386 Total assets 1,893,507 2,159,733 Total liabilities and shareholders equity 1,893,507 2,159,733 The accompanying notes are an integral part of these financial statements. 3

17 Statement of Income Years Ended December 31 In thousands of reais (A free translation of the original in Portuguese) Gross sales revenues 1,528,856 1,218,260 Sales deductions (105,776 ) (62,044) Net sales revenues 1,423,080 1,156,216 Cost of sales (679,038 ) (530,886) Gross profit 744, ,330 Operating income (expenses) Selling (74,999) (31,930) General and administrative (includes R$ 2,551 of management fees; R$ 1,661) (10,218) (11,380) Financial expenses (44,042) (56,958) Financial income 2,863 6,682 Equity in the earnings of subsidiary and associated companies 1,180 (Provision) reversal for loss on investments 27,312 (45,007) Other operating expenses, net (160,562) (52,156) (259,646 ) (189,569) Profit before monetary and foreign exchange variations 484, ,761 Monetary and foreign exchange variations On assets (69,749) 141,852 On liabilities 115,876 (339,726) 46,127 (197,874) Operating profit 530, ,887 Non-operating expenses, net (2002 mainly residual value of permanent asset disposals) (5) (4,017) Profit before income tax 530, ,870 Income tax (94,689) (53,606 ) Net income for the year 435, ,264 Net income per share at the end of the year - R$ The accompanying notes are an integral part of these financial statements. 4

18 Statement of Changes in Shareholders Equity In thousands of reais (A free translation of the original in Portuguese) Capital reserves Revenue reserves Special restatement Incentivated of Share Investment Revaluation depletion Retained Retained Capita l fixed assets premium subsidies reserve reserve Legal profits reserve earnings Total At December 31, , , ,551 1,517 41, , ,127 Establishment of revaluation reserve 29,554 29,554 Partial realization of revaluation reserve (20,190) 20,190 Distribution of profits (R$ per common share and R$ per preferred share) (72,933) (72,933) Transfer to reserve 69,929 (69,929) Net income for the year 180, ,264 Appropriation of net income:. Proposed dividends (R$ per common share and R$ per preferred share) (85,626) (85,626). Transfer to reserves 9,013 85,625 (94,638) At December 31, , , ,915 1,517 50, , ,386 Partial realization of revaluation reserve (22,525) 22,525 Distribution of profits (R$ 1.16 per common share and R$ 1.27 per preferred share) (6,074) (6,074) Distribution of profits (R$ per common share and R$ per preferred share) (128,331) (128,331) Net income for the year 435, ,829 Appropriation of net income:. Payment of dividends (R$ per common share and R$ per preferred share) (87,507) (87,507). Payment of dividends (R$ per common share and R$ per preferred share) (146,925) (146,925). Transfer to reserves 21, ,131 (223,922) At December 31, , , ,390 1,517 72, ,280 1,024,378 The accompanying notes are an integral part of these financial statements 5

19 (A free translation of the original in Portuguese) Statement of Changes in Financial Position Years Ended December 31 In thousands of reais Financial resources were provided by Operations Net income for the year 435, ,264 Expenses not affecting working capital: Depreciation and amortization 71,300 59,384 Amortization of deferred charges 252 Residual value of permanent asset disposals 1,265 2,344 Equity in the earnings of subsidiary and associated companies (1,180 ) Provision (reversal) for loss on investments (27,312) 45,007 Provision for loss on ICMS recoverable (long-term) 56,970 Monetary and foreign exchange variations on long-term receivables and liabilities (35,103) 98, , ,166 Third parties Decrease in long-term receivables 212 Increase in long-term liabilities 18,130 22,798 Total funds provided 521, ,176 Financial resources were used for Transfer from current assets to long-term receivables 46,773 Increase in long-term receivables 25,746 Permanent assets Property, plant and equipment 70,754 54,567 Investments 61 70,754 54,628 Transfer from long-term liabilities to current 132, ,463 Distribution of dividends and profits 368, ,559 Total funds used 598, ,423 Increase (decrease) in working capital (77,227 ) 25,753 Current assets At the end of the year 400, ,094 At the beginning of the year 630, ,044 (230,006) 273,050 Current liabilities At the end of the year 572, ,018 At the beginning of the year 725, ,721 (152,779) 247,297 Increase (decrease) in working capital (77,227 ) 25,753 The accompanying notes are an integral part of these financial statements. 6

20 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated (A free translation of the original in Portuguese) 1 Operations The Company operates an integrated project which comprises the mining and concentration of low-grade iron ore (Germano/Alegria mines), transportation via a slurry pipeline system, pelletizing, and subsequent shipment through its maritime terminal (Ponta Ubu). Most of the production is exported. The iron ore reserves ceded by Companhia Vale do Rio Doce to the Company, and for which the Company has the mining rights, are currently estimated at 4.1 billion tons (Australian Code Concept JORC). Production in 2003 was 15.7 million wet metric tons ( million wet metric tons). The Company has a 49% holding in Usina Hidrelétrica Guilman-Amorim S.A. and is the owner of the Muniz Freire hydroelectric plant in the State of Espírito Santo. These two hydroelectric plants generate approximately 32% of the Company s total energy needs. Exports are mainly effected through the wholly-owned subsidiary, Samarco Finance Ltd. 2 Significant Accounting Principles The financial statements at December 31, 2003 and 2002 were prepared in conformity with accounting practices adopted in Brazil. (a) Determination of net income Net income is determined on the accrual basis of accounting, and is adjusted by income tax payable on taxable income and deferred income tax recoverable in subsequent years when certain provisions become deductible. Income tax is calculated at the reduced rate of 18% on exploration profits subject to tax incentive. The Company is not subject to the Social Contribution on Net Income. (b) Current assets and long-term receivables Inventories are stated at the average cost of purchase or production, which is lower than replacement cost or net realizable values. The other assets and receivables are stated at realizable values and include accrued income and monetary and exchange variations when applicable, except for prepaid expenses which are stated at cost. 7

21 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated (c) Permanent assets These assets are stated at cost including restatements up to December 31, 1995, based on official indices, and take the following matters into consideration:. Investments in subsidiary and associated companies are recorded on the equity method of accounting;. Depreciation and amortization of property, plant and equipment is calculated principally on the straight-line method, in accordance with the expected useful lives mentioned in Note 9, and also on the tonnage produced/sold, based on studies made by the Company s technical area;. The accounts (i) industrial installations (buildings, machinery and equipment), (ii) slurry pipeline and systems, (iii) port and storage facilities, (iv) vessels and (v) vehicles include revaluations recorded in prior years, based on appraisal reports issued by independent appraisers (Note 9). (d) Current and long-term liabilities These are stated at their known or estimated amounts, including accrued charges and monetary and exchange variations on a daily pro rata basis, when applicable. (e) Foreign currency transactions The asset and liability foreign currency balances are translated into local currency (R$) at the exchange rate prevailing at the year end US$ 1.00 = R$ (2002 US$ 1.00 = R$ ). 3 Cash and Banks Cash and bank current accounts. Local 561 8,105. Abroad 25, ,820 Financial investments 1,149 27, ,925 8

22 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated 4 Trade Accounts Receivable The trade accounts receivable fall due in up to 90 days and are summarized below: Samarco Finance Ltd. 208, ,415 Other customers (mainly abroad) 31,000 20,798 Total 239, ,213 5 Value-Added Tax on Sales and Services (ICMS) Recoverable ICMS credits with the State of Minas Gerais amount to R$ 4,990 (2002 R$ 2,044), net of a provision for loss of R$ 555 (2002 R$ 197), based on a management estimate, which is recorded in Other operating expenses, net. During 2002, the Company reclassified the credits with the State of Espírito Santo to Longterm receivables. During 2003, Company management decided to increase the provision for loss on credits with the State of Espírito Santo by R$ 56,970, to total 100% of the credits. 6 Inventories Finished products 22,201 39,965 Work in process 24,987 21,975 Consumable goods and spare parts 33,635 29,383 Advances to suppliers 3,661 12,422 Other 2 84, ,747 9

23 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated 7 Other Accounts Receivable Current assets Advances to employees 2,857 2,002 Receivables from hydroelectric projects 1,954 Advances for tugboat services Receivables from leasing of port space Other 488 1,547 4,054 7,017 Long-term receivables COHESA (i) 11,728 10,631 Other ,769 10,666 (i) This amount represents accounts receivable from Cooperativa Habitacional dos Empregados da Samarco COHESA (the Company s employee housing corporative), in connection with the plan introduced by the Company on March 1, 1994 to sell company houses and plots of land to employees, financed over periods which vary between 6 and 12 years. Amounts are restated on the basis of the collective salary increases granted by the Company and will be received on termination of Plano Habitacional Samarco (PHS) (the Company s housing plan), that is, when the employees make final settlement on their financing contracts. 10

24 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated 8 Investments in Subsidiary and Associated Companies (a) Information on these investments may be summarized as follows: Usina Hidrelétrica Samarco Samarco Guilman- Finance Iron Ore Amorim S.A.(i) Limited Europe B.V. (ii) Total Number of shares (thousand) or quotas held: ,000 50,000 18, ,000 50,000 18,000 Holding - %: Capital: , , Net book equity: 2003 (38,448) (103) (718) 2002 (100,470) 1,736 1,449 Net income (loss) for the year: ,022 (549) (1,189) 2002 (91,032) (207) 1,387 Book balance of the investment: ,736 1,449 3,185 Equity in the earnings (loss): (207) 1,387 1,180 Provision for loss on investments (expense)/reversal: ,318 (1,839) (2,167) 27, (45,007) (45,007) (i) Information for 2003 as of November 30, (ii) Information for 2002 as of November 30, (b) (c) A provision to cover the net capital deficiency of the subsidiaries Samarco Finance Ltd. and Samarco Iron Ore Europe B.V. and of the associated company Usina Hidrelétrica Guilman- Amorim S.A., of R$ 20,182 at December 31, 2003 (2002 R$ 50,679), has been recorded in Long-term liabilities. The associated company Usina Hidrelétrica Guilman-Amorim S.A. has unrealized profits in transactions with the Company of R$ 521 at December 31, 2003 (2002 R$ 1,449). 11

25 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated 9 Property, Plant and Equipment Accumulated Depreciation depreciation/ rates Cos t Revaluation amortization Net Net (in years) Land 17,873 17,873 2,413 Mining property rights Right-of-way 1,578 1,578 1,578 Mineral rights 12,763 (5,160) 7,603 8, Other rights 685 (558) Industrial facilities (buildings, machinery and equipment) 1,121, ,290 (492,477) 1,080,343 1,063, to 43 Slurry pipeline and systems 293, ,423 (247,693) 287, , to 43 Furniture and fixtures 2,598 (937) 1,661 1,320 8 Vessels 1, (1,038) to 26 Vehicles 17,325 5,597 (17,490) 5,432 7,385 4 to 25 Construction in progress 43,907 43,907 64,081 1,513, ,431 (765,353) 1,446,381 1,448,192 (i) Based on appraisal reports issued by independent appraisers, the Company revalued certain groups of fixed assets in 1980, 1986, 1998 and 1999 and 2002, whose balances currently total R$ 50,862, R$ 14,371, R$ 326,584, R$ 270,573 and R$ 36,041, respectively. (ii) In 2003, independent experts issued an appraisal report for certain fixed asset groups which had been revalued four years previously, which presented a revaluation surplus of R$ 1,317 over book values of R$ 951,306. The Extraordinary General Meeting of shareholders held on October 22, 2003 determined that this excess over the revaluation already recorded need not to be booked. (iii) Construction in progress mainly refers to expenditures with the Slimes Drying Project, in the Germano facility, and in the Integra Project (related to the implementation of the R/3 SAP System). Management believes that these projects will be completed during

26 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated 10 Advances on Foreign Exchange Contracts Advances on foreign exchange contracts are mainly used to finance working capital. The advances mature between January and December 2004 and are subject to exchange variation and interest of between 2% to 5.6% per year (2002 from 3.6% to 9.5% per year). 11 Loans and Financings in Foreign Currency Expansion project ABN AMRO Bank 7,890 20,017 Export Development Corporation EDC 5,238 12,812 13,128 32,829 Import financing ABN AMRO Bank 10,575 WestLB Bank 3,817 5,559 Dresdner Bank 8,069 5,107 11,886 21,241 Prepayments of exports Banco BNP Paribas Brasil S.A. 48,152 70,666 Banco Itaú S.A. Europa 35,333 Dresdner Bank Lateinamerika AG 22,966 48, ,965 Usina Hidrelétrica de Muniz Freire (hydroelectric plant) International Finance Corporation IFC 27,256 49,113 Total 100, ,148 Current 62, ,874 Long-term 37, ,274 13

27 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated (a) The long-term amounts fall due as follows: , ,831 29, to ,632 27,677 37, ,274 (b) Financial charges Loans and financings accruing fixed rates are subject to exchange variation and annual average interest of 4.33% ( %). Those with variable rates are subject to exchange variation and annual average interest of LIBOR % (2002 LIBOR %). (c) Guarantees The loans are guaranteed by promissory notes, sureties from shareholders and securitization of exports. 12 Provision for Contingencies Management reviews the known contingencies and assesses the possibilities of loss, adjusting the provisions, as necessary. There are various civil, labor and tax (mainly income tax) contingencies for which management, based on the opinion of its internal and external legal advisors, has recorded a provision of R$ 88,062 at December 31, 2003 (2002 R$ 76,099). The Company is challenging in court the calculation basis of PIS and COFINS established by Law 9718/98. Based on the opinion of its legal advisors, management does not expect any loss on the outcome of this litigation. The amount involved is approximately R$ 65,000 (2002 R$ 35,000). 14

28 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated Also, there are other contingencies, mainly from tax assessment notices for alleged nonpayment of Social Contribution on Net Income (CSLL) and alleged underpayment of Financial Compensation for Mineral Resources Exploration (CFEM), amounting to approximately R$ 430,000 (2002 R$ 315,000), for which management, based on the opinion of its internal and external legal advisors, does not expect any loss on the outcome of these contingencies. 13 Taxes and Contributions (i) The Company has been contesting in the State of Minas Gerais whether the Value-Added Tax on Sales and Services (ICMS) is payable on semi-finished products, based on the interpretation of Complementary Law 65/91, of April 15, During 2003, the Company agreed with the State of Minas Gerais to withdraw the lawsuits related to this contingency and paid the amount of R$ 69,603, recorded in Other operating expenses, net. (ii) On May 28 and 29, 1998, the government of the State of Espírito Santo published Laws 5654/98 and 5655/98, which consolidated an agreement reached between the State and the Company to settle ICMS disputes. Law 5654/98 determined that the Company should contribute approximately R$ 9,000 for the renovation of Hospital São Lucas in Vitória and the paving of the ES-146 state highway between UBU and Jabaquara. These projects have been concluded. Law 5655/98 determined that the Company should pay R$ 4,500 in cash. The total disbursement was R$ 13,500, and the Company received permission to recover, in installments, R$ 13,600 of ICMS credits via transfers to its suppliers and related companies in the state of Espírito Santo as from the date of that agreement. During 2000, the offset of approximately R$ 52,000 of other credits was authorized. However, since the second quarter of 2001, the offsets were discontinued because they are no longer permitted by the State of Espírito Santo. As mentioned in Note 5, Company Management decided to increase the provision for loss on credits with the State of Espírito Santo by R$ 56,970 to total 100% of the credits. (iii) On July 26, 1999, the National Treasury filed a court-ordered collection against the Company due to supposed lack of payment of Social Contribution on Net Income (CSLL) related to calendar year 1992, which historical value total R$ 21,896 (principal, interest and fine). The Company was assessed on July 24, 2000 by inspectors of the Secretariat of Federal Revenue for allegedly not paying the CSLL in calendar years 1993 to The historical amount (principal, interest and fine) of this assessment is R$ 73,305 and fine of R$ 4,

29 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated On June 13, 2001, the National Treasury filed a new court-ordered collection against the Company due to supposed lack of payment of CSLL related to calendar year 1991, which historical value totals R$ 36,475 (principal, interest and fine). On December 6, 2001, the Company received another assessment notice for alleged nonpayment of CSLL, with a historical amount (principal, interest and fine) of R$ 18,998 and R$ 11,020 for fines for the period from January 2000 to August Management believes that its position of not having to pay this contribution will prevail, based on the opinion of its legal advisors and on a favorable final decision in a Declaratory action regarding the non-existence of a tax liability and its related rescissory actions, and therefore did not record a provision for loss of these assessments, which total R$ 166,689 at historical amounts (principal, interest and fine) and fines. (iv) On January 29, 2002, the Company was assessed by inspectors of the Third District of the National Department of Mineral Production (DNPM) for underpayment of the Financial Compensation for Exploration of Mineral Resources (CFEM), prescribed by article 20, paragraph 1 of the 1988 Federal Constitution, and established by Law 7990/89. This underpayment resulted in a liability of R$ 100,771, including legal surcharges. On March 18, 2003, the Municipality of Mariana Filed a suit against the Company for the collection of the differences related to supposed underpayment of CFEM, taking into consideration the same arguments used by DNPM in its process, in addition to covering the same assessment period mentioned above. Management, based on the opinion of its legal advisors, has not recorded any provision to cover possible loss on these claims since it does not expect an unfavorable outcome. (v) On September 4, 2002, the Company was assessed by the Secretariat of Finance of the State of Espírito Santo for allegedly having presented, during the period from January 1997 to December 2001, tax documents in an electronic format which was not in compliance with the standards prescribed by legislation. The historical amount of this assessment is R$ 633,458. Management, based on the opinion of its legal advisors, has not recorded any provision to cover possible loss on this claim since it does not expect an unfavorable outcome. 16

30 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated 14 Shareholders Equity (a) Capital Capital comprises 5,243,306 shares, of which 5,243,298 are common shares and 8 are preferred shares, with no par value. Each common share has the right to one vote at a Shareholders Meeting. Preferred shares are nonvoting, but have priority in the return of capital without premium upon dissolution of the Company, as well as a dividend 10% greater than that paid to the common shares. Capital is held as follows: Number of shares % of total Common Preferred capital Companhia Vale do Rio Doce 2,621, % BHP Billiton Brasil Ltda. 2,621, % 5,243, % (b) Dividends 25% of annual net income must be distributed as a dividend. The Board of Directors may authorize the distribution of an interim dividend from net income for the year, retained earnings or from revenue reserves, in conformity with article 204 of Law 6404/76. The Company, with the approval of the Board of Directors, may pay or credit interest on own capital under the terms of current legislation, the net amount of which will be considered as part of the compulsory dividend. The Board of Directors approved the distribution of prior year profits of R$ 134,405 (2002 R$ 72,933), together with the amount of R$ 85,626, which had been proposed by the Company at December 31, 2002 (2001 R$ 21,791). In addition, the Company paid interim dividends of R$ 234,

31 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated The dividends may be summarized as follows: Net income for the year 435, ,264 (-) Legal reserve (21,791) (9,013) Calculation basis 414, ,251 Minimum compulsory dividend - 25% 103,510 42,813 Dividends paid / proposed 234,432 85,626 As a percentage of the calculation basis 56.62% 50.00% (c) Revaluation reserve This reserve records the revaluations made by the Company in 2002 and in prior years. These reserves are transferred to retained earnings as the revalued assets are depreciated, sold or written off. (d) Retained profits reserve At December 31, 2003, management proposed a retention of profits of R$ 223,280 (2002 R$ 155,554) to cover future investments, in conformity with article 196 of the Brazilian Corporation Law, based on an investment budget to be approved by the Board of Directors. 15 Other Operating Expenses, Net These expenses refer mainly to the payment of contingencies relating to ICMS on semi-finished products (Note 13 (i)) and to the additional provision for loss on the accumulated ICMS credits in the State of Espírito Santo (Note 5). 18

32 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated 16 Income Tax (a) Deferred income tax On temporary additions.current assets 24,800 12,393.Long-term receivables 12,602 15,633. On revaluation reserve.long-term liabilities 92,366 97,100 The temporary additions refer mainly to the provision for loss on ICMS credits and for contingencies. (b) Income tax expense Profit before income tax 530, ,870 Additions (deductions):. Recording (adjustments) of operating provisions 22,188 18,758. Equity in the earnings or loss / provision for loss on investments (27,312) 43,827. Realization of revaluation reserve 27,260 24,503. Other 10,072 (14,615). Profit from fiscal incentive activities (527,145) (297,710) Calculation basis 35,581 8,633 Statutory rate 25% 25% Income tax liability (8,895) (2,158) Tax on the profit from fiscal incentive activities (rate of 18%) (94,886) (53,588) Tax on revaluation reserve 4,907 4,313 Other 4,185 (2,173) Total income tax expense (94,689) (53,606) 17 Benefits for Retired Employees 19

33 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated The following information is disclosed in accordance with paragraph 81 of Accounting Standard and Procedure (NPC) No. 26 of the Institute of Independent Auditors of Brazil (IBRACON), which was made mandatory through CVM Deliberation No. 371/2000, of December 13, (a) Accounting policy for the recognition of actuarial gains and losses At December 31, 2002 the Company obtained an actuarial report on the benefits offered to its employees upon retirement. The result of this study showed a deficit of R$ 1,578. The Company opted not to recognize this deficit in shareholders equity immediately, as permitted by CVM Instruction 371, and is amortizing the past service cost, calculated as of December 31, 2001, over five years as from (b) General description of the characteristics of the benefits to retired employees The actuarial report valued the retirement benefits taking into consideration the definitions included in the regulations relating to eligibility, benefit formulas and readjustment bases of the following plans: Private Pension Plan I of Employees and Managers, managed by Bradesco Previdência e Seguros S.A. Plan I comprises the following benefits: Time of contribution pension with a lump-sum redemption or annuity; Disability pension; Surviving spouse pension. 20

34 Notes to the Financial Statements at December 31, 2003 and 2002 All amounts in thousands of reais unless otherwise indicated ValiaPrev Benefits Plan, managed by Fundação Vale do Rio Doce de Seguridade Social The ValiaPrev plan comprises the following benefits: Normal retirement pension; Early retirement pension; Supplementary disability pension; Supplementary death benefit pension; Pension due to death; Deferred benefit from termination; Supplementary annual bonus; Income from annual bonus; Redemption. In addition, the actuarial report valued the supplementary pensions for disability, death and annual bonus, known as the Risk Plan. (c) Liability recognized in the balance sheet Based on the actuarial report at December 31, 2003, the Company has recorded in Other accounts payable, in current liabilities, the amount of R$ 2,803 (2002 R$1,578), of which R$ 1,419 related to Private Pension Plan I (2002 R$ 889) and R$ 1,384 to ValiaPrev Benefit Plan (2002 R$ 689). The corresponding expense was recorded in Other operating expenses. 21