SBS

Business Context and Reporting Period

Company: Companhia de Saneamento Básico do Estado de São Paulo (SABESP)
Filing Type: Form 6-K (ITR - Quarterly Information Form)
Reporting Period: Quarter ended March 31, 2014
Business Overview: SABESP is a mixed-capital company controlled by the São Paulo State Government, providing water and sewage services in 364 municipalities within the state. Operations are primarily based on 30-year concession, program, and service contracts. The company is listed on BM&FBOVESPA (SBSP3) and the NYSE (SBS).

Key Financial Metrics (Q1 2014 vs. Q1 2013)

Material Changes and Performance Drivers

• Revenue Growth: Net operating revenue increased 5.6% driven by a 5.2% increase in billed volume (4.9% water, 5.5% sewage) and a 5.3% average tariff adjustment effect. Construction revenue also rose 7.2% due to higher investments.
• Profitability Pressure: Despite revenue growth, Net Income declined 3.7%. This was primarily due to a 33.3% increase in depreciation and amortization (R$ 65.0 million) resulting from the capitalization of new intangible assets, and a R$ 57.8 million increase in other operating expenses.
• Expense Variations:
  • Services: Increased 37.6% (R$ 86.0 million), largely due to a R$ 41.4 million reversal of a provision related to a prior agreement with the São Paulo Municipal Government and R$ 13.0 million in legal services for the Diadema municipality resumption.
  • Payroll: Increased 7.6% due to wage adjustments and pension plan provisions.
  • General Expenses: Decreased 29.1% due to lower provisions for lawsuits.
• Financial Result: Net financial result remained stable at R$ 27.5 million. Foreign exchange gains on loans decreased due to lower depreciation of the Japanese Yen against the Real, partially offset by higher US Dollar depreciation.

Outlook, Risks, and Contingencies

• Water Scarcity: The company faces a critical water shortage in the Cantareira System. SABESP implemented a consumption reduction incentive program (30% discount for 20% reduction) and restricted outflow from the system. Management noted that if reservoir levels do not improve, more drastic measures may be required, potentially increasing costs.
• Tariff Revision: ARSESP approved a 5.44% tariff repositioning index effective May 11, 2014. However, due to the water crisis, SABESP's Board resolved to postpone the application of this index to a date no later than December 2014 to ensure market stability.
• Legal and Contractual Risks:
  • Concession Expirations: 55 concession agreements had expired and were under negotiation as of March 31, 2014, representing 16.84% of gross revenue. Management expects renewal but acknowledges the risk of discontinuity.
  • EMAE Dispute: Ongoing negotiations with EMAE regarding the use of Guarapiranga and Billings reservoirs. No agreement was executed as of the filing date, posing a risk to service continuity and cost structure.
  • Diadema: A new 30-year agreement was signed in March 2014 to resume operations, resolving prior judicial settlements.
• Foreign Exchange Risk: Significant exposure to USD and JPY denominated debt (R$ 3.7 billion). A 10% depreciation of the Real could impact pre-tax results by approximately R$ 372.5 million.

Key Facts for Investor Verification

• Dividend Policy: Interest on Shareholders' Equity of R$ 0.78633 per share was approved for payment. The Annual Shareholders' Meeting approved a capital increase via capitalization of reserves.
• Capital Expenditure: Significant investments in intangible assets (R$ 510.4 million cash outflow) and the commencement of the São Lourenço Production System (R$ 6.0 billion PPP project) are underway.
• Non-Revenue Water: The loss ratio decreased to 24.1% in Q1 2014 from 25.5% in Q1 2013, indicating progress in the Corporate Program for Water Loss Reduction.
• Regulatory Environment: Monitor the implementation date of the tariff repositioning index and the status of the water consumption reduction program, as these directly impact near-term revenue recognition.