SBS

Business Context and Reporting Period

Company: Companhia de Saneamento Básico do Estado de São Paulo - SABESP (NYSE: SBS; Bovespa: SBSP3)

Reporting Period: First Quarter 2004 (ended March 31, 2004)

Business Overview: SABESP is the largest water and sewage utility in the Americas and the third largest globally by customer count. The company operates in the State of São Paulo, Brazil. Financial results are presented in Brazilian Reais (R$) in accordance with Brazilian corporate law.

Key Financial Metrics

Debt and Liquidity: Total indebtedness payable by the end of 2004 is R$ 883 million, with 26.5% denominated in US dollars. Total long-term liabilities stood at R$ 7.25 billion as of March 31, 2004.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 9.5% primarily due to an 18.95% tariff readjustment implemented in August 2003.
• Volume Decline: Water and sewage volumes billed to the retail market decreased 2.6% due to a consumer education campaign promoting rational water use amid low reservoir levels.
• Profitability Pressure: Net income dropped 32.8% despite revenue growth. This was driven by a 17.3% increase in operating costs and a significant rise in financial expenses.
• Cost Drivers:
  • Salaries: Increased 17.7% due to collective labor agreements and performance-based compensation plans.
  • Electric Power: Increased 28.7% due to higher consumption, tariff adjustments by ANEEL, and the Emergency Capacity Charge (ECE).
  • Credit Write-offs: Increased 63.2% (R$ 15.3 million) compared to 1Q03, which included a one-time recovery of credits.
• Financial Expenses: Decreased 17.1% due to lower domestic interest rates (CDI) and reduced foreign debt interest expenses resulting from the appreciation of the Real against the US dollar.
• Foreign Exchange: Monetary and foreign exchange variations increased by R$ 148.0 million due to the Real's appreciation in 1Q03 versus a slight devaluation in 1Q04.

Guidance, Outlook, and Risks

Operational Outlook: The company continues to expand services, with water connections increasing 5.0% and sewage connections increasing 6.3% year-over-year, aided by the acquisition of the São Bernardo do Campo network. Operating productivity rose 7.5%.

Funding and Capital Projects:

• FGTS Funding: SABESP requested R$ 714.2 million in funding for 40 new projects, with approval expected by the end of May 2004.
• BNDES Loan: Finalizing a R$ 300 million loan in H2 2004 for environmental recovery and water system projects.
• JBIC Loan: Concluded negotiations for a yen-denominated loan of approximately R$ 571.5 million for the Santos metro area Environmental Recovery Program. Contract signing is expected in June 2004, pending Senate approval of the federal guarantee.

Risks and Contingencies:

• Environmental Provisions: General expenses increased 33.9% largely due to provisions for environmental contingencies.
• Regulatory Approval: The JBIC financing is contingent upon the approval of the federal guarantee by the Brazilian Senate and National Treasury.
• Forward-Looking Statements: Management notes that future results depend on economic conditions, industry trends, and operating factors, with no guarantee that expectations will be met.

Investor Verification Checklist

• Volume vs. Tariff Mix: Verify the sustainability of revenue growth given the 2.6% decline in water volumes and reliance on prior tariff adjustments.
• Cost Inflation: Monitor the trajectory of electric power costs and salary increases, which are structural cost drivers.
• Debt Maturity: Review the R$ 883 million debt due in 2004 and the refinancing status of international obligations.
• Regulatory Approvals: Confirm the status of the Senate approval for the JBIC loan guarantee and the FGTS funding allocation.
• Credit Quality: Assess the trend in credit write-offs, noting the volatility caused by one-time recoveries in the prior year.