SBS

Business Context and Reporting Period

Company: Companhia de Saneamento Básico do Estado de São Paulo - SABESP (NYSE: SBS; Bovespa: SBSP3)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third Quarter 2008 (ended September 30, 2008)
Announcement Date: November 19, 2008
Currency: Brazilian Reais (R$)

SABESP is one of the world's largest water and sewage service providers. The filing details financial results for 3Q08 and the first nine months of 2008 (9M08), comparing them to the same periods in 2007.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net operating revenue increased 6.8% in 3Q08, driven by tariff adjustments (4.1% in Sept 2007, 5.1% in Sept 2008) and a 2.5% growth in billed water and sewage volume.
• Profitability Decline: Net income fell 39.5% to R$ 231.1 million. EBITDA decreased 4.8% and EBIT dropped 6.9%.
• Cost Inflation: Costs and expenses rose 15.4% to R$ 1.056 billion. Key drivers included:
  • Services: Increased 59.6% due to expanded collection contracts, advertising campaigns, and maintenance.
  • General Expenses: Surged 86.9% due to re-rating of lawsuits from "possible" to "probable" following unfavorable court rulings.
  • Treatment Supplies: Rose 23.9% due to algae proliferation in the Guarapiranga Reservoir requiring more chemicals.
• Financial Expenses: Net financial expenses increased 25.3% to R$ 162.2 million, primarily due to a R$ 51.6 million increase in interest on lawsuit indemnities.
• Foreign Exchange Impact: A significant R$ 247.7 million gain on liabilities occurred due to the 20.2% appreciation of the US Dollar against the Real, partially offset by asset variations.
• Non-Operating Result: Recorded a negative result of R$ 120.6 million, largely due to a fixed asset write-off related to the settlement of the Third Amendment to the GESP Agreement.

Guidance, Outlook, and Risks

• Debt Management: In early November 2008, SABESP concluded its 9th issue of simple debentures totaling R$ 220 million (R$ 100m at CDI + 2.75% and R$ 120m at IPCA + 12.87%).
• Operational Outlook: The company continues to expand services, with water connections up 2.5% and sewage connections up 3.2% year-over-year. Water losses decreased to 28.3% from 30.3%.
• Risks and Contingencies:
  • Legal: Significant provisions for contingencies (R$ 370.9 million current, R$ 668.6 million long-term) due to lawsuits. Changes in lawsuit probability ratings materially impact general expenses and financial interest.
  • Operational: Algae proliferation in reservoirs increases chemical treatment costs.
  • Forward-Looking Statements: Management notes that future results depend on economic conditions, industry trends, and regulatory factors. There is no guarantee that expected results will occur.

Investor Verification Checklist

• Legal Provisions: Verify the magnitude and probability of the lawsuits driving the 86.9% increase in general expenses and the associated interest charges.
• FX Exposure: Assess the impact of the US Dollar appreciation on future debt servicing costs given the R$ 1.5 billion USD-denominated debt balance.
• Cost Sustainability: Determine if the 59.6% increase in "Services" expenses is recurring (e.g., collection contracts, advertising) or one-time.
• Asset Write-offs: Review the details of the R$ 139.7 million fixed asset write-off related to the GESP Agreement settlement.
• Debt Schedule: Review the debt amortization schedule, noting significant maturities in 2009 (R$ 1.34 billion) and 2010 (R$ 901.6 million).