Companhia de Saneamento Basico do Estado de Sao Paulo - SABESP (SBS) 2011 Q4 法說會逐字稿

Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to SABESP'S conference call to discuss its results for the fourth quarter of 2011. The audio for this conference is being broadcast simultaneously through the Internet at the website www.sabesp.com.br. At the same address, you can also find the slideshow presentation available for download.

We inform that all participants will only be able to listen to the conference during the Company's presentation. After the Company's remarks are over, there will be a Q&A period. At that time, further instructions will be given. (Operator instructions.) Please note this event is being recorded.

Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of SABESP'S management and on information currently available to the Company.

Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions, and other operating factors could also affect the future results of SABESP and could cause results to differ materially from those expressed in such forward-looking statements.

Today with us we have Mr. Rui Affonso, Chief Financial Officer and Investor Relations Officer, Mr. Mario Arruda Sampaio, Head of Capital Market and Investor Relations, and Ms. Nara Maria Marcondes Franca, Head of Accounting.

Now I'll turn the conference over to Mr. Arruda Sampaio. Sir, you may begin your conference.

Hello, everybody. Thank you for joining us for this fourth quarter. Actually, we're going to be more focusing on the year-end results. We have here a couple of slides to go through. Let's start by slide three.

Here we present the water and sewage billed volume, which was 3.1% higher than in 2010 with billed volume increasing across all consumption categories. This increase in billed volume was due to the increase of 2.5% in water connections and 3.6% in sewage connections, to the intensification of fraud prevention initiatives, and to the increase in the rate of replacement of water meters in the Sao Paulo metro region.

The loss ratio reassumed its downward trend, reaching 25.6% in December after a period of stability in 2010 due to reduced or discontinued maintenance initiatives caused by difficulties and delays in the bidding process related to the renewal of the maintenance costs, which affect our loss ratio reduction efforts.

We would like to let you know that the Corporate Program for Water Loss Reduction for the period between 2012 and '19 is being reviewed in such a way that the water loss goals for the coming years will be adjusted. The exact figures we are still under discussion -- are still under discussion and decision. Nonetheless, the priority and focus will be maintained, and this program continues to be of relevant importance to the Company's long-term strategy.

Now let's move to slide four where we will comment on our financial results. Net operating revenue increased by 7.6% in 2011. Note that this figure includes construction revenue, which recorded a 4.4% growth in the period.

On the other hand, gross operating revenue, which excludes construction revenue, moved up by 8.5%, being positively affected by the billed volume upturn of 2.6% for water and 3.6% for sewage and also by the tariff increase of 4.05% as of September 2010 and 6.83% as of September 2011.

Costs and expenses including construction costs totaled BRL7.5 billion, 14% above 2010. However, if we exclude construction costs, costs and expenses increased by 18.4%.

EBITDA remained flat at BRL3.2 billion between 2010 and 2011. The EBITDA margin came to 32.4% versus 34.9% in the previous year. When we exclude the effects of construction revenue and costs, EBITDA margin turns out to 41.1% in 2011 versus 44.7% in 2010.

If we, in addition to excluding construction revenue and costs, also exclude nonrecurring additional actuarial liability of BRL157 million, something that we will discuss later on, EBITDA margin for this year reaches 43.1%.

EBIT dropped 8.4% from BRL2.7 billion in 2010 to BRL2.4 billion in 2011, yet net income totaled BRL1.2 billion, 25% less than 2010, mostly due to the BRL448 million negative impact of the exchange rate variation on foreign denominated loans and financing as a result of the 12.6% appreciation of the dollar against the real in 2011 versus a 4.3% depreciation of the dollar over the real in 2010.

Now let's move to slide five. Let's present here the main variations in costs and expenses in relation to the previous year. Costs and expenses moved up by 14% over 2010. The main factors behind this extension were the increase of 47.7% in general expenses, 39.2% in depreciation and amortization, 28.8% in payroll and benefits, and 13% in treatment supplies.

On the other hand, we highlight the 48.3% decline in loan write-offs. The 48 -- sorry, the 47.7% increase in general expenses was due in great part to the provision of BRL162.1 million corresponding to 7.5% of the revenue obtained from providing sanitation services to the city of Sao Paulo, net of the Cofins and Pasep taxes that are transferred to the Municipal Sanitation and Infrastructure Fund, and, in accordance to what you already know, the Sao Paulo metropolitan service contract that we signed with the city and with the state of Sao Paulo.

Note that the provision -- note that the 7.5% provision in 2010 began at the third quarter of that year, while in 2011 it covered the whole year. Another factor that also fueled cost items in general expenses was the provision for legal contingencies.

Moving to depreciation and amortization expenses, as you can see they grew by 39.2%, mostly due to the amortization terms adjustments between the assets' useful life and the contract duration, whichever is the shortest one, something that will be recurring for the next quarter. But, let's highlight that, in this context for this period, the main variation and the main adjustment refers to the amortization of intangible assets related to the Sao Paulo metro region service contract with the city and the state governments.

Regarding payroll and benefits, the 28.8% increase was predominantly associated with additional actuarial liability. Note that a relevant part of these expenses are nonrecurring in the coming quarters, as is the case of the actuarial liabilities in the G0 plan, remembering that the G0 plan is a complementary retirement benefit for those employees that moved from previous state companies into SABESP, and it's ruled by law 4819. And this amounted to BRL157.5 million.

Another addition to costs was the migration of 22% of all employees from the defined benefit plan we call the Sabesprev Mais -- sorry, from the defined benefit plan, or let's call it our old plan, to the new plan called Sabesprev Mais, which is a defined contribution plan. That generated expenses of BRL60.8 million.

We also recorded a BRL22.4 million increase related to the penalties or fines that are applied to the employers due to employee dismissal. This is under the Government Severance Indemnity Fund, we call it here the FGTS, due to two reasons.

One was a higher number of layoffs this year, 2011, mainly as a result of the TAC, the Conduct Adjustment Agreement with the state prosecutor, which you are already familiar. For the record, just for the record, this last year we laid off 1,148 employees against 870 in 2010 and 1,900 in 2009 when we began this adjustment agreement.

The second reason for the increase is due to the new labor legislation that modifies the calculation of severance pay motivated by employer layoffs. Nonetheless, let's think about this. If we analyze exclusively payroll and benefits direct costs, we note a 12.9% expansion, in other words, a controlled and reasonable expansion.

The 13.3% growth in treatment supply was due to the replacement of aluminum sulfate by aluminum polychloride and the increase of chlorine consumption as a result of water source condition. Remember that water sources conditions are very sensitive to the type of chemicals that are applied during the production -- water production process.

On the other hand, loan rates declined by BRL112 million, or 48%, chiefly due to higher provisions in 2010 related to private customers totaling BRL34 million and to municipal public entities totaling BRL140 million, of which BRL54 million was related to the Sao Paulo municipal government. In other words, 2010 we had a greater provision base than in 2011. That is the reason for the difference of 11 -- BRL112 million, sorry.

Let's move now to slide six. We here present the main variations in the items that affected our net income. Net operating revenue varied positively by BRL697 million, or 7.6%, over 2010. Costs and expenses impacted negatively BRL920 million, representing an increase of 14%, a figure higher than the net operating revenue growth we just commented.

Other revenue and expenses presented a decline of BRL92.1 million, mainly due to provisions related to assets from past concession related to exactly -- to assets from past concessions with the city of Maua and also due to write-offs of obsolete assets.

Net financial revenues and expenses had a negative impact of BRL254 million on the results for the period. This variation was predominantly due to the negative exchange rate effect due to the 12.6% appreciation of the dollar in 2011 versus the 4.3% depreciation in 2007 (sic -- see press release). This variation generated an impact -- direct impact of BRL448 million in the expenses of 2011.

The increase in financial expenses related to the exchange rate variation was partly offset by a reduction of approximately BRL33.6 million in interest rate expenses on domestic loans and financing compared to 2010. This is due in great part to the amortization of the eighth and the ninth debentures issued in June and October 2011, respectively, as well as a reduction in financial expenses as a result of the lower need for interest provision on losses.

Financial revenue also supported -- financial revenue, sorry, moved up by BRL153.4 million, partly offsetting the negative effects of the exchange variation, all this thanks to the higher financial revenues obtained due to the higher cash availability.

Finally, income tax and social contributions fell by BRL164 million, mostly due to the exchange impact and partly mitigating the -- obviously partly mitigating the effects of this event, as we can see.

Let's move to slide seven. Let's talk about the debt. In February 2012, the Company issued for public distribution its 15th debenture in the amount of BRL771 million. This was made through two series and was placed with restricted placement efforts pursuant to the CVM Instruction 476.

The first series totaled BRL287 million. Interest paid was -- the interest offered was -- CDIs was 0.99% year with amortization occurring on years three, four, and five, while the second series totals BRL484 million with interest rates of EPCA inflation index plus 6.2% year with amortizations on years six and seven.

Important to note that the proceeds of this issuance were used to settle financial commitments already in 2012, more specifically to amortize a portion of the second series of the last debentures issuance totaling BRL202 million, this occurred in March, and especially the prepayment in February of the 13th debentures issuance totaling BRL600 million due in August 2012.

Also in February, the Company entered into a loan agreement with the Japan International Cooperation Agency, we call it JICA, in the amount of JPY33,584 billion, which is equivalent to approximately BRL710 million at the execution date, to support the second phase of the Corporate Program for Water Loss Reduction.

Investment in this phase of the program are estimated in a total BRL1.1 billion, BRL390 million of which represent SABESP's part in this project. The loan terms are the traditional 25 years with a seven-year grace period and an interest rate of 1.7% year in obviously yen exposure.

Note that in 2011 the Company amortized a total of BRL1.9 billion and raised funds in the amount of BRL1.7 billion. Obviously, these funds raised through capital markets and also through financing. At the same time, its cash position increased from BRL2 billion in 2010 to BRL2.1 billion in 2011, not to say that in the same period net debt to EBITDA ratio remained flat at 2.0 times.

In this context, I would like to highlight our debt profile. As you already know, the fact that SABESP is a mixed capital Company gives us access to financing from multilateral and official public entities in the international arena which offer special funding conditions such as the just mentioned JICA loans with 25 years, seven year grace periods, and very low rates, absolutely unparalleled in Brazil whether public or private funding.

Nonetheless, the cheap and long term international financing does impact our total currency exposure. Our fourth quarter and foreign denominated debt exposure corresponds to 36% of our total debt. But, as you can see on the slide, the maturity of the debt is very much spread out through time, so with very little amortization concentration. In fact, the greatest one being a BRL140 million Eurobond maturity four years ahead of us in 2016.

Let's move to the next slide and let's talk our last themes for this presentation on ARSESP. We would like to give you an update, a very quick update, on the development of the new tariff methodology that has been made public for discussion by the ARSESP, the State Sanitation and Energy Regulatory Agency.

As you already know then, in January ARSESP published its initial tariff methodology proposal for the first cycle and held three public hearings, the last one being in Sao Paulo a week ago. The main points addressed by ARSESP in these public hearings were the agency reiterated the published timetable and confirmed that it will perform the tariff revision by the end of August, although this has very recently changed, as you will see and we will comment further on.

ARSESP and SABESP will discuss the investment plan proposed before the tariff cycle, which will be included in the tariff proposal. ARSESP will perform an audit on the asset base. That is being studied by companies hired by SABESP. Part of the productivity gains will be passed on to customers. So, this a very, very summary of the highlights they made on their public hearing.

On the other side during the same -- during the hearing, SABESP was allowed to make its points and comments, some of which we would like to share with you such as the inclusion of provision for doubtful accounts in the tariff, something that was not clearly contemplated, a first tariff cycle that is longer than the proposed five years.

The Company also highlighted that our tariffs are already at the low end side when compared to tariffs from other state sanitation companies in Brazil, as you can see on slide eight. So, flip to eight and nine of this presentation.

As for the regulatory OpEx, considering the Company has been constantly cutting costs, as can be seen by the low tariff levels when compared to Brazilian peers, we recommend the regulator should consider our current OpEx, as he has already said he will consider as a starting point, but already at efficient levels.

We find necessary also greater flexibility for SABESP to request tariff revision any time and for any reason, and not to be capped by a specific event or trigger values. And last, we also reiterated that we are responsible for approximately 30% of the reinvestment in basic sanitation in Brazil last year.

We consider the public hearings to have been very favorable to the Company and the process as a whole. And we are optimistic on the methodology for our business.

To finalize, we would like to bring to your attention that ARSESP has just edited resolution 319 dated March 23 and published on March 24th, that was Saturday, in the public diary or newspaper known here as the D-O-E, DOE, a new timetable for the disclosure of the tariff methodology which modifies all dates of each of the original steps.

We highlight that the changes in the dates of SABESP presentation of its asset base moved from March 31st, 2012 to August 31st, 2012, and the publication of the final tariff revision and the initial tariff from August 30, 2012 to November 31, 2012.

In the next and the last slide, we present a summary of the timetable with the old -- now with the old dates on the left side and the new dates on the right side. And these are in bold to facilitate your comparison.

Well, that concludes our initial results, and now we would like to open for questions and answers. Thank you.

(Operator instructions.) Michael Gaugler of Brean Murray, Carret.

Good morning, everyone.

Morning, Michael.

Congrats on a nice quarter.

Thank you.

Your opening remarks and presentation answered a lot of the questions that I had coming into today's call. I guess I would swing first to the fourth quarter results. One thing I noticed, and you did a nice job on it on your overview on the annual results, but I noticed the fourth quarter cost of sales were higher than what would normally be anticipated. And I was wondering what was behind that.

Okay. Let me put on hold just for a second.

Take your time.

Michael, just coming back to your question, you asked specifically cost of sales or overall cost, SG&A?

Just the cost of sales line in the fourth quarter.

Okay. Michael, we're having a hard time finding the specific line you're asking. I apologize, but if you could be more specific it would help us.

That's fine, Mario. We can follow up after the call on it just to kind of make it briefer and easier.

The other question that I had, you mentioned in your remarks about reducing headcount on an annualized basis in 2011 and you gave the numbers of 2010 and for 2009 as well.

Yes.

When you look out into the future, I mean, you've really -- I mean, in the years that you've been at SABESP, headcount has been reduced rather dramatically. Is there a lot left in terms of the ability to reduce headcount, or are you looking -- when you look out to the future now, do you see it as you're pretty much at the staffing levels that you're going to need to run the business going forward?

I think -- Michael, let me just chat with Rui, because I think Rui might be the guy to make the point here.

Sure.

Just a second.

Michael, just to make sure I'm in the right track here with Rui, but I think what -- we're adding a lot of capacity for the next years and these years. So, I think what we can see is not further reduction, but us -- also not any significant increase as we move on in the years to come.

So, we're adding significant amounts of treatment facilities, a significant amount of network, and obviously network are more labor intensive than the facilities. But, we think we reach on a per employee level that is fairly reasonable.

We do find, obviously, that we can work some gains more related to how we structure and how our division is distributed and so forth. This has been an ongoing effort in here with not yet any major significant changes if we centralize or we do not centralize some of the activities, which could bring some SG&A benefit.

But, in terms of total headcount, I think the call is basically what Rui just guided us to tell you.

Okay. And then, one final question. I know that in the past the Company had been looking to expand outside the Sao Paulo region, had established some preliminary, I guess for lack of a better term, joint ventures in other areas of South America. And we haven't heard a whole lot about that in the recent calls. And I'm wondering do you see the Company expanding outside of the Sao Paulo metro region still, or are you pretty much focused now on the mandate to increase water and sewage coverage to the maximum in your existing geographic footprint?

I believe that the Company did its first introduction into different markets in a different way to understand a little bit of the game. The new administration is putting some pressure on us to propose something more structural and well driven in such that it does not deviate management time, and at the same time provides for us to take the opportunities that are out there and growing and so forth.

But nonetheless, I believe that, from the strategic planning exercise we went through here, the focus of this Company is to expand -- to accomplish its full sanitation program for the 363 municipalities we currently operate and look for opportunities that are close by metro region and Sao Paulo state, still Sao Paulo state. And all of this through some mechanism, again, that will give SABESP management focus and articulate in a better way as it moves forward.

So, in summary, we did not -- we are focused in what we do, but we are working hard to bring a structure that can help us support and be part of this expansion, whether first in the state of Sao Paulo or further on outside the state of Sao Paulo.

Okay. All right. Thank you, gentlemen. I'll -- that's my last question.

Okay. And we owe you the cost of sales. By the end, we might come back with something, okay?

Sure.

Okay. Thanks, Michael.

Thank you.

(Operator instructions.) Marcelo Sa of Bradesco.

Hi, everyone. Actually here is Vladimir Pinto. Marcelo had to leave the call.

My question is on the municipalities that buy water and some sewage service in bulk, how the situation of those who are not paying is evolving. Any definitions or any developments you'd like to share with us? Thank you very much.

Okay. Vladimir, give me just one second.

Vladimir, Mario back here. Let me give it this way. In general, we continue the procedure as usual. If we invoice the municipality, we already not even consider in our revenues the portion of what we historically know that they are not paying.

The balance of that we are going to justice. Legal proceedings, as you know, in Brazil take a long time. We have been winning some of these legal proceedings. These legal proceedings, to some extent, have led some of the municipalities to look after SABESP before negotiation.

We have basically one case that we are developing a negotiation. It's something public. It's public also in the sense that even the municipal council has passed a law approving the negotiation. We're talking about Diadema.

Diadema is the case where, at some time in the past, we operated the system. They took over the system on a one side decision. They assumed the assets. They have never paid back the assets to us. We are -- we went into litigation in this perspective, and actually we won. The other part is that they also have not been paying the full bill.

Where we are working with Diadema is an agreement where a new company will be established. And basically we will -- our part of the company will be paid through -- by the debt they owe us. I believe we will not have any cash outlaid in this acquisition of part of this company. Any case, this is, let's say, on the works and the positive side.

We also were in a discussion with the municipality of Maua, which is very much the same case. We, at some time in the past, operated the city of Maua assets. They took over. They have never indemnified us for the assets. We went to court. We have, to some extent, won in court.

But, then again, they did not accept to do any type of negotiation such as the Diadema. And given that, the payment for the value of the assets will be done through a new federal law that allows the municipality to pay in a very, very long, long term. It's called the [precatorios].

We consider that it's very, very little and very insignificant, the return of this value from the assets. So, we decided to provision. So, that is one of the reasons our bottom line was fairly hit during the period. The provision of BRL86 million obviously did not help the bottom line.

On all the other ones, we are just business as usual. We provide water, they pay part, and we go to court. That's how we're -- but, we are always trying to approach and see if we can find any type of arrangement that can eliminate this, recover the past, and establish a more, let's call, neutral future and positive future, okay?

Okay. May I do another question, please? On the sanitation front, do you have any news on the passing through this fee on the city of Sao Paulo to the tariffs in the town? Do you have any information you could give us, please?

Yes. The information I can give you is always the public information, which is made available by AESBE. The information we have and we interpret from ARSESP is -- basically was disclosed during exactly this methodology cycle. There is a part of the proposal that the AESBE will allow legal and contractual -- the pass-through of nonrelated operational fees. So, cost or transfers or whatever. There is a specific line that we can interpret that that is where the AESBE will fit the transfer to the tariff of the 7.5%.

As you can see, it is an interpretation. It's still fairly not clear. But, we believe that is where they will fit the pass-through, okay?

All right.

Basically you will get -- if you live in Sao Paulo, the idea is that you will get a water bill showing how much you -- what was your water consumption and how much you're paying for that, what is your sewage consumption, how much you're paying for that, and then specific line saying and outlining any specific contractual fee or any related transfer fund that is being passed to the end user according to any legal obligation established between the parties. And this is where potentially the 7.5% will be passed through.

All right. Thank you very much.

Okay. You're welcome.

Joao Pimentel of BTG Pactual.

Good morning, everyone. I have a question. Last night we saw the regulator release the new date for the tariff revision, and specifically it seems that the tariff revision that was expected to happen in August will now happen in November.

My question is, as SABESP tariff readjustment happens in September and the tariff revision will now happen in November, is it going to be the case that the tariff -- the new tariff, the new methodology, will only be implemented only in the next tariff revision in the next year, in 2013, because -- like as it happened with the distribution companies in the utility sector that we saw the postponement. As the tariff revision happened after the date of the tariff revision of that specific year, they were postponed to the next year.

So, my question is, is that going to happen with SABESP as well, or can we expect the tariff revision -- the original one that was supposed to happen in September to happen only November already with the new methodology?

Okay. We only know what you know in terms of what was put out recently by the regulator. So, our interpretation first is that what happened was a technical adjustment on the schedule. It's just a technical adjustment and it's very clear.

We are working on the asset base. It's a surmounting work. The regulator obviously has been following our work. And once we get it done, he has to do the same work. So, I think as much as it happened in other -- we think as much as it happened in other sectors, it is normal for technical adjustments in the timetable and the schedule.

So, I think that our statement is we do not consider this a postponement as we saw in the past. We see the regulator very much is doing a very strong effort to implement this tariff first review. So, we believe that the November date continues a very strong date.

Now, the second part, the question really is we do have in August announcement of September implementation of tariff adjustments to inflation where we use the parametric formula. And the thought was that if they were both going to occur at the same time, both being the tariff adjustment plus the revision, whatever the outcome of the revision, and the point is if you move the revision to November, what will happen to the August adjustment?

I think what we can only say is that we expect that the adjustment will be implemented based on the parametric formula in August. That is our expectation. And in November, the new tariff will be implemented over what was adjusted in August.

Now, specifically if that is going to happen or not, I think it's going to be definitely one of the questions we're potentially going to be -- formally make to the regulator. For the Company, we believe that no further postponements will happen other than the one just shown here.

Perfect. Thank you very much.

Okay.

(Operator instructions.)

Just one point. It's Mario again just to make sure that when I said tariff revision and the value of that, it can be always plus or minus. I did not want to make any statement that the tariff revision will necessarily generate a outcome above inflation, okay? So, that's it, just to make sure that I'm talking about the event and not the outcome of the event. Sorry to interrupt.

(Operator instructions.) Showing no further questions, I will now turn the conference back to SABESP for their final remarks.

Well, once more, thank you very much for your time and for your questions. We will hold the Portuguese conference later on today. So, for those of you interested, we invite you to participate. Along with the conference, we will also have a meeting with analysts here at the same time.

So, thank you and see you soon for the first quarter results. Good-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.