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Companhia de Saneamento Basico do Estado de Sao Paulo-SABESP (NYSE: SBS ) Q1 2016 Earnings Conference Call May 17, 2016 9:30 AM ET Executives Mário Arruda Sampaio – Head-Capital Market and Investor Relations Analysts Henrique Peretti – J.P. Morgan Operator 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 First Quarter of 2016. The audio for this conference is being broadcast simultaneously through the Internet on the website, www.sabesp.com.br. At that same address, you can also find the slideshow presentation available for download. We would like to inform you that all participants will be only 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] 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. Mário Arruda Sampaio, Head of Capital Market and Investor Relations; and Mr. Marcelo Miyagui, Head of Accounting. Now, I’ll turn the conference over to Mr. Arruda Sampaio. Sir, you may begin your conference. Mário Arruda Sampaio Okay, thank you and good morning everybody. This is one more first quarter here at 2016 conference call. We have nine slides in front of us and as usual afterwards we will have a question-and-answer session. So let’s get started on Slide 3, here we show the company’s billed volume and then sewage volume, which was up by 1.9% in the first quarter of 2016 with an increase of 1% in water and 3% in sewage compared to the first quarter of 2015. Thanks to a greater water availability, which has allowed us to increase the volume distributed to our consumers this was the first quarter since the beginning of the crisis in the early 2014 in which we have recorded an increase in billed volume. It is important to bear in mind that since January 2016 we have not been using water from the technical reserve and the water pressure reduction in the distribution network has been limited to nine time period as was the case before the crisis. The Company is producing more water to be distributed to consumers and we are authorized now to move up to 23 cubic meters per second from the Cantareira systems since February as opposed to the 13 to 15 cubic meters per second we were authorized to withdraw in most of the period the greatest periods in months of 2015. As a result of the increased water availability we also increased water production volume by 8.8%. Now moving to slide 4, quickly over the financial results net operating revenue increased 22.7% over the same period last year, it produced 15.2% tariff increase since June 2015. The lower granting of bonus with an impact of 153.8 million in the first quarter of 2016 versus 211.2 million in first quarter 2015. The application of contingency tariff in the amount of 160 million in the first quarter this year against 79.3 in first quarter 2015 and a 1.9% up turn in total build volume and 1% of which is water and 3% is sewage as mentioned in the previous slide. Municipalities commercial and constructions costs increased 76.3% in the period adjusted and that totaled 907 million against 1.35 billion recorded last quarter. While the adjusted EBITDA margin came to 30% this quarter against 55% last years the same first quarter. If we exclude the effects of construction revenue in cost the adjusted EBIDA margin was 37.2% this quarter against 71.6 in 2015 first quarter. Net income totaled 628.8 million against 318.2 million first quarter 2105. Let’s move on to Slide 5. Let’s go through quickly the main variations in costs in relation to the same period last year. In comparison with the first quarter of 2015, there was a 76.3% increase in construction costs and expenses. We exclude the construction costs, cost expenses climbed by 127.4%. However, if we exclude the effects of the non-recurring GESP, it’s our agreement with the state of São Paulo that we made last quarter, and the reimbursement of R$696 million, costs and expenses increased 16.7%. The main items that influenced this upturn were the increase of 312% in general expenses, 51% in electricity, 18.6% in the allowance for doubtful accounts, and 7.4% in payroll, benefits and social security obligations. Again for more detail in all these costs variations, please refer to our earnings and any doubt, as usual, call us. Let’s go to Slide 6. Here, we represent again quickly the main variations year-over-year in the items that affected our net income, which again totaled R$628.8 million. Net operating revenue increased R$559.2 million, or 22.7%. Costs and expenses, including construction costs, increased R$1.41 billion, or 76.3%. Other operating revenue and expenses had a negative variation of R$25.6 million. Net financial expenses monetary restatement and foreign exchange variations had a positive variation of 1.3 billion, mostly due in great – almost all due to the depreciation of the dollar and the Yen against the Real in first quarter that is the dollar reduced 8.9% and the Yen 2.4%. All this compared within the appreciation in the first quarter of 2015 [Audio Disturbance] 20.8% for the dollar and 20.3% for the Yen. Finally, income tax and social contribution increased R$507.7 million, due to the increase in taxable income recorded in the first quarter 2016, when compared with the tax loss recorded in first quarter last year. Now let’s move on to Slide 7 and Slide 8. Here we will go through a brief update on rainfall and water inflow in the Cantareira System. On Slide 7 we can observe that after rainfall and water inflow inline with expected average for the rain period in the Cantareira system which ended in March, it was a very dry with very low rainfall. Now let’s move to Slide 8 and here we can see that in April despite this lower rainfall the Cantareira system recorded an average water inflow again which is the water that flows into the reservoir that will be built reservoir capacity and this was a 24.1 cubic meters per second volume that is below the historical average was a period was higher than the one absorbed last year in the year before that during the big crisis period. Going overall to the talking about the reservoir conditions when we compared with 2015 and 2014, as we have already mentioned during the rainy period which began in October last year and then end at March this year rainfall and water inflow return to the expected average was a period allowing the recovery of the reservoirs. Remember that we have the collaboration of the population in saving water and that reacts to that measures we’ve taken to manage water supply and demand, it merges you were just carried out by the company the water network pressure management to reduce water losses and again the return to rainfall is expected to on average was a period has allowed us to end April with a start volume of 1.34 billion liters of water compared with 589 billion liters in April 2015 and in these both cases we included that clinical reserve and 556 billion liters in it compared to April 2014 but in this case we do not include the technical reserve. Now again due to the investments undertaking to extract water from the technical reserve in 2016 the company has 545 billion liters more than 2015 and 578 billion liters more than 2014 obviously this figure last its prior to the technical reserve, our ability to tap technical reserve. Now again just a beginning of the bonus program in February 2014 to the end of April there was a savings of 332 billion liters of water, this is the amount of the water we saved, to give you an idea of what this represents this is equivalent to almost two Guarapiranga reservoirs and the amounts saved is sufficient to supply to entire population for the São Paulo metro region for approximately 100 days. Now from April to September, as you probably know, first the dry period and it was period of expected lower and less bulky rainfall. Remember also that along with the dry period there was a reduction in temperature and hence a reduction in the volume of water used by people. This is very important to set expectations for the upcoming month. Well then in some reservoirs received water during the rainy period in excess of demand, and the actual amount is unused during the drought. Remember, it’s very important to remember that. And then considering that the reservoir levels at the end of March, the beginning of the dry period, even with a very low rainfall in April as previously commented, it does not alter the decision taken by the company so far, especially concerning dam of the contingency tariff on this program and they increase in production and supply of trees and water. Now let’s move to Slide 10. Here we can see the evolution of water production in the metro region of São Paulo from the beginning of the water crisis in February 14 all the way to April 16. The increase in production since October 15 until now is reported by the recovery of the reservoirs and very much driven by two factors. The first factor is the authorization to increase water withdraw from the Cantareira system, again, which went from close to 14 cubic meters to 19 cubic meters in January this year and now 23 cubic meters since February. Second is the completion of the interconnection of the building’s reservoir to the Alto Tietê system which we have been commenting, which enabled the transfer of 4 cubic meters per second from back to the reservoir. Note, there’s greater water availability in the Alto Tietê system, increases the water security of this system consequently for the entire metro region. And so though the necessary works carried out by the company in the years of 2014 and 2015 resulted in 6.5 cubic meters of more water available for treatment. Furthermore, as already mentioned in previous calls, the Sao Lourenço water system with 31.9% of the work already carried out, is scheduled for completion in late 2017. Remember that this system is totally new and increase of the bulk water availability and treatment capacity for the metro region São Paulo at 6 cubic meters per second. Again, also on the construction, the Jaguari and Atibainha reservoir interconnection project will add an average of 5.13 cubic meters per second of bulk water availability to the metro region of São Paulo through the Cantareira system. In this case the construction has begun. It’s already on work since February this year and should be ready by 2017. So, in total, in the period of 2015 to 2017, there will be an expansion in the water availability and security of close to 21 cubic meters per second and an increase in production of 7.4 cubic meters per second. Just to put in perspective prior to the crisis, we have an approximately 75 cubit meters of both water availability and close to 70 cubic meters of water production capacity. So this is a very big leap in a very short-term, increasing substantially our water security for the metro region. So, in summary, our active management of water supply and demand in the region, the greater availability and increased water security and the average and favorable rainy seasons 2015-16 are all very positive factors that allow us to say that we are today in a better conjuncture and structural situation than last year and with a greater certainty to face the balance of this year and next year. Let’s go to our last slide. We will comment here on the tariff adjustment and the cancellation of the bonus program and the contingency tariff. As you probably know, on March 31, ARSESP accepted our request for the cancelation of the bonus program and the contingency tariffs for the bills metered as of May 1. This progress was made in light of the improved water conditions combined with the conclusion and the advanced progress of works to increase water security, which allows us for greater predictability of water source conditions and water security levels in the metro regions of São Paulo. This inception in February 2015 until the end of March 2016 as well this program resulted in a reduction of revenues in the period of R$1.456 billion. This reduction was partially offset by an additional revenue of R$660 million obtained with the implementation of the contingency tariff. So in net terms, during the application period, the bonus program and the contingency tariffs had a negative effect on revenues of R$796 million. As we move forward, we will not see that. So considering this, the cancellation of these two measures, especially the bonus program and with its incentive to reduce consumption, the effects of this reduction in billed volume and average price given that a lower consumption leads to a lower tariff rate no longer will occur suggesting a recovery of revenue in the coming quarters. On April 11, in line with the regulatory agenda, so we are exactly on time and moving on the regulatory agenda assessed public resolution 643 which authorized us to apply a tariff increase of 8.4478% as of May 12. This index comes from the inflation index implementation of 9.3864 estimated based on the EPCA variation from March 15 to March 16 and it excludes the productivity factor of 0.9386%, considering our consumption of – our consumption reading cycles and the procedures we have to go through. Please take note that the full impact of this tariff adjustment and the bonus cancelation will be observed only fully in the second half of 2016 were precisely as of August. The full impact of this adjustment as you can see we will see a better as we move on. So finally these are our remarks, now we will open for questions. Question-and-Answer Session Operator [Operator Instructions] It appears there are no questions now I will turn the conference back over to SABESP for their final remarks. Pardon me, sir. We do have one question from Henrique Peretti with J.P. Morgan. Please go ahead. Henrique Peretti Hi, Arruda, thanks for the opportunity. I would like to understand why billed volumes increased only 1.9% if water production volumes increased 8.8% in the quarter, where is the gap here? Mário Arruda Sampaio Okay – Henrique, this is Mário. The reason they don’t match is that we have the take-or-pay range of zero to ten cubic meters. So if people consumed that we still tried the same thing. So that is the difference. So people are probably moving within that range, consuming more within that range, but not sufficient to trigger aggressively a change in category. So to the great extent the take-or-pay from zero to ten cubic meters is what causes this effect, okay. Henrique Peretti Okay thank you. Operator As there are no further this concludes our question-and-answer session. I’ll turn the conference back over to SABESP for their final remarks. Mário Arruda Sampaio Okay guys first let me just make a quick correction on my speech here. The bonus cancellation in the continuous direct cancellations will have immediate effect on revenues as of May 1. Okay different than I said it will be differed, if it’s not differed, it’s immediate, they only differ full effect if the tariff increase. So okay, made that correction thank you very much for your participation. So let’s comeback next quarter. Hopefully good news also. Thank you very much. Bye-bye. Operator The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. 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